United States: An Economist’s View Of Market Evidence In Valuation And Bankruptcy Litigation

Last Updated: June 3 2014
Article by Dr. Faten Sabry and William Hrycay

Courts often face many challenges when assessing the solvency of a company whether public or privately held. Examples of difficult valuation questions include: would a company with a market capitalization of several hundred million dollars possibly be insolvent? Or, would publicly-traded debt at or near par be conclusive evidence that the issuer is solvent at the time? Or, would a company's inability to raise funds or maintain its investment grade rating at a given time be sufficient to rule on solvency?

It is common in valuation and solvency disputes to have qualified experts with very different opinions on the fair market value of a company, often using the same standard approaches of discounted cash flows and comparables. How would the courts or the arbitrators decide and what is the role of contemporaneous market evidence in such disputes? In this article, we discuss the role of market evidence and possible misinterpretations of such evidence and highlight recent court decisions in the United States.

We start with a few basic definitions. The fair market value is defined as the price at which an asset would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. The three standard valuation approaches are the discounted cash flow approach, the market comparables approach, and the asset approach. The discounted cash flow approach estimates the value of the business based on the present value of expected future cash flows. A market comparable approach estimates the value of a business using performance metrics of comparable companies such as earnings. The asset approach estimