bankruptcy valuation issues: fraudulent transfer and preference attacks

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Bankruptcy Valuation Issues: Valuation in the Context of a Fraudulent Transfer or Preference Attack

VALUATION 2016 SERIESPremier date: May 27, 2016

Premier Date: MAY 27, 2016

Bankruptcy Valuation Issues: Valuation in the Context of a Fraudulent Transfer or Preference Attack

VALUATION 2016 SERIES

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meet the facultyPANELISTS

Richard Claywell J. Richard Claywell, CPAGary Frantzen Alvarez & MarsalGary Lotzer Vantera Partners, LLC

MODERATOR Chris Cahill Lowis & Gellen LLP



Practical and entertaining education for business owners and executives, accredited

investors, and their legal and financial advisors. For more information, visit

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NOT BE CONSIDERED LEGAL ADVICE. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.

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about this webinar

Bankruptcy trustees, debtors, and liquidating trustees often file lawsuits against former insiders (such as shareholders and executives) to avoid and recover alleged fraudulent transfers. They also commonly sue suppliers to avoid and recover alleged preferential payments in the weeks leading up a bankruptcy case. The outcome of such litigation depends in part upon the value of the debtor’s assets and whether the debtor was solvent and/or adequately capitalized at the time of those transfers. This Financial Poise webinar provides a brief overview of such litigation and explains how experts determine solvency and asset values after the fact.

about this series“What is it worth?” A valuation (or appraisal, if you prefer) can be performed on virtually any asset: the equity of a company or options to buy the equity of a company; intangible assets (such as patents and trademarks or even contingent liabilities); real estate; and any sort of personal property. Valuation permeates the business and legal worlds, bearing upon investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and litigation, among others. Join some of the leading experts in the country as they discuss in plain English the basics and the latest in valuation topics and why valuations of assets can vary so greatly from one professional to another.

As with all Financial Poise webinars, each episode in the series is designed to be viewed independently of the other episodes, and listeners will enhance their knowledge of this area whether they attend one, some, or all of the programs.


episodes in this series

Dates above are premier dates All webinars also available On Demand through West LegalEd Center and Vimeo

EPISODE #1 What’s it Worth: Valuing a Business for Sale1/19/2016

EPISODE #2 Valuing Lost Profits for Litigation Purposes2/26/2016

EPISODE #3 Selecting the Right Valuation Expert3/18/2016

EPISODE #4 Valuing Your Brand and Other “Soft” Assets4/29/2016

EPISODE #5 Bankruptcy Valuation Issues: 5/27/2016Valuation in the Context of a Fraudulent Transfer or Preference Attack


• 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 Bankruptcy 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.

The Legal Context of Insolvency and Avoidance Actions


• 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 debtors solvency at the date of transfers, then the transfer is not an avoidable preference

Avoidance and Recovery of Preferential Transfers – 11 U.S.C § 547(b), (f), and (g).


• “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

Definition of Insolvency – 11 U.S.C. § 101(5), (12), and (32).


• 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 Constructive Fraudulent Transfers – 11 U.S.C § 548(a).


• 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

Avoidance and Recovery of Fraudulent Transfers - State Law


Balance Sheet Test

• A company is insolvent if its debts exceed its assets on a fair value basis

Adequate Capital Test

• A company is engaged in (or is about to engage in) a business or a transaction for which it has unreasonably small capital

Cash Flow Test

• A company is incurring debts that would be beyond its ability to pay as such debts matured

Avoidance/Insolvency Valuations


The Balance Sheet Test is a test of insolvency defined as the “. . . financial condition such that the

sum of such entity’s debts is greater than all of such

property, at a fair valuation. . .”.

The Bankruptcy Code requires that the test be performed based on a

“fair valuation” of the assets. “Fair valuation” is not defined in the Code. Generally, it has been interpreted by the bankruptcy

courts as fair market value. “See Andrew Johnson Properties, Inc., CCD Dec. ¶ 65,254 (D.C. Tenn. 1974); Briden v. Foley, 776 F.2d

379, 382 (1st Cir. 1985).

The Balance Sheet Test


Going concern vs. Liquidation. Generally the value should be determined based on a

premise of a going concern….UNLESS the value of the assets in liquidation is deemed > the value of the assets as a going concern.

Compare the value of the company’s debts # (including contingent liabilities) to the

concluded value of its assets on a debt-free going concern

basis.

