Valuation Tenets in Bankruptcy

<p>To properly understand many key provisions in the Bankruptcy Code, one must become
acquainted with the concept of valuations. After all, valuation is the linchpin of
the bankruptcy process. Throughout the Code, courts are commanded by the legislature
to assign values to assets and liabilities. Although central to the entire process,
the Bankruptcy Code provides little guidance in how assets or liabilities are valued.

</p><p>As a general matter, when confronting a valuation issue in bankruptcy, courts
should not lose sight of several significant themes.

</p><p><i>Value is as much a matter of process as it is results.</i> For example, the
"general definition" of value under the Bankruptcy Code may be found in §506(a).
This provision provides that:

</p><blockquote>
Such value shall be determined in light of the purpose of the valuation and of
the proposed disposition or use of such property...
</blockquote>

<p>Thus, the import of the language is to reject a notion that there is one true
correct value. This particular perspective on value and valuations in bankruptcy is
supported by the language in, among other provisions, §101(32). In that
provision, to determine insolvency, a court must consider both the property and
liability of the debtor at a "fair valuation." These provisions suggest a functional
approach to any valuation issue in bankruptcy.

</p><p><i>Value does not exist "in the air."</i> What value a court should assign to an asset
or liability in bankruptcy depends on the context of the inquiry. For example,
§548 provides that a trustee may avoid a transfer "of an interest of the debtor
in property" where the debtor was insolvent and "received less than a reasonably
equivalent value in exchange for such transfer." Section 548(d)(2) then goes on
to define "value" for these purposes as "property, or satisfaction or securing of a
present or antecedent debt of the debtor." One may be left with a great sense of
frustration after considering these wonderfully vague pronouncements.

</p><p>However, great treasures can be mined from these words. For example, the language
of §548(a)(1) focuses a court's attention on the actual context of the valuation
process. Section 548 condemns fraudulent transfers because they harm the creditors as
a class where a debtor (1) had the actual intent to hinder, delay or defraud
creditors or (2) received legally insufficient value at the time it was insolvent.
Based on the language employed in §548, the valuation process is made from the
perspective of creditors of the estate. Section 548(d)(2)'s focus on property
and debt and its exclusion of unperformed promises to furnish support to the debtor
brings this point home. The U.S. Supreme Court also reminded us that valuation in
the fraudulent transfer context is about creditor expectations as to value.<i></i>

</p><p><i>Keep your eye on precisely what is being valued.</i> Again, §548(a)(1) teaches
us a valuable lesson of valuations in bankruptcy. When analyzing whether a debtor
received less than a reasonably equivalent value, the section does not ask us to
compare the property transferred by the debtor and what was received in exchange;
rather, the section focuses our attention on a transfer "of <i>an interest</i> of the debtor
in property." The lesson here is that a court must remain diligent in its focus on
the valuation of the interest of the debtor in the property and not on the value of
the property itself.

</p><p><i>Which valuation standard should a court apply?</i> A court may have to confront a host
of possible valuation models in determining the value of a company or an asset or
liability. In this context, we often see the term "going concern" tossed about. The
concept of going concern is not a measure of valuation at all. It is an expression
of the current status of a business. Certified public accountants express their
opinions on a company's financial statements based on a going-concern standard. A
going concern is a company that will continue in operation for an indefinite period
of time. In contrast, the longevity of a company may be in question if it has a
negative net worth, liquidity or leverage problems, or performance problems.

</p><p>Although going-concern is not a measure of valuation per se, it does affect the
valuation model ultimately embraced. Typically, if a company may be characterized as
a going-concern, then the values assigned to specific assets and liabilities are based
on values more closely approximating fair market value. Moreover, if a company may
be characterized as a going-concern, then certain assets, such as goodwill, are
generally included at their fair market value, although an adjustment to the book value
of goodwill may still be in order.

</p><p>In contrast, if a company may be characterized as a failing or failed business,
then the values assigned to specific assets or liabilities more closely approximate
orderly liquidation to liquidation values. Moreover, if a company may be characterized
as a failing or failed business, then certain assets, such as goodwill, are assigned
little to no value at all.

</p><p><i>Value is opinion.</i> An expert's testimony as to value is simply that expert's
opinion—nothing more or nothing less. All valuation testimony is opinion and should be
governed by the trilogy of Supreme Court opinions beginning with <i>Daubert.</i> In a future
article, I will discuss the Supreme Court's opinion in <i>Daubert</i> and how that opinion
affects financial expert testimony in bankruptcy courts.

</p>