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VALUATION IN THE CONTEXT OF A FRAUDLUENT TRANSFER OR PREFERENCE ATTACK Part of the VALUATION 2015 Series Premier Date: October 9, 2015. MEET THE FACULTY. PANELISTS Richard Claywell Business Valuation. MODERATOR Gary Frantzen , Alvarez & Marsal.
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VALUATION IN THE CONTEXT OF A FRAUDLUENT TRANSFER OR PREFERENCE ATTACK Part of the VALUATION 2015 Series Premier Date: October 9, 2015
MEET THE FACULTY PANELISTS Richard Claywell Business Valuation MODERATOR Gary Frantzen, Alvarez & Marsal
Practical and entertaining education for business owners and executives, Accredited Investors, and their legal and financial advisors. For more information, visit www.financialpoisewebinars.com DISCLAIMER: THE MATERIAL IN THIS PRESENTATION IS FOR INFORMATIONAL PURPOSES ONLY. IT SHOULD NOT BE CONSIDERED LEGAL ADVICE. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS
ABOUT THIS SERIES Valuation is used by financial market participants to determine the price they are willing to pay or receive to effect a sale of a business or an asset. The same valuation tools are often used by valuation experts to resolve disputes related to estate and gift taxation, divorce litigation, corporate disputes, allocate business purchase price among business assets, estimate the value of ownership interests for buy-sell agreements, shareholder disputes or estate planning as well as many other business and legal purposes. Attorneys often work with valuation experts.
ABOUT THIS EPISODE Bankruptcy trustees, debtors, and liquidating trusts often file claims against former shareholders/executives for alleged fraudulent transfers or attempt to block transfers before they happen. These issues revolve around the value of the debtor’s assets and whether the debtor was solvent and/or adequately capitalized. This webinar will help attorneys understand how experts determine retrospective solvency and asset values.
EPISODES IN THIS SERIES EPISODE #1 Valuing a Business For a Sale 2/6/15 EPISODE #2 Valuing Lost Profits for Litigation Purposes 3/6/15 EPISODE #3 How to Select the Right Valuation Expert 7/10/15 EPISODE #4 How to Value Your Brand and Other “Soft” Assets 9/25/15 EPISODE #5 Valuation in the Context of Fraudulent Transfer or Preference Attack 10/9/15 EPISODE #6 Valuing Real Estate11/6/15 (Dates below are premier dates; all webinars also available on demand)
The Legal Context of Insolvency and Avoidance Actions • A debtor or its duly-empowered successor (e.g., chapter 7 trustee, chapter 11 trustee, liquidation trustee pursuant to a plan) is able to enlarge the estate with cash recovered from certain recipients of transfers from the debtor by what are collectively called “avoidance actions” • Avoidance actions are causes of action under the Code and the Code combined with state law, by which the transfer is “avoided” and the property that had been transferred (usually money) recovered by the debtor or trustee for the benefit of all creditors of the estate. The defeated transferee usually gets an unsecured claim for the amount avoided and recovered. • Avoidance actions include actions to avoid and recover preferential transfers and actions to recover fraudulent transfers.
Avoidance and Recovery of Preferential Transfers – 11 U.S.C § 547(b), (f), and (g). • Debtor or trustee may avoid and recover transfers of debtor’s property made within the 90 days immediately preceding the filing of the petition for bankruptcy (within one year if transferee was an insider). • Elements the debtor or trustee must prove to avoid the transfer: • Transfers were made to or for the benefit of a creditor, on account of antecedent debt. • The debtor was insolvent at the time of the transfer. • Transfers enabled the creditor to receive more than it would in a liquidation. • The Code adds a presumption that the debtor was insolvent during the 90 day period. • If transferee successfully rebuts the presumption and proves debtor’s solvency at the date of transfers, then the transfer is not an avoidable preference.
Definition of Insolvency – 11 U.S.C. § 101(5), (12), and (32). • “Financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation.” • Fair valuation of all property. • Stated sum of all debts (not necessarily fair valuation). • “Debts” are defined based on the Code’s extremely expansive definition of “claim,” so that, for measuring insolvency, debts include (among other things) contingent and unliquidated claims against the debtor. • “Property” of the debtor is anything that is “property” under applicable state law. • “Fair valuation” is not defined in the Code.
Avoidance and Recovery of Constructive Fraudulent Transfers – 11 U.S.C § 548(a). • Debtor/trustee can avoid and recover intentionally fraudulent transfers that were made by the debtor within two years prior to the beginning of the bankruptcy case without proving insolvency. • Debtor/trustee can avoid and recover constructive fraudulent transfers that were made by the debtor within two years prior to the beginning of the bankruptcy case by proving that the debtor did not receive “reasonably equivalent value” [a valuation battle we do not focus on here] for the transfer, and that the transfer either: • was made while the debtor was insolvent or made the debtor insolvent, or • left the debtor with unreasonably small capital, or • was made with debtor’s intent or belief that it would incur debts beyond debtor’s ability to pay them. • The debtor or trustee usually try to prove insolvency at the time of the transfer, but there are other proof options.
Avoidance and Recovery of Fraudulent Transfers - State Law • Bankruptcy Code allows the debtor/trustee to “stand in the shoes” of an unsecured creditor • Debtor/Trustee can sue transferees of property from the debtor • Debtor/Trustee can avoid and recover such transfers as fraudulent transfers under state law. • Most states have adopted the Uniform Fraudulent Transfer Act. • Provisions do not differ in important ways from section 548 of the Code. • UFTA adds a presumption of insolvency if the debtor is generally not paying its debts as they become due. • Proving the debtor’s insolvency at the time of the transfer can still be the linchpin of an avoidance action. • The “look-back” period generally exceeds two-years under state laws.
The Balance Sheet Test • Factors considered in the analysis: • Economy, industry and business environment • Historical and projected financial performance • Comparative company and transaction analyses • Present value of expected future benefits - discounted cash flow analysis • Investment risk for underlying business – required rate of return • Liabilities and claims against the company • Non-operating assets and value of identified contingent liabilities • Frequently Used – easy to understand. • If Company fails the balance sheet test, it is insolvent by definition and there may be no reason to conduct more tests...depending on the evidence.
Valuation Parameters • Valuation Approaches and Methods • Standard of value • Premise of value • Valuation date
Valuation Approaches and Methods • Cost approach: • Cumulative value of assets based on replacement cost of each asset adjusted for utility/age. • Useful for investment holding companies, REITs, etc. • Applicable when cumulative liquidation value of the assets is greater than going concern value. • Market approach: • Comparable uncontrolled transactions method – market multiples based on observed transactions for similar investments. • Comparable public company method – market multiples based on price quotes for similar investments in public companies. • Income approach: • Income capitalization – single period “normalized” benefit divided by capitalization rate. NOTE: this method is the same as the use of a market multiple. • Discounted cash flow analysis – This method is favored by the bankruptcy courts.
Standard of Value • The definition of value being utilized for a valuation. • Bankruptcy court requires a “fair valuation” but does not define the term. • Primary standards of value • Fair market value/arm’s length standard – US tax and certain state law. • Fair value – For state legal matters, the term may be defined by statute or case law in the particular jurisdiction. Differs from state to state. • Fair value US GAAP – financial reporting/accounting. • Investment value (i.e., strategic value) – “the value to a particular investor based on individual investment requirements and expectations.” Used in decision making. The same asset may have vastly different values under different standards of value
Premise of Value • Operational Premise: • Going concern (value in-use) - Assumes continued future use of the assets as a group. • Liquidation (value in-exchange) – Assumes sale of assets piece-meal • Orderly (sold over reasonable period of time). • Forced (time-constrained - similar to auction; i.e., “fire sale”). • Valuation Premise: • Value in-exchange – the value of an asset or business interest assuming it will be changing hands in a real or hypothetical sale. • Value to the holder – the value of an asset or business interest assuming it is not being sold but instead is being maintained in its present form by its present owners. • In the context of solvency, the bankruptcy courts have generally held that an operational premise of going concern is appropriate rather than liquidation, but have been relatively silent on the valuation premise.
Valuation Date • All valuations only represent a snapshot in time and are performed as of a specific date to be clearly identified for the user. • In the context of fraudulent conveyances, the valuation date is generally the date of the transfer. The value of the same asset can change from one date to another
Adequate Capital Test • The Adequate Capital test is intended to analyze a company’s robustness to the general economic uncertainty that all businesses face. • Given its capital structure, how far below projected performance can it fall and remain viable/solvent? • How sensitive is the company’s value/solvency to external factors that impact the business? • What if it takes longer to achieve certain assumed changes in the business? • What is the cushion of value above the company’s debt? • How does the company’s leverage, liquidity and other characteristics compare to the industry and its competition based on key ratios? • How likely is it that the company will violate its debt covenants?
Cash Flow Test • Analyze the company’s ability to generate free cash flow to meet obligations to its creditors when they come due: • Net Annual Cash Flow from Operations. • Borrowing capacity. • Other sources of capital. • Project monthly, quarterly and/or annual cash required to operate the business - i.e. pay debts as they come due • Adequate debt capacity to finance temporary shortfalls. • Ability to repay or refinance all debt at maturity. • Financial flexibility. • Allows an evaluation of the company’s capital adequacy and financial flexibility, which might include cash from operations, additional borrowings, reduced capital expenditures, asset sales, or a combination thereof.
