Many in the business community wrongly assume that all accountants are business valuation experts. The UK courts are increasingly finding this assumption to be problematic, and they’re equally as willing to dismiss testimony when they sense a lack of direct relevant experience.

Francesca Muscutt, a partner at DAC Beachcroft, believes three UK decisions in the last year are essential for business valuation experts taking on new litigation engagements now. Her new article, “Accountancy Experts—The Importance of Objectivity, Relevant Expertise and Operating on a Level Playing Field,” suggests that the days of using accounting generalists in the UK courts may have ended. It emphasises the value of independent, specialised, experienced, and certified business valuation experts in litigation.

“There has been a spate of cases where expert witnesses have received some harsh judicial criticism,” Muscutt concludes.

The idea that experts must have relevant expertise is not new to anyone involved in business dispute resolution, but the court’s disregard for accountancy evidence in De Sena v Notaro [2020] EWHC 1031 (reported previously by BVWire—UK) was uniquely clear, Muscutt says. In that decision, the court held:

[E]xpertise is acquired by doing the thing in question, usually over many years, and merely being an accountant (or anything else) for a long time does not mean that you become an expert in everything that accountants (or whatever it may be) commonly do.

Even business valuation specialists may find themselves in serious trouble if they run afoul of CPR Part 35, PD 35 and the related 2014 Guidance for the Instruction of Experts in Civil Claims (2014 Guidance). These provisions “ensure all experts of like disciplines have access to the same material,” Muscutt says—pointing to an even more recent case of Dana UK Axle Ltd v Freudenberg FST [2021] EWHC 1413. The judge in this decision found serious breaches because the defendant exchanged information directly with the expert, circumventing both the legal team and the process for disclosing information obtained in conversations and site visits.

The result was harsh. “These breaches meant the parties’ experts were not operating on the same level playing field and the Defendant’s evidence was excluded in its entirety,” Muscutt says. “Direct contact between experts and client, without solicitor involvement, should always be avoided.”

A third case, Beattie Passive Norse v Canham Consulting Limited [2021] EWHC 1116, refers to a “worrying trend” noted by the courts. A business valuation expert’s “independent, objective opinions will be tested while giving oral testimony at trial and their evidence may be disregarded if they have insufficient expertise, or if they are perceived as simply a mouthpiece for those instructing them,” Muscutt concludes.

The overall debt level of independent UK businesses has more than quadrupled in the past year, increasing from £0.5 billion to £2.2 billion. The trend is not news to anyone. Still, a new report from an industry panel released 20 July on behalf concludes 150,000 of these local businesses “face imminent collapse” because they’re under a “huge debt mountain” of unsustainable loans taken out during the pandemic.

The fourth in the series of Grimsey Review Papers, led by Bill Grimsey (former chief executive of Iceland and Wickes), noted that independent retail and independent hospitality businesses accounted for half of the debt for these struggling enterprises. Overall, the businesses “face five times the debt they had going into the pandemic.”

The report documents the catastrophic cost to local communities when these terminally overleveraged businesses fail and recommends a number of government measures to save them, including needed adjustments to the “Levelling Up” programme and deferral of interest and HMRC enforcement for another year.

Business valuers analysing these businesses may need to adjust their assumptions, procedures, and even methods. Even short-term cash-flow forecasts must be risk-adjusted when it’s uncertain whether those cash flows will exist in 30 or 60 days. The government response to this report is also uncertain, so analysts can’t tell whether a programmatic solution might save the day.

For valuers:

• Any analysis must include a judgment of the likelihood that the standard of value will be anything other than liquidation. As of this date, without clear mandates of support, it appears impossible that these businesses will survive (as one valuer said, “All of the relatives and mattresses have been exhausted and there’s still 5X leverage.”)

• It may be helpful to specifically document debt coverage capabilities under multiple scenarios.

• Lattice or even option modelling might help derive clearer support for whether a “cliff” event can be avoided.

The full report can be accessed here.

