Virtually all unlisted companies' articles of association include provisions that restrict the transfer of the company's shares. Often, any shareholder proposing to transfer shares must offer them first to the other shareholders or to the directors or to persons nominated by the directors. Commonly, transfers to a share-holder's own family are excluded from such restrictions.

In such pre-emption provisions the price, or the means of fixing the price, at which the shares in question must be offered has to be determined - by the auditor, in probably a majority of such cases.

There are numerous variations in such provisions. The simplest is where it is provided that the shares must be offered at a price to be fixed by the auditors. A frequent variation on this is a provision that the proposing transferor is required to state the price he seeks and, if the directors agree it, that price is used. Only if it is not agreed is the auditor required to make a valuation.

In some articles, it is provided that the price is to be fixed by a valuer to be agreed by the parties or, in the absence of agreement, to be nominated by an independent third party, eg, the president of a professional body.

There are many pitfalls for the unwary in making such valuations. The basis of valuation will vary according to the actual words used in the relevant provisions in the articles concerned. Contrary to popular belief, few auditors have much knowledge or experience of the relevant valuation law and practice. Since it will usually be the case that the transferor shareholder is bound by the valuation and, in the absence of fraud or mistake, cannot get it amended, his or her only remedy, if dissatisfied with the valuation, is to make a claim against the valuer for negligence.

Exemption from the audit

However, my purpose here is not to discuss such technicalities but to draw attention to a potential problem that arises from the removal of the statutory audit requirement for smaller companies by s 249A, Companies Act 1985. If a company has taken advantage of this exemption, it will not have appointed an auditor. What then would be the position if pre-emption provisions in its articles, which require valuation by the auditor, are invoked?

Clearly the proposing transferor and the other shareholders could agree to waive the articles' provisions and appoint a valuer. Frequently, however, the pre-emption provisions will have been invoked where there has been dissension between the proposing transferor and the directors and other shareholders. In such a case the directors would probably be advised that an auditor would have to be appointed. Moreover, it would almost certainly be desirable that, once appointed, the auditor should remain in office until after the next agm and should report on the accounts laid before that meeting. If the auditor appointed to do the valuation were in fact to resign immediately after it and did not perform an auditor's full duties, a transferor who was dissatisfied with the valuation might well have grounds for challenging it on the grounds that the auditor's appointment was a sham. In effect, therefore, the company would have to meet the cost of not only the valuation but also the full audit of at least the next accounts.

So companies that take advantage of the exemption from audit under s 249A and whose articles contain pre-emption provisions requiring the auditor to value shares for the purposes of those provisions should be advised to amend them.

It might be provided that such valuations should be made by an expert agreed by the proposing transferor and the directors or, in the absence of agreement, by a valuer nominated by, perhaps, the Council of the Society of Share and Business Valuers.

Even in cases where the exemptions under s 249A are not available or are not being used, such an amendment to pre-emption provisions could be considered. Proposing transferors frequently feel that the auditors are too involved with the directors to be truly independent. Indeed, auditors often ask my own firm to advise on such valuations, because they feel themselves that they are too closely involved with the directors to be perceived to be independent.

Professional ethics

In many cases the auditor may feel that he does not have the necessary knowledge and experience needed to carry out the valuation. If he is a chartered accountant, he will have it in mind that one of the fundamental principles laid down in the Guide to Professional Ethics is that a member should not accept or perform work that he or she is not competent to undertake unless he obtains such advice and assistance as will enable him to do the work competently. In addition to the ethical factor there is the practical one of the potential danger to the auditor's professional indemnity cover.

Caveat auditor!

Bruce Sutherland CBE FCA FTII is a partner in Bruce Sutherland & Co, share valuation specialists (tel: 01608 651091, email:

[email protected]), and is chairman of the Society of Share and Business Valuers, which has as members most of the recognised experts in this field in the UK. It maintains a record of each member's areas of expertise so that it can make suitable nominations in cases referred to it.