One of the primary business restructuring goals is the adjustment of a company’s burdensome obligations. If a business is going to be reorganized, matching a company’s obligations to its value is key to the rehabilitation and “fresh start” concepts that underpin the Bankruptcy Code. Determining that value is where concepts of valuation come into play, and the need for a valuation of a debtor’s business or assets arises at various points in the lifecycle of a restructuring: determining whether to sell or retain assets; considering adequate protection; in the grant of priming liens for a financing; whether postpetition interest is allowable; and in the plan confirmation process, among other situations.
Bankruptcy courts are the arbiters of the value of a debtor’s assets at first instance. So-called “judicial valuation” to determine the value of a debtor’s business or assets rests on evidence presented by parties-in-interest in the case, their respective experts, and any experts appointed by the court to testify on valuation issues. To the extent bankruptcy judges require expert testimony to assist the court in reaching a decision, existing law (section 105 of the Bankruptcy Code and the Federal Rules of Evidence) already gives the court the power to do so.
While a number of different valuation methodologies exist, the Bankruptcy Code doesn’t mandate which approach parties and their experts should use. The three main approaches to valuation in restructuring situations are:
- The cost/asset based approach, which assumes that the value of a business is equivalent to the net worth of its assets (various related methodologies exist to measure the value of those assets);
- The market approach, whereby the value of a business can be measured by comparing key financial metrics to similarly situated companies or assets (comparable company analysis), or by looking at sales of similar businesses or assets (prudent transaction analysis); and
- The income approach, which considers that the value of a business or assets match the future cash flows accruing to its owner (discounted cash flow analysis).
The choice of valuation approach will typically result in a different valuation being assigned to a company or business, as the ABI Report describes:
[T]he valuation of an enterprise . . . is an exercise in educated guesswork. At worst it is not much more than crystal ball gazing. There are too many variables, too many moving pieces in the calculation of value . . . for the court to have great confidence that the result of the process will prove accurate in the future. Moreover, the court is constrained by the need to defer to experts and, in proper circumstances, to Debtors’ management.
While valuation litigation can be time-consuming and expensive, two wrongs apparently make a right: the uncertainty that a judicial valuation process creates encourages parties to negotiate a consensual resolution. Despite the inherent uncertainty involved in the valuation processes occurring during a bankruptcy and reorganization process, the ABI Commission concluded that no change to existing law was recommended, though courts were encouraged to use their own experts where helpful. The inherent flexibility that the judicial valuation approach gives to parties to select the most appropriate valuation methodology given the profile of a debtor’s business or assets underpins is utility, and led the ABI Commission to its conclusion: if it ain’t broke, don’t fix it.
In re Mirant Corp., 334 B.R. 800, 848 (Bankr. N.D. Tex. 2005); American Bankruptcy Institute Commission To Study The Reform of Chapter 11 Final Report and Recommendations, p. 182.