Campbell, Iridium, and the Future of Valuation Litigation
Michael W. Schwartz and David C. Bryan, 67(4): 939 - 956 (August 2012)
Five years ago, two landmark federal court valuation decisions, Campbell and Iridium, held that market evidence—rather than the testimony of paid litigation experts—should be relied on to value corporations for purposes of litigation. While a number of decisions have followed Campbell and Iridium, their full potential to make business valuation litigation less costly and less susceptible to hindsight bias has yet to be realized.
Trademark Licensing in the Shadow of Bankruptcy
James M. Wilton and Andrew G. Devore, 68(3): 739-780 (July 2013)
When a business licenses a trademark, transactional lawyers regularly advise that if the trademark licensor files for bankruptcy, the licensee could be left without a right to use the mark and with only a bankruptcy claim for money damages against the licensor. Indeed, the ability of a trademark licensor to reject a trademark license and to limit a licensee’s remedies to a dischargeable claim for money damages has been a significant risk for licensees for twenty-five years based on the Fourth Circuit case, Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. This result is grounded in the Bankruptcy Code prohibition on remedies of specific performance for non-debtor parties to rejected contracts and is in accord with Bankruptcy Code policy of affording debtors an opportunity to reorganize free of burdensome contracts. In the summer of 2012, however, the Seventh Circuit, in its decision Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, held that a non-debtor trademark licensee retains rights to use licensed trademarks following rejection of the contract by the debtor-licensor. The decision, derived from a pre-Bankruptcy Code paradigm for understanding the rights of non-debtors under rejected executory contracts that convey interests in property, creates a circuit split over the implications of trademark license rejection. This article asserts that the Sunbeam Products case misconstrues the rights of a trademark licensee as a vested property right and is therefore incorrect under both the holding of the Lubrizol case and the pre-Bankruptcy Code paradigm on which the Sunbeam Products case relies.
Market Evidence, Expert Opinion, and the Adjudicated Value of Distressed Businesses
Robert J. Stark, Jack F. Williams, and Anders J. Maxwell, 68(4): 1039-1070 (August 2013)
One year ago, The Business Lawyer published an article arguing that courts, when adjudicating the value of distressed businesses, should predominantly defer to “market” evidence, rather than expert opinion. In Campbell, Iridium, and the Future of Valuation Litigation, authors Michael W. Schwartz and David C. Bryan contended that near-universal judicial deference to market data: (1) is supported by recent developments in the case law; (2) would obviate judicial “hindsight bias”; and (3) would enable a more efficient valuation process. Messrs. Schwartz and Bryan further argued that, to solidify the paradigm change, courts should start imposing a pretrial obligation on any litigant intending to present expert valuation opinion to move specially, under Federal Rule of Evidence 702(a), for allowance to do so. This article offers an opposing viewpoint and argues that Messrs. Schwartz and Bryan interpret applicable case law selectively, outside of a broader jurisprudential context, and in a manner that disregards deeply ingrained legal principles. The authors here further contend that: (a) Messrs. Schwartz and Bryan have not presented a compelling case of widespread judicial “hindsight bias”; (b) they have also failed to make a persuasive showing that their proposal will lead to meaningful process efficiencies; and (c) their thesis fails to appreciate the complexity of market dynamics. This article concludes that market evidence tends to require expert interpretation, especially when used to value troubled businesses.
A Further Comment on the Complexities of Market Evidence in Valuation Litigation
Gregory A. Horowitz, 68(4): 1071-1082 (August 2013)
This comment offers another view in the dialogue concerning the use of market evidence in valuation litigation initiated in these pages one year ago. In Campbell, Iridium, and the Future of Valuation Litigation, Michael Schwartz and David Bryan argued that an understanding of the importance of market evidence, and of costs and vagaries of a battle of valuation experts, should lead courts to adopt a rebuttable presumption against the admissibility of expert valuation testimony. Like Messrs. Stark, Williams, and Maxwell, whose views are forcefully advanced in a separate article here, I find this proposal ill-advised, but for somewhat different reasons. I agree with Messrs. Schwartz and Bryan that market evidence is central to any question of value, but argue that the market never speaks for itself, indeed never speaks with a voice capable of lay interpretation. By way of example, I present a “debt discount test” for determining whether the market deems an enterprise to be insolvent (the question at issue in both Campbell and Iridium) and show that, even while this test substantially simplifies the interpretation of market data, expert opinion is inevitably required in its application. The increasing recognition of the importance of contemporaneous market information will improve valuation litigation and narrow areas of good-faith dispute without the need for radical procedural limitations on the adversarial process.
Best Practices Report on Electronic Discovery (ESI) Issues in Bankruptcy Cases
ABA Electronic Discovery (ESI) in Bankruptcy Working Group, Bankruptcy Court Structure and Insolvency Process committee, ABA Business Law Section, 68(4): 1113-1148 (August 2013)
Equity Receivers and the In Pari Delicto Defense
Hon. Steven Rhodes and Kathy Bazoian Phelps; 69(3): 699-716 (May 2014)
Federal equity receivers are creations of equity. The in pari delicto doctrine is similarly a defense based in equity. When equity receivers are called upon to administer the assets of a receivership entity for the benefit of defrauded victims, courts sitting in equity must balance the needs of the victims with the rights of the defendants to assert the in pari delicto defense to litigation claims brought by the receiver against them. The competing equities reveal the great discretion that courts can exercise in permitting litigation claims to proceed in the face of the assertion of the in pari delicto defense. Courts, however, must also be mindful of a variety of issues and obstacles in deciding whether to allow the in pari delicto defense.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
The Medicare Provider Agreement: Is It a Contract or Not? And Why Does Anyone Care?
