Recent Developments Reshape the Use of Qualified
Case law and rule
changes highlight the dynamic and fluid environment with respect to valuation
With bankruptcy and other forms of litigation
becoming increasingly complex, recent cases demonstrate how expert business
valuation professionals can help attorneys protect their clients from becoming
subject to increasingly aggressive legal tactics. The recent Hennings Feed & Crop Care
bankruptcy case (C.D. Ill., 2007) serves as one example.
The debtor, Hennings,
was an agricultural chemicals dealer who sold to a number of end-users,
including other dealers, at a discount. The transactions were otherwise
“arms-length,” but because the third-party dealers paid a price that was less
than Henning’s cost, as calculated by the trustee’s expert, the trustee claimed
they were fraudulent transfers.
In Illinois, the look-back period (i.e., the time
during which a trustee may “look back” to recover actual and constructive
fraudulent transfers) is four years. Thus, the Hennings trustee sought to
recover the difference between the debtor’s cost and what the dealers paid for
purchases during the four years preceding the bankruptcy.
Based on the expert evidence, the court found for
the trustee, and the unsuspecting dealers were liable for millions of dollars of
improper discounts in below-cost purchases that occurred over the four years. As
harsh as that seems, the dealers may have caught a break; if the trustee had
been able to prove that an actual (rather than constructive)
fraudulent transfer took place, the dealers might have been required to pay the
total value of all purchases during the four years.
A look-back provision can pose other threats. For
example, when an over-leveraged buyer acquires a business that ultimately seeks
bankruptcy protection, the selling shareholders may be exposed to claims of
fraudulent transfer. For a certain number of years after the sale – depending on
the look-back period of the particular state – if and when the business becomes
insolvent, an aggressive bankruptcy trustee could force the shareholders to pay
back the proceeds of the sale. Remarkably, this could happen even if, at the
time of the sale, the business was profitable, there was no debt on the balance
sheet, and the owners sold it in good faith to an unrelated party in an
Solvency opinion. Considering the risk, it
may be wise for the seller to engage a business valuation expert to render a
solvency opinion at the time of the transaction, or later, at the time of any
bankruptcy filing. A solvency opinion essentially states that:
As the boundaries of bankruptcy law continue to
change, accredited business valuation experts can continue to assist attorneys
by identifying and compiling evidence for fraudulent transfer claims and/or
trying to predict where the other side might find grounds for the same.
New SEC Rule 2290 Raises the Bar on Fairness
The Securities Exchange Commission recently
approved amendments to Rule 2290, which addresses the disclosures and procedures
related to the issuance of “independent” fairness opinions. Originally proposed
by NASD (the National Association of Securities Dealers, which has since
reincorporated as the Financial Industry Regulatory Authority [FINRA]), the
stated objectives of the new rule are to provide greater clarity to investors
and to simplify compliance. Factors such as Sarbanes-Oxley, shareholder
lawsuits, and state investigations helped encourage SEC approval, and the new
rule has put fairness opinions under heightened scrutiny.
Corporate boards and executives often seek fairness
opinions in sales and/or acquisitions to provide a legal “safe harbor” for the
financial aspects of the transactions. The opinion provides a public statement
that the consideration in the proposed transaction is fair from the
shareholders’ perspective. Too often, however, critics and the courts have
complained that fairness opinions are nothing but rubber-stamped endorsements of
corporate deals rendered by the investment bankers, who could have a conflict of
interest. With the advent of Rule 2290, those days may be ending.
Notably, the new rule recognizes that the real
issue with fairness opinions was not so much their flawed analysis but, rather,
their procedural limitations. For instance, a provider may have had too little
time to make the proper analysis or received wrong information. Because fairness
opinions are subject to public disclosure, third parties can sometimes use them
in unintended ways or to draw incorrect conclusions. A fairness opinion is some
evidence of fair dealing and fiduciary compliance, but it is never an
attestation of the “best price” or a substitute for good business judgment.
The new disclosure requirements in Rule 2290 should
help shareholders as well as boards of directors make better-informed decisions.
In addition to disclosing the parties’ additional roles in the transaction,
opinions must now disclose any material relationships during the two years prior
and any contingent compensation. Management-supplied information must receive
independent verification, and a fairness committee must approve the overall
New procedural requirements relate largely to the
selection and qualification of the fairness committee members and the process by
which they will conduct a balanced, independent review. This includes the
selection of appropriate valuation methods, because, while a fairness opinion is
not a formal valuation, it should include at its core a credible valuation.
Opinion providers should start documenting their analysis right from the start
of the engagement and be prepared for disclosure in every deal.
Credentials, Experience, Methods
An area of increasing legal challenge goes directly
to the qualification of an expert to testify in business valuation.
As a recent case –
Rosvold v. LSM Systems
Engineering, Inc., 2007 U.S. Dist. LEXIS 82061 (November 6, 2007) –
demonstrates, a graduate degree from one of the top business schools in the
country may not be enough to qualify an expert to testify in business valuation.
To support his breach of contract claim, the plaintiff in this case proposed a
well-educated business executive to testify regarding the value of a 6%
corporate interest. In a pre-trial Daubert hearing, the U.S. District Court
(E.D. Michigan) assessed the expert’s level of “knowledge, skill, experience,
training, or education” under Rule 702 of the Federal Rules of Evidence.
Defense counsel successfully challenged the
would-be expert’s qualifications, prompting the Court to rule:
“Other than his personal
experience of ‘acquiring several companies’ and having earned his … master’s
degree from the Wharton School of Business at the University of Pennsylvania
…, [the expert’s] résumé fails to incorporate any professional experience in
Further, the Court found that the expert was not
enrolled or active in any of the “recognized organizations or institutions that
establish the standards or rules to which their members must adhere when
preparing a business valuation.”
While not dispositive, the expert acknowledged that
this was the first time he’d been asked to provide testimony in litigation. He
also admitted that he had not written any articles or books relating to the
challenged subject matter. Perhaps most damaging, the methodology the expert
used in his report was not clear, and the Court excluded his testimony under
Rule 702 for failing to be “the product of reliable principles and methods.”