Passing Balance Sheet Test:Debt-free value of the assets > the value of its debts (i.e.

equity value is positive)



• 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 Approaches and Methods• Standard of value• Premise of value• Valuation date

Valuation Parameters


• 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

Valuation Approaches and Methods


• 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 valuations under different standards of value

Standard 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

Premise of Value


• 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

Valuation Date


• 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?



Determines if a business entity

was engaged in a business or a

transaction for which it had

unreasonably small capital.

Intended to determine whether a

company is likely to survive, assuming

reasonable business

fluctuations in the future.

Analyze the company’s

robustness to the general economic uncertainty that all businesses

face.

Ratio analysis and debt

covenants

Often applies industry

benchmarks



• 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

Cash Flow Test


• Motion for Use of Cash or Non-Cash Collateral

• Relief of Automatic Stay Adequate Protection

• Feasibility of Plan• Best Interest of Creditors

Plan of Reorganizatio

n Confirmation

Other Bankruptcy Valuations


• 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 – Use of Cash Collateral


• 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 – Relief From Stay


• 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

Adequate Protection


• 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

Plan Feasibility


More About The Faculty: D


CHRIS [email protected]

Mr. Cahill is counsel with Lowis & Gellen LLP, in Chicago, Illinois. He guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial mega-case experience at national law firms representing very large debtors, and has counseled and litigated on behalf of manufacturers and secured lenders in large and middle-market cases.

Mr. Cahill also publishes frequently and speaks regularly on commercial insolvency issues. He is an executive editor of Commercial Bankruptcy Litigation, 2d Edition (Jonathan P. Friedland, Elizabeth Vandesteeg & Christopher M. Cahill eds., 2016) and is the host of Financial Poise Radio, a weekly broadcast for investors, on www.financailpoise.com.

mailto:[email protected]


RICHARD [email protected]

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.



GARY [email protected]

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.With more than 25 years of experience, Mr. Frantzen has provided valuation advice in a wide variety of situations and industries to management, board members and special committees, attorneys, individuals and the courts. Notable assignments include: the valuation of tangible and intangible assets of a multi-billion dollar, multinational corporation for fresh start accounting; the valuation of the assets of a regional health system with respect to its acquisition by a major university medical center; the valuation of large water and transportation infrastructure projects for financing-related purposes and financial reporting; the valuation of the tangible and intangible assets of a large, multinational chemical producer acquired by a large private equity sponsor; and the valuation of the shares of a publicly-traded hospital management company related to a dissenting shareholder dispute when their shares were acquired in a private transaction.


More About The Faculty:D

MICHAEL PATKERD


[email protected]. Pakter focuses on financial analysis, forensic accounting, economic damages, valuation issues and investigations. He has experience in financial forensics, determining lost profits, business interruption claims, earn-outs, analyzing financial transactions and balances, establishing fair value and reconstructing incomplete, misstated and/or falsified financial information.

Mr. Pakter provides consulting and litigation support services to trial lawyers, trustees, examiners, receivers, business owners and managers and units of federal, state and local government. He has experience with disputed financial transactions in commercial litigation, conducting investigations, examining financial transactions and balances, Court-ordered accounting and bankruptcy core proceedings.

Mr. Pakter has more than 35 years of experience in accounting, financial analysis, financial forensics and investigations, including more than 15 years of experience in economic damages and business valuations. He has participated in public hearings and alternative dispute resolutions, submitted expert reports in several jurisdictions and testified in arbitrations, regulatory proceedings and State, Federal and Bankruptcy Courts. Courts and arbitral bodies have recognized him as an expert in accounting, business valuation, financial analysis, economic damages and business economics.

Visit www.eisneramper.comEisnerAmper. Let's Get Down to Business®

EisnerAmper LLP is a leading full-service advisory and accounting firm, and is among the largest in the United States. We provide audit, accounting, and tax services, as well as corporate finance, internal audit and risk management, litigation services, consulting, private business services, employee

benefit plan audits, forensic accounting, and other professional advisory services to a broad range of clients across many industries. We work with high net worth individuals, family offices, closely held businesses, start-ups, middle market and Fortune 500 companies. EisnerAmper is PCAOB-registered and provides services to more than 200 public companies and to thousands of entities spanning the hedge, private equity, brokerage and insurance

space in the financial services marketplace. As companies grow we help them reach their goals every step of the way. With offices in New York (NY), New Jersey (NJ), Pennsylvania (PA), California (CA), and the Cayman Islands, and as an independent member of Allinial

Global, EisnerAmper serves clients worldwide.

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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.