Contentious valuations: The art of the counterfactual Valuation services
Jim Davies, Partner in FRP’s Financial Advisory team regularly provides expert evidence in respect of litigious and contentious valuation matters heard in the High Court. Contentious valuations: The art of the counterfactual
Establishing the true value of something that has been transacted upon (such as an asset, business or investment) is often at the very heart of commercial disputes that end up in litigation. A transfer of ownership may have occurred (or been prevented) at some historical date, and a stakeholder whose economic situation has been negatively impacted may develop a hypothesis that the value the subject asset was transacted at was not a reflection of its true value. If that party feels they have suffered economic loss as a result, they may be inclined to litigate. Typically, a claimant will allege that: (i) something was transferred out of their ownership (or economic benefit) at an undervalue, or into their ownership at an overvalue, and (ii) certain actions taken by another party had caused the transfer to take place at the price that it did. Alternatively, the allegation may be that certain actions of another party had caused a transfer not take place at all, or value to not have been transferred or created in a way that it otherwise would have been.
Given the range of circumstances that can lead to commercial disputes, there is unlimited variation in the background detail of value-centric allegations – each case is essentially unique. However, where there is perceived discrepancy between the price at which an asset has transacted and that asset’s true value, it is common for the claimant to allege that illegality or negligence in respect of information or process has played a part, and that an accused party is to blame. Evidence around valuation can become the central battleground of such cases.
Jim Davies Partner Financial Advisory London +44 (0)7841 829 826 jim.davies@frpadvisory.com
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True value?
There is no definition of ‘true value’ within the valuation profession. Even with perfect information, reliable professional advice and a proper transaction process, valuation remains inherently subjective. Perceptions of risk and opportunity differ between different prospective buyers and what an asset may be worth to one party may not make economic sense to another. Valuation is not a ‘truth’. Instead, valuation professionals generally look at ‘market value’ or ‘fair value’ as a basis of establishing what something is (or was) worth. The former is an IVSC (International Valuation Standards Council) concept whilst the latter derives from IFRS (International Financial Reporting Standards). They are essentially intended to mean the same thing: the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion * . The role of a valuation expert witness in the context of a commercial dispute is typically to assess the market (or fair) value of a subject asset or investment at a particular point in time. The task is usually framed somewhat more precisely – the context being intricately detailed and perhaps a defined set of available information being established.
In many cases, there is another element – the counterfactual component. This becomes central to the question of value if it is alleged that value has been destroyed, diminished or otherwise altered by an action that prevented a certain set of events from occurring. A sliding doors moment. It may be that a series or combination of actions (as opposed to a single act) is alleged to have taken value down the wrong path: either way, the set of events that a claimant believes would have occurred in the absence of the alleged acts becomes the counterfactual basis of valuation. The expert’s task: to assess the value of what would have been. In basic terms the valuer must: go back in time to the relevant date; paint a picture of an alternative world in which the counterfactual scenario actually unfolded; then assess the value of the subject asset in a commercially reasonable manner. Detailed consideration must be given to:
1. The Counter Facts 2. Chronology 3. Commerciality
* Market Value per IVSC
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The counter facts Chronology
Commerciality
The key marker on the timeline of a counterfactual valuation exercise is the fork in the road. The point at which the alleged act(s) took the value of the subject asset down a different path than that which it otherwise would have followed. That may not however be the date at which a valuation is required. More typically, a counterfactual-centred dispute requires a valuation to be conducted at a point in time after the fork in the road, but assuming the counterfactual pathway had been followed, not the actual one. Nonetheless, the expert valuer will typically need to go back to the fork in the road and build a picture of the counterfactual from there. It is then necessary to consider what information it is appropriate to rely upon. A ground rule is that a valuation at a past date should be based only on information that was available at that date, and nothing subsequent. The valuer is tasked with turning the clock back to the appropriate date, and gathering the relevant information that then existed, that would be used to assess the value of the subject asset. Where the valuation date comes after the fork in the road, the valuer’s task also includes determining the suite of information that would be likely to have existed in the counterfactual scenario. Taking the previously mentioned container terminal example, that may mean preparing several years’ worth of counterfactual financial statements based on a best-estimate out-turn for the business, in order to assess the financial performance and position of the subject company at the relevant valuation date. Such an exercise may require a combination of research, benchmarking, probability assessment and financial modelling. The more evidence-based such an exercise is, the more compelling the resulting valuation.
The valuer must start with a detailed understanding of how events are assumed to differ from historical reality in the counterfactual scenario. What exactly would have occurred differently if the alleged actions had not taken place? This can range from the simple to the complex. A simple counterfactual example would be: what would have been the outcome of a sale process if the seller of an asset had conducted an open market M&A process rather than transferring the asset privately to a related party? Essentially, how would market value have differed from the actual transaction price? As a more complex example: what would the current financial position and value of a subject company be if a plot of land that was seized from it by a bank had been used to develop a container transhipment terminal, the company had secured contracts in line with the business plan and operated the facility for the last several years? A precise understanding of the counter facts is necessary in order to ensure that the question being answered by the expert is the exact question being asked. Given potential nuances between the framing and the interpretation of a counterfactual scenario, it is often important that instructing solicitors and the appointed valuation expert discuss certain details within the valuers’ instructions before they are finalised. Outside of the dispute arena, other court-determined processes such as schemes of arrangement and restructuring plans also rely upon counterfactual valuation evidence. The successful sanctioning of such cases depends on the judge being comfortable that no party (typically being compromised creditors) is worse off under the proposed restructuring than they would be in the most likely alternative. Expert evidence is required to present the most likely hypothetical scenario that would unfold if the plan were not to be approved, and what the value of the subject company would then be.
A third key aspect is commerciality: ensuring (and being able to evidence) that the analysis underpinning the counterfactual information and the resulting valuation is conducted in a manner consistent with the commercial realities of the situation. What is most likely to have happened in the real world if the counterfactual had unfolded? And how would the commercial factors at play influence the value that would have been attributed to the subject asset? Whilst theory and accurate analysis are fundamental disciplines of valuation, demonstrating the likely commercial realities of a given situation is equally important in preparing a compelling expert opinion. Opinions with impact require: 1. Expertise: Any testifying expert must understand and respect the limits of their own expertise. Direct knowledge and experience are essential parts of the toolkit, whilst recognising which elements sit outside one’s boundary of expertise is also critically important. 2. Evidence: Supporting assertions and assumptions with a strong body of evidence gives weight to an expert opinion, whilst unsupported statements can leave the door open to challenge. 3. Storytelling: The ability to bring the relevant fact- base, valuation analysis and supporting evidence together in a digestible and lucid manner helps the opinion that is ultimately expressed to have maximum impact.
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Our work FRP is a leading independent advisory firm with experts in the fields of Restructuring, Corporate Finance, Debt Advisory, Forensics and Financial Advisory. Jim Davies leads FRP’s valuation offering and provides expert witness valuation services in respect of commercial disputes and contentious restructuring processes. Jim has been appointed on matters spanning SME shareholder disputes, to litigation involving listed companies and sovereign wealth funds. Jim has also provided the counterfactual valuation evidence for four of the last six restructuring plans to have been sanctioned by the High Court * .
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* As of August 2023
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January 2024
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