The Importance of Business Valuations in Chapter 11 Bankruptcy Proceedings
The intent of Chapter 11 Bankruptcy reorganization is to allow relief to the debtor in possession while the business attempts to continue operating under court supervision.
Once the petition for bankruptcy is filed, the court issues an automatic stay to prevent creditors from foreclosing on assets or taking legal action against the debtor.
The valuation can assist the courts when deciding whether the creditors can lift the stay or the debtor can obtain financing to continue operations.
A valuation expert assists the courts in determining the facts of the case, and can enter the proceedings at any stage of the initiation process.
Of course, any valuation must be prepared in accordance with applicable bankruptcy law and procedure, as well as meet the accepted methodologies and approaches while continuing to remain impartial.
Though many experienced valuators shy from the court setting, their expertise and assistance to the courts can significantly affect the proceedings by informing the bankruptcy judge, debtor in possession (DIP), the committee of unsecured creditors and/or equity-holders, as well as secured creditors of the value under various assumptions: liquidation of its assets, going concern or combination of both.
In order for a petition to be confirmed by the courts, the plan of reorganization must meet certain tests that are legally fair and equitable.
Chapter 11 is not exclusive of reorganization, and the Code implicitly recognizes that in some cases, value may be maximized through some combination of reorganization and liquidation.
A business may be worth more if sold in whole as a going concern, and valuation experts can calculate its fair market value during the confirmation phase.
The courts need to know if the business can satisfy its creditors within various scenarios of risk and the "going concern" sale is a popular trend.
A debtor in possession's plan must maximize the value of the assets as well as save the residual estate of the pre-bankruptcy owners.
The complexity of bankruptcy law involves tension between these two concepts of going concern and asset liquidation.
On one side is the efforts to maximize the value of assets and the other is to save the residual stake of the pre-bankruptcy owners.
Saving the going concern means continuing to operate the business which means continuing to incur risk.
Creditors are typically risk adverse.
However, if the business is liquidated today, the creditors get nothing; if the business continues they may get something, but the creditors bear the risk of loss.
Continuing a business has inherent risk: company-specific risk, risk of changes in the economy and interest rates, all of which must be factored into the decision during the confirmation stage of bankruptcy.
The professional valuation provides a tool to the courts to analyze from experienced and impartial analysis the underlying value based on these different assumptions, risks and standards of value.
Motions by secured creditors to lift the stay seek to foreclose on the assets of the company.
The creditors can seek relief by demonstrating "cause, including lack of adequate protection.
" The judge has the discretion and can rely on the valuation to seek the details of equity standing of the business.
The actual condition of the business is not usually as simple as it appears based upon the financial statements and tax returns filed with the courts.
The definition of value is the first and foremost issue at the inception of the bankruptcy process.
"Value" can mean different things to different parties: fair market value, market value, fair value, true value, investment value, intrinsic value, fundamental value, insurance value, book value, use value, collateral value and so on.
There are income, asset and market-based methods of business valuation.
The premise of value utilized in the valuation process assumes either a "going concern" or "liquidation" of the subject.
The Bankruptcy court utilizes the outcomes of these different assumptions-based approaches to make its determination.
At the beginning of the bankruptcy, a valuation may determine whether the creditor can lift the automatic stay and if the debtor can use cash collateral or obtain DIP financing.
At the confirmation stage, the valuation can assist in the tiers of debtor's capital ownership structure.
Chapter 11 allows the debtors to attempt to preserve the business while working out the debt repayments.
Preserving the business can yield a greater return to the creditors than selling off the business assets in a liquidation.
It is difficult to determine whether the business can rebuild successfully and steps taken during the valuation can bring forth details regarding the management team, estimated future income stream and market conditions.
Many factors relating to the condition of the business are analyzed for purposes of the valuation; trends in the industry, competition and other companies in the same or similar industry.
In addition, any contingent liabilities are searched for and considered for the likelihood of occurring and their effect on value.
The process will also search and value unrecorded assets of the business such as intangibles and intellectual property including copyrights and trademarks.
In re Exide Technologies, 303 B.
R.
48 (Bankr.
D.
Del.
2003) Chapter 11 case illustrates the importance of valuation at confirmation, and provides guidance on valuations in this context.
The details of the Exide case, capital tiers, obligations and reorganization plan were complex, which made the computation of value even more critical.
There were significant differences of opinion between the valuations prepared by the debtor versus those done by the creditors.
In the end, the court favored the Committee's valuation.
In each valuation the same three methods were utilized: Comparable Company Analysis, Transaction Analysis and Discounted Cash Flow.
The experts differed in the underlying data and multiples used in applying these methods.
The court sided with the adjustments that took a forward-looking approach and addressed the "taint" of the bankruptcy on the company's worth, while avoiding subjective adjustments to get to a "market" value based upon historical performance exclusive of the bankruptcy.
Confirmation is not the end of the bankruptcy process as much as all parties would like to think.
Distributions to creditors can come under challenge with claims of fraudulent transfers and inappropriate preference payments.
Transfers by the DIP for "less than reasonable equivalent value" under 548(a)(1)(B) or constructive fraud will have to defend those claims relevant to the value.
Preferential payments or transfers made within 90 days before the bankruptcy or determination of insolvency can be challenged by the creditors as well.
A valuation expert should be engaged as early as the confirmation phase by all parties in the case of a Chapter 11 filing as the expert is often able to influence the court's decisions based upon supported and accepted methodologies.
This is better for parties, assisting in securing a "win-win" situation.
Once the petition for bankruptcy is filed, the court issues an automatic stay to prevent creditors from foreclosing on assets or taking legal action against the debtor.
The valuation can assist the courts when deciding whether the creditors can lift the stay or the debtor can obtain financing to continue operations.
A valuation expert assists the courts in determining the facts of the case, and can enter the proceedings at any stage of the initiation process.
Of course, any valuation must be prepared in accordance with applicable bankruptcy law and procedure, as well as meet the accepted methodologies and approaches while continuing to remain impartial.
Though many experienced valuators shy from the court setting, their expertise and assistance to the courts can significantly affect the proceedings by informing the bankruptcy judge, debtor in possession (DIP), the committee of unsecured creditors and/or equity-holders, as well as secured creditors of the value under various assumptions: liquidation of its assets, going concern or combination of both.
In order for a petition to be confirmed by the courts, the plan of reorganization must meet certain tests that are legally fair and equitable.
Chapter 11 is not exclusive of reorganization, and the Code implicitly recognizes that in some cases, value may be maximized through some combination of reorganization and liquidation.
A business may be worth more if sold in whole as a going concern, and valuation experts can calculate its fair market value during the confirmation phase.
The courts need to know if the business can satisfy its creditors within various scenarios of risk and the "going concern" sale is a popular trend.
A debtor in possession's plan must maximize the value of the assets as well as save the residual estate of the pre-bankruptcy owners.
The complexity of bankruptcy law involves tension between these two concepts of going concern and asset liquidation.
On one side is the efforts to maximize the value of assets and the other is to save the residual stake of the pre-bankruptcy owners.
Saving the going concern means continuing to operate the business which means continuing to incur risk.
Creditors are typically risk adverse.
However, if the business is liquidated today, the creditors get nothing; if the business continues they may get something, but the creditors bear the risk of loss.
Continuing a business has inherent risk: company-specific risk, risk of changes in the economy and interest rates, all of which must be factored into the decision during the confirmation stage of bankruptcy.
The professional valuation provides a tool to the courts to analyze from experienced and impartial analysis the underlying value based on these different assumptions, risks and standards of value.
Motions by secured creditors to lift the stay seek to foreclose on the assets of the company.
The creditors can seek relief by demonstrating "cause, including lack of adequate protection.
" The judge has the discretion and can rely on the valuation to seek the details of equity standing of the business.
The actual condition of the business is not usually as simple as it appears based upon the financial statements and tax returns filed with the courts.
The definition of value is the first and foremost issue at the inception of the bankruptcy process.
"Value" can mean different things to different parties: fair market value, market value, fair value, true value, investment value, intrinsic value, fundamental value, insurance value, book value, use value, collateral value and so on.
There are income, asset and market-based methods of business valuation.
The premise of value utilized in the valuation process assumes either a "going concern" or "liquidation" of the subject.
The Bankruptcy court utilizes the outcomes of these different assumptions-based approaches to make its determination.
At the beginning of the bankruptcy, a valuation may determine whether the creditor can lift the automatic stay and if the debtor can use cash collateral or obtain DIP financing.
At the confirmation stage, the valuation can assist in the tiers of debtor's capital ownership structure.
Chapter 11 allows the debtors to attempt to preserve the business while working out the debt repayments.
Preserving the business can yield a greater return to the creditors than selling off the business assets in a liquidation.
It is difficult to determine whether the business can rebuild successfully and steps taken during the valuation can bring forth details regarding the management team, estimated future income stream and market conditions.
Many factors relating to the condition of the business are analyzed for purposes of the valuation; trends in the industry, competition and other companies in the same or similar industry.
In addition, any contingent liabilities are searched for and considered for the likelihood of occurring and their effect on value.
The process will also search and value unrecorded assets of the business such as intangibles and intellectual property including copyrights and trademarks.
In re Exide Technologies, 303 B.
R.
48 (Bankr.
D.
Del.
2003) Chapter 11 case illustrates the importance of valuation at confirmation, and provides guidance on valuations in this context.
The details of the Exide case, capital tiers, obligations and reorganization plan were complex, which made the computation of value even more critical.
There were significant differences of opinion between the valuations prepared by the debtor versus those done by the creditors.
In the end, the court favored the Committee's valuation.
In each valuation the same three methods were utilized: Comparable Company Analysis, Transaction Analysis and Discounted Cash Flow.
The experts differed in the underlying data and multiples used in applying these methods.
The court sided with the adjustments that took a forward-looking approach and addressed the "taint" of the bankruptcy on the company's worth, while avoiding subjective adjustments to get to a "market" value based upon historical performance exclusive of the bankruptcy.
Confirmation is not the end of the bankruptcy process as much as all parties would like to think.
Distributions to creditors can come under challenge with claims of fraudulent transfers and inappropriate preference payments.
Transfers by the DIP for "less than reasonable equivalent value" under 548(a)(1)(B) or constructive fraud will have to defend those claims relevant to the value.
Preferential payments or transfers made within 90 days before the bankruptcy or determination of insolvency can be challenged by the creditors as well.
A valuation expert should be engaged as early as the confirmation phase by all parties in the case of a Chapter 11 filing as the expert is often able to influence the court's decisions based upon supported and accepted methodologies.
This is better for parties, assisting in securing a "win-win" situation.
