Bankruptcy judges “have become familiar and comfortable with the DCF, comparable companies, and comparable transactions methodologies,” writes the Hon. Christopher S. Sontchi, U.S. bankruptcy judge for the District of Delaware, in his new article in the Spring 2012 American Bankruptcy Institute Law Review (available by subscription or purchase from ABI). “Indeed, these methods are often referred to as the ‘standard’ methodologies," said the judge, adding:
While use of an “alternative” valuation may be appropriate, one should be reluctant to depart from the familiar. The judge will be inherently suspicious of the use of such an alternative valuation. The valuation professional should be prepared to provide a clear reason for not using the DCF, comparable companies, and/or comparable transactions methodologies. Otherwise, the judge may suspect that the professional is manipulating the valuation to reach a predetermined result and, thus, will give the valuation little or no weight.
Similarly, although financial professionals will often add a risk premium or other adjustment to their selected approach, “judges are inherently suspicious of these adjustments,” Sontchi says, concerned that they are “being made to manipulate the valuation to reach a predetermined result.” The valuation expert also risks “confusing the judge” with any alternative method or adjustments. “Remember, most bankruptcy judges are ‘self-taught’ in corporate finance.” In fact, Sontichi credits an “excellent treatise” by Professor Aswath Damodaran as his primary source: Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (2nd edition, 2002).
Although the article is a bit basic for BV experts, the judge’s peers are reading and referring to it. In a recent case, bankruptcy judge Richard Fehling cited Sontchi’s work as “an excellent article”—and then proceeded to find one expert’s use of the cost method as “strikingly inappropriate” to value technology. Moreover, in his “hypothetical” capitalization of income approach,” the expert seemed to have pulled his figures “from thin air.” Read the complete digest of Holber v. M&T Bank (In re Scheffler), 2012 Bankr. LEXIS 2568 (June 5, 2012) in the August 2012 Business Valuation Update; the court’s decision is posted at BVLaw.