A bankruptcy court raises the discount rate because of the bad economy

Appraisers struggling to defend their discount rates will get some guidance from the short discussion in Miller Bros. Coal v. Consol of Kentucky, Inc, 2009 WL 4904032 (Bkrtcy. E.D. Ky.))(Dec. 11, 2009).

This downturn is not an ‘act of God.’ In the first half of the opinion, the defendant tried to excuse its breach of a coal mining agreement by claiming that the severe economic downturn in 2009 amounted to a force majeure—an exterior event, completely outside its control. However, declining consumer demand, rising inventories, and stalled operations are “normal” market risks, the court ruled, and not the result of a “superior force,” or unforeseeable act of God. In agreeing to the fixed-price contract, the defendant assumed “the normal risk…that the market will change,” the court said, and it could not escape responsibility despite a precipitous drop in coal prices and contract opportunities.

The plaintiff claimed it was entitled to lost profits damages in excess of $10.2 million. In particular, the expert applied a discount rate of 10%, based on the plaintiff’s actual cost of capital (which had been under 8% prior to its parent’s bankruptcy) plus a slight risk premium. She also believed the 10% discount rate was consistent with the effective annuity nature of the income stream under the coal mining agreement, especially given its fixed-price aspect and its costs.

The court determined that 10% was too low, and found a 15% rate “more reasonable in light of the normal attendant risks of mining coal.” (Essentially, the court appears to have shifted the defendant’s arguments regarding an economic “force majeure” from the question of overall liability to the determination of damages—in particular, the risks inherent in the determination of a discount rate.)

The court made additional market-related adjustments to the expert’s damages analysis. For instance, she failed to include the plaintiff’s forecasts of losses on its surface mining operations, which during the contract period conservatively amounted to $2 million. The plaintiff also would have incurred nearly $500,000 in additional fees to a subcontractor. Finally, offsets for development, permitting, gas relocation, reclamation, and other cost reimbursements totaled nearly $3.65 million.

Overall, the expert’s analysis was “convincing” and supported the plaintiff’s claims for damages calculations in this case, the court held. After its own adjustments for current market conditions and costs, including a more realistic discount rate, it awarded net damages of $3.96 million.