Adequate Protection – Use of Cash Collateral • Cash collateral is “cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest ….” 11 U.S.C. § 363(a). • The trustee must provide “adequate protection” of the value of the secured creditor’s interest in its collateral in order to use the cash collateral. 11 U.S.C. § 363(e). • The trustee has the burden of proof on the adequacy of any proposed protection of the secured creditor’s interest. 11 U.S.C. § 363(p)(1).
Adequate Protection – Relief From Stay • A secured creditor may obtain relief from the stay to allow it to foreclose “for cause, including the lack of adequate protection of an interest in property….” 11 U.S.C. § 362(d)(1). • The trustee has the burden of proof regarding whether the secured creditor’s interest is adequately protected, although the secured creditor has the burden of proof on the issue of whether the debtor has any equity in the property. 11 U.S.C. § 362(g).
Adequate Protection • A party with an interest in the debtor’s property is entitled to have the value of that interest adequately protected during the course of the bankruptcy case. • Example: a secured creditor with a security interest in the debtor’s property • Demonstrating that the party’s interest in the debtor’s property is adequately protected may require valuation of that property.
Plan Feasibility • Key – Financial Projections • Adequate Assurance – Is Cash Flow Positive? • Best Interest of Creditors: Burden of Proof - Better result than a liquidation of assets? • Appraisal of Non-Cash Collateral is usually needed. • Experienced expert hired to give an opinion on • Fair Market Value and/or Liquidation Value • Depreciation rate • Equipment (or collateral) depreciation or diminution in value is considered with secured lenders in determining adequate assurance.
MORE ABOUT THE FACULTY GARY FRANTZEN gfrantzen@alvarezandmarsal.com Gary Frantzen leads Alvarez & Marsal's Valuation Services practice in Chicago. He specializes in the valuation of businesses and business interests including equity, liabilities and debt securities, options and other derivative securities / instruments, intellectual property and other tangible and intangible assets. Mr. Frantzen has provided opinions of value, fairness and solvency for a wide variety of purposes including financial reporting, tax planning and reporting, dispute resolution, mergers and acquisitions and other business purposes.He has advised clients regarding the value impact of potential strategic alternatives, business plans and enterprise transactions; valued assets for business combinations, fresh start accounting and impairment measurement; valued business interests for tax planning and reporting, and has provided independent fairness and solvency opinions regarding contemplated transactions. Mr. Frantzen earned a bachelor's degree in civil engineering from the University of Illinois at Urbana-Champaign and master's degree in business administration from DePaul University in Chicago. He is a Chartered Financial Analyst (CFA) and registered as a General Securities Representative and Securities Agent (FINRA Series 7 and 63). He is a member of the CFA institute and CFA Society of Chicago.
MORE ABOUT THE FACULTY RICHARD CLAYWELL richard@biz-valuation.com Richard is a practicing Certified Public Accountant, and holds the additional designations of Accredited in Business Valuation, Accredited Senior Appraiser, Certified Business Appraiser, International Certified Valuation Specialist, Certified Valuation Analyst, Certified in Merger & Acquisition Advisor, Master Analyst in Financial Forensics, Certified in Fraud Deterrence, Accredited in Business Appraisal Review. Richard has been valuing closely held companies since 1985. Richard’s practice is restricted to business valuation, economic damages, profit enhancement and exit planning. Richard received his Bachelor of Science in Accounting in 1979 from the University of Houston – Clear Lake. He then received certification as a Public Accountant in 1983. Over the years, Richard has earned additional accreditations that relate to business valuations, economic damages and fraud. Richard has been an instructor for the National Association of Certified Valuation Analysts for many years, has been an instructor for the Internal Revenue Service and the International Association of Consultants Valuators and Analysts (IACVA). Richard is currently the Director of Education for the IACVA and is responsible for the business valuations materials being taught in 55 countries. Richard has taught business valuation or economic damage courses in China, Korea, Taiwan. Richard has performed over 1,000 business valuations since 1985. Richard has testified in Texas County Court, Texas State Court, Bankruptcy Court and Texas State Courts. Richard has given testimony in economic damages (lost profits), shareholder disputes, personal injury, wrongful termination and divorce.
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Important Notes • THE MATERIAL IN THIS PRESENTATION IS FOR GENERAL EDUCATIONAL PURPOSES ONLY. • IT SHOULD NOT BE CONSIDERED LEGAL, INVESTMENT, FINANCIAL, OR ANY OTHER TYPE OF ADVICE ON WHICH YOU SHOULD RELY. • YOU SHOULD CONSULT WITH AN APPROPRIATE PROFESSIONAL ADVISOR TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.