In a bankruptcy-cum-Daubert case that turned on solvency, a court recently rejected both parties’ claims that the opposing financial expert testimony was inadmissible. Among the myriad of attacks (all unsuccessful) against the experts was the plaintiff’s claim that the debtor’s expert had relied on management projections without scrutinizing the forecasts and examining the underlying facts or data. In contrast, the court found the expert’s deposition testimony, in particular, showed the expert assessed the reasonableness of the projections. Whether his decision to rely on the forecasts was reasonable was an issue for the jury to decide.
Failure to go behind the projections? The debtor was a pulp, paper, and tissue mill in Maine that suffered a business interruption loss and, in December 2013, received a cash settlement from its insurance company. Within six months, the board of directors authorized two distributions to a holding company that was the sole member of the debtor. Some 15 months after the last distribution, the debtor filed for Chapter 11 bankruptcy. The bankruptcy trustee appointed the official committee of unsecured creditors, i.e., the plaintiff in this case. The committee filed a lawsuit in which it tried to avoid and recover the distributions. The plaintiff argued the transfers were constructively fraudulent; the debtor was insolvent at the time of the distributions. In contrast, the debtor argued various solvency tests showed the debtor was solvent during the relevant times.
Both parties retained financial experts to support their positions, and both parties tried to exclude the rivaling expert under Federal Rule of Evidence 702 and Daubert.
The plaintiff criticized the defense expert’s solvency analysis under various tests: payment of debts test, balance sheet test, and capital adequacy test. According to the plaintiff, the expert testimony about the capital adequacy test and the income approach to the balance sheet test was unreliable, and, therefore, inadmissible, because the expert “blindly accepted mere summaries of management-prepared, EBITDA-level projections.” He did not test the reasonableness of the projections by examining the underlying facts or data or considering conflicting information, including other contemporaneous projections that were forecasting significant negative EBITDA. Also, if the expert had reviewed past financial performance against the then forecast performance, he “would have discovered that the Debtor’s prior performance was uniformly more negative than prior projections.”
‘Robust projection process’? The court found the plaintiff’s claim ignored evidence that the expert did question and analyze the reasonableness of the projections. For example, when asked during his deposition what he did to assess the reasonableness, he said he had reviewed deposition testimony of key board members and they all seemed to agree the projections included everything they knew at the time. According to the expert, the board members “talked to sales people, they talked to the operating people … So the projections were built from the ground up. It wasn’t somebody sitting in the office just making up numbers.” He said it appeared to him that the projection process was “fairly robust.” He also noted the board members “understood the business. They develop projections every year, budgets every year, reviewed financials.” He said he considered testimony from an outsider with industry expertise, who said the forecasts were reasonable. Moreover, he said, in the past, “they’ve hit $5 million of EBITDA or more.… So it’s not like they’re boldly going where no man has gone before.” Considering all of these factors “leads me to say that they’re reasonable.”
The court said the expert’s deposition testimony showed the expert (who was an accredited, experienced valuator) “applied his own expertise in assessing the reasonableness of the projections.” While the existence of opposing evidence may justify criticism of the expert’s conclusions, “that does not make his testimony inadmissible,” the court said. It added that the plaintiff could probe the reasonableness of the expert’s use of the projections through cross-examination, “and a jury can assess his response.”
The case is Official Committee of Unsecured Creditors v. Calpers Corp. Partners, LLC, 2020 U.S. Dist. LEXIS 125769 (July 17, 2020). Find a digest of all the valuation issues arising in the case and the court’s opinion at BVLaw (subscription required).