Bankruptcy Valuation Methodology in Practice

Bankruptcy Valuation Methodology in Practice

By Jeffrey S. Sabin and Carol Weiner Levy

Excerpt from 2011 Emerging Issues 6116

Valuation Methodology in Practice

Arguably, there is nothing special about causes of action as an asset class and, thus, nothing particularly surprising about the Polis [an enhanced version of this opinion is available to subscribers] rule.  Complex estate causes of action may be difficult to value, but then again so are closely held businesses, illiquid investment securities, intellectual property, mineral rights and artwork.  Bankruptcy courts have long figured out how to appraise these esoteric forms of value, relying primarily on expert opinion and underlying data. There does not appear to be any obvious reason to think estate causes of action are any different.

What is unique about valuing causes of action, however, is that the bankruptcy court must also consider, and render a general judgment concerning, the likelihood of success on the merits of the litigation, thus delving into the legal issues that are the subject of the cause of action and the potential defenses, cross-claims and counterclaims that may be asserted in the litigation. This is a natural component of claim valuation; but a judicial determination of claim value is not supposed to morph into a trial on the merits, although that may be the natural inclination of the valuation process. The complex nature of valuing estate litigation led one bankruptcy judge to ruminate that "there are dangers in trying to fix probabilities with too much precision, as if the litigation recoveries are subject to a mathematical model. We are much more likely to be talking about win or lose scenarios with huge swings in outcome."

Initially, valuation of estate causes of action requires a gathering of facts. Federal Rule of Bankruptcy Procedure 2004 permits parties in interest to examine any entity with regard to any act, conduct, liability or any matter that could affect the administration of the debtor's estate.  The scope of a 2004 examination is broader than the discovery allowed under the Federal Rules of Civil Procedure and may be in the nature of a "fishing expedition," so long as the purpose of the examination is not to harass the debtor.  Thus, a debtor or other party in interest might conduct a series of 2004 examinations during a chapter 11 case, before a cause of action has been commenced, in order to determine whether a valuable asset exists. Unlike discovery under the Federal Rules of Civil Procedure, which is commenced after a complaint has been filed, Bankruptcy Rule 2004 provides debtors and creditors with an opportunity to broadly evaluate a cause of action precommencement and determine whether it can be included as a contingent source of creditor recovery in a reorganization plan. In addition, if contingent claims are assigned to a postconsummation litigation trust, the trustee usually obtains assignment of the lawyer-client privilege, giving the trustee are real insider's view of the potential litigation before it is commenced.

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JEFFREY S. SABIN is co-head of Bingham McCutchen LLP's global Financial Restructuring Group, one of the world's top restructuring practices with more than 100 restructuring lawyers in the United States, London, Frankfurt, Hong Kong, and Tokyo. Mr. Sabin focuses on creditors' rights, bankruptcy, debt restructuring, financial transactions, and acquisitions of troubled assets. He has more than 30 years of professional experience in the field. He has represented public companies, lenders, committees of secured and unsecured creditors, boards of directors, and investors and acquirers in numerous chapter 11 cases and out-of-court restructurings. Mr. Sabin has chaired and taught numerous legal education and professional programs and is the author of many published articles and outlines on bankruptcy-related topics. He is a Fellow of the American College of Bankruptcy and a recent chair of the New York City Bar Association's Subcommittee on Fraudulent Conveyance Law. He is also a co-head of Bingham's Task Force on Dodd-Frank Financial Reforms. In 2007, he was named as one of the finalists for the National Public Justice Award for securing a precedent-setting ruling against FEMA on behalf of the class of almost one million persons left homeless by Hurricane Katrina. Mr. Sabin received a B.S. and a B.A., magna cum laude, from Cornell University and his J.D., cum laude, from Boston College Law School.

CAROL WEINER LEVY is Of Counsel at Bingham McCutchen LLP in its Financial Restructuring Group. Her practice focuses on distressed bank debt and claims trading, chapter 11 mergers and acquisitions, and other strategic transactions for financially distressed companies. She represents hedge funds and other institutional investors in transactions involving financially distressed entities, as well as other secured and unsecured creditors in out-of-court restructurings and chapter 11 cases. She has co-authored various publications on claims trading and its role in the chapter 11 process. She received her B.A. from the University of Michigan and her J.D. from the University of Michigan Law School.