Compulsory Redemption in Limited Liability Companies – Legal Framework and Valuation

Mandatory redemption represents a unique mechanism in Norwegian corporate law that provides majority and minority shareholders with mutual redemption rights under certain circumstances. This form of redemption differs significantly from other redemption provisions as it does not require breach, breach-like situations, or statutory provisions. The article highlights the central legal frameworks for mandatory redemption and the principal questions related to valuation.

Legal Basis for Mandatory Redemption

The Norwegian Companies Act § 4-26 and the Public Limited Companies Act § 4-25 constitute the central legal basis for mandatory redemption. The provisions provide a mutual redemption right:

1. A shareholder with more than nine-tenths of the share capital and votes in the company can redeem the minority shareholders

2. Each of the minority shareholders has a corresponding right to be redeemed by the majority shareholder

This mutual redemption right can be invoked at any time, setting it apart from preemptive rights that can only be asserted when the share changes ownership. The mandatory redemption rules in the Companies Act § 4-26 and the Public Limited Companies Act § 4-25 are identical in substance but have different applications:

• The Companies Act § 4-26 applies when the parent company is a private limited liability company

• The Public Limited Companies Act § 4-25 applies when the parent or subsidiary is a public limited company

Scope of Application

In contrast to ordinary redemption rules, which are primarily relevant in companies with limited share distribution, the mandatory redemption rules are particularly practical in:

• Larger private limited liability companies

• Public limited companies

• Group relationships

This is due to the rules presuming a concentration of shares where one shareholder holds more than 90 percent of both the share capital and votes.

Rationale for Mandatory Redemption Rules

The rules on mandatory redemption are justified by the need for freedom of action, but with different considerations for majority and minority shareholders:

Majority's Redemption Right

The majority's redemption right is justified by the practical challenges a dominant shareholder may have with a small minority. This may include:

• Need for full control over the company

• Desire to remove administrative costs associated with having minority shareholders

• Simplify decision-making and company structure

Minority's Redemption Right

The minority's redemption right is justified by the particularly strong position the majority shareholder has when controlling over 90 percent of the company. The minority may need to:

• Exit a situation with very limited influence

• Realize the value of the shares when liquidity is low

• Protect against potential abuse by the majority

Procedure for Mandatory Redemption

The mandatory redemption rules in the Companies Act § 4-26 and the Public Limited Companies Act § 4-25 require the parent company to make an offer for a redemption sum. If the offer is not accepted or the parties do not achieve an amicable resolution, the question of compensation shall be determined by appraisal.

The process can be outlined schematically as follows:

1. Decision on mandatory redemption

2. Proposal of redemption sum

3. Negotiations on redemption sum

4. In case of disagreement: Appraisal

5. Possible appeal of the appraisal

Valuation in Mandatory Redemption

The most contentious issue in mandatory redemption concerns the valuation of shares. The Companies Act and the Public Limited Companies Act do not contain explicit provisions on valuation principles in mandatory redemption.

Principles for Valuation

The Supreme Court in the Norway Seafoods decision (Rt. 2003 p. 713) established that the redemption sum in mandatory redemption should correspond to the shares' "real value," which is the same criterion applied in other redemption provisions of the law.

The following principles have been established in case law:

1. The shares' "real value" should be calculated based on the underlying values in the company

2. All shares of the same class have the same value

3. The assessment should relate to the time when the decision on mandatory redemption was made

4. The valuation method must be determined specifically in each case

Theoretical Discussion: Market Price vs. Underlying Values

A key question is whether the valuation should be based on:

1. Market price: The price the market sets for the share

2. Company's underlying values: An economic assessment of the company's values

The Supreme Court concluded in the Norway Seafoods decision that the underlying values should be decisive. This also applies in cases where there is a difference between the market price of the shares and the company's underlying values.

Premium and Discount

In the market, discrepancies between share price and underlying values can occur:

• Premium: When the market value is higher than the underlying values

• Discount: When the market value is lower than the underlying values

The Supreme Court's decision means that minority shareholders in a mandatory redemption have a claim to their proportion of the company's full underlying values, regardless of whether there is a discount in the market.

Squeeze-out Situations vs. Takeover Situations

Mandatory redemption can occur in various situations:

1. Squeeze-out: Situations where the majority has controlled the company over time

2. Takeover: Situations where a buyer has recently taken control

In the Borgarting Court of Appeal decision reported in RG 2007 p. 769, it was established that the underlying values are decisive also in takeover situations, with reference to the Supreme Court in the Norway Seafoods decision, presuming that every mandatory redemption must be characterized as a squeeze-out.

Conclusion

Mandatory redemption represents a unique mechanism in the corporate law that balances the concern for the majority's management rights with the minority's need for protection. Case law has established that minority shareholders have a claim to the shares' "real value" based on the company's underlying values, regardless of the market price. This principle ensures that the minority gets its full share of the company's values during mandatory redemption.

For both majority shareholders and minority shareholders, it is important to be aware of these valuation principles when mandatory redemption is considered or implemented. The appraisal court will apply these principles to determine the redemption sum in dispute situations.