The Corporate Insolvency and Governance Act 2020 (CIGA), rushed through the UK Parliament in a five-week period last summer, is now over a year old. Driven by the pandemic, this was the largest reform to UK insolvency law in over 20 years. It was intended to sort the major insolvencies of large organisations with multiple share classes and creditor classes. While the provisions are not relevant to small or medium enterprises, the impact on business valuation methods and standards will likely trickle down over time.

CIGA’s new restructuring plan (under s.26A of the Companies Act 2006) replaced the previous Scheme of Arrangement with one major difference: the introduction of the cross-class cram-down (CCCD) mechanism and requirements that business valuation professionals now document how value cascades throughout the capital structure of the company in question.

CCCD’s already appear in the US Chapter 11 regime, and, as of January this year, Holland have added them, bringing the practice to the EU for the first time.

While a Scheme of Arrangement required the support of 75% by value and 50% by the number of each class of affected creditors, a CIGA restructuring plan requires only the support of 75% by value of creditors in each class who vote. Under the restructuring plan, if the consent of all classes of creditor cannot be secured, the court can invoke the CCCD. Also, if the business valuer determines that a creditor is “out of the money,” that creditor may be excluded from voting.

Business valuers can support the courts with ‘most likely’ analyses under CIGA: The new process puts more pressure on valuations, and it also appears to favour restructuring outcomes other than liquidation. The interpretation of “supporting valuation evidence” is only now starting to be tested in the UK courts, with the Virgin Active restructuring plan in May 2021 leading the way. The New Look and Regis cases also highlighted the need for early independent expert input on identifying the “most likely” outcome in formulating restructuring plans (both New Look and Regisplans originated prior to CIGA).

The UK courts have also affirmed their support of “most likely” outcomes, and a further concept of “no worse off” terms, when they approved the recent DeepOcean restructuring plan.

Additionally, Grant Thornton continues to administer the restructuring plan for supply chain finance firm Greensill Capital’s UK operation, which lent money to firms by buying their invoices at a discount and collapsed in March 2021. Credit Suisse and steel magnate Sanjeev Gupta’s GFG Alliance have independent valuers representing their claims in this collapse.

As more companies become subject to the new plans, most financial analysts who have commented on this provision anticipate litigation and challenges to the plan and its valuation assumptions at nearly every step.

Some elements of a business valuation conducted for purposes of insolvency that will require more preparation and support appear to include:

• Providing even more scenario analysis than in the past to aid the court in approving a new plan;

• Additional defensive support against the claims of dissenting parties who may be deemed out of the money;

• Recognition of the need for an accelerated sale of the business, since each week of delay will reduce the likelihood of an ultimate sale;

• Inclusion of “path analysis” for both tangible and intangible assets if liquidation becomes necessary;

• Consideration of recapitalisation or refinancing of the business if any, leading to a requirement for new projections, rather than budgets or forecasts that predate the claim for restructuring;

• Nearly complete reliance on DCF analyses and scenarios, particularly assuming volatility in market multiples continues. (Martin Drummond of Alverez & Marsal has been quoted as saying, “DCF is perfectly suited to the valuation of distressed businesses as it can explicitly assess the costs, losses, and time frame required in getting any business back on track.”);

• Additional stress-testing of DCF scenarios so that the courts and creditors can identify further deterioration of the quality of cash flows immediately; and

• A likelihood that many stakeholders will need their own independent business valuation expert to have their position fully considered.

23-24 August: Excel Modelling—Investment Appraisal, Valuation, and Business Cases, ICAEW live online, 09:30-12:30 BST

6-14 September: Practical Business Valuation, ICAEW live online (four sessions), 09:30-12:30 BST (repeated 1-9 December)

13-16 September: IMAA's Damodaran on Valuation, live online (repeated 8-11 November)

23 September: Fried Frank Webinar on the UK’s New Cross-Class Cramdown Restructuring Provisions, virtual

3-5 October 2022: 12th Annual International Valuation Conference, Riyadh, Saudi Arabia

24-26 October: ASA International Conference, Las Vegas and online

27-29 October: IVSC Annual General Meeting (programme and format information to come)

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David Foster at ukeditor@bvresources.com.