Samuel R. Maizel and Jody A. Bedenbaugh, 71(4): 1207-1240 (Fall 2016)
The article first considers the conflicting positions taken by the United States Government regarding whether the Medicare Provider Agreement is an executory contract in and outside of bankruptcy court. It examines whether the Government’s positions can be reconciled, and if the Government should be barred by preclusion and estoppel principles from asserting in bankruptcy court that a Provider Agreement is an executory contract. The article then discusses whether the Provider Agreement should be treated as an executory contract in bankruptcy, and the implications of such treatment on a bankrupt provider’s ability to transfer its Provider Agreement to a purchaser under the Bankruptcy Code and related issues, such as the Government’s setoff and recoupment rights and successor liability.
The Past and Future of Debt Recharacterization
James M. Wilton and William A. McGee, 74(1) 91-126 (Winter 2018/2019)
The bankruptcy doctrine of debt recharacterization, as developed in four federal circuits, uses multi-factor tests derived from tax cases involving solvent companies. Aspects of these tests make no sense when applied to debt of insolvent companies and the U.S. Treasury has determined that, even for the purpose originally intended, the tests produce “inconsistent and unpredictable results.” The Ninth Circuit has now joined the Fifth Circuit in looking to state law as the basis for determining whether debt claims should be recharacterized as equity and disallowed in bankruptcy cases. This Article examines these two approaches, analyzing arguments for and against application of a federal or a state law rule of decision for debt recharacterization. Drawing on U.S. Supreme Court precedent, statutory analysis, and policy, the Article shows that, under long-standing legal principles, state law provides the proper framework for determining whether debt should be recharacterized as equity in bankruptcy and offers both consistency between state and federal courts and a higher degree of predictability concerning the enforcement of insider debt. The article predicts that the U.S. Supreme Court will ultimately resolve the circuit split in favor of a state law rule of decision. In anticipation of such a ruling, the article concludes by providing an overview of choice of law issues and state law approaches to debt recharacterization.
Oil and Gas Rights in Bankruptcy: Beware the Many Pitfalls for Interest Holders and Creditors
Richard L. Epling, 74(1) 127-150 (Winter 2018/2019)
Lenders, vendors, pipelines, storage facilities and other businesses that lend money to or do business with the working interest owner/lessors of oil and gas properties often assume that their contractual bargains will prevail over the rights and claims of other participants in the hydrocarbon production process. Such persons often fail to take into account the varied local and state laws affecting the definitions of what is real and personal property, the requirements for perfection and certain overriding priorities granted to field operators, suppliers and vendors in certain cases. Bankruptcy is the crucible for testing these conflicting rights and claims, and there have been some instructive recent developments in several key court decisions.
How Efficient Is Sufficient: Applying the Concept of Market Efficiency in Litigation Bradford Cornell and John Haut, 74(2) 417-434 (Spring 2019)
The concept of market efficiency has been adopted by courts in a variety of contexts. In reality, markets can never be perfectly efficient or inefficient, but exist somewhere in between depending on the facts and circumstances. Courts, therefore, face a problem in deciding how efficient is sufficient in any particular legal context. Because market prices incorporate the views of numerous market participants, courts have often been willing to presume that a market is efficient so long as the appropriate criteria are satisfied. However, those criteria are different for different types of cases, such as securities class actions, appraisal actions, and cram downs in bankruptcy.
Simple Insolvency Detection for Publicly Traded Firms
J.B. Heaton, 74(3) 723-734 (Summer 2019)
This article addresses current limitations of financial-market-based solvency tests by proposing a simple balance-sheet solvency test for publicly traded firms. This test is derived from an elementary algebraic relation among the inputs to the balance-sheet solvency calculation. The solvency test requires only the assumption that the market value of assets equals the sum of the market value of the firm’s debt plus the market value of the firm’s equity. The solvency test is a generated upper bound on the total amount of debt the firm can have and still be solvent or, alternatively, the minimum amount of stock-market capitalization the firm must have if it is solvent at current debt prices. The virtue of the method—apart from its ease of implementation—is that it makes possible the detection of balance-sheet insolvent firms notwithstanding the possibility that not all of the firm’s liabilities—including hard-to-quantify contingent liabilities—can be identified. As a result, the method allows for the detection of balance-sheet insolvent firms that otherwise might escape detection. The method proposed here can identify insolvent firms that should be retaining assets and not paying them out to shareholders as dividends or repurchases, identify stocks that brokers and investment advisers should treat as out-of-the-money call options that may be unsuitable investments, and can help auditors identify publicly traded firms that are candidates for going-concern qualifications and other disclosures.
Third-Party Releases in Bankruptcy Cases: Should There Be Statutory Reform?
Richard L. Epling; 75(2): 1747-1768 (Spring 2020)
Third-party releases, which can function as de facto discharges of nondebtors, have become an increasingly common feature of reorganization plans. There is no definitive Supreme Court case dealing with the legality and scope of such plan provisions, and the seven circuit courts of appeals that have addressed release issues have either disagreed or posited various legal tests and standards to satisfy the “extraordinary circumstances” bar they set for approving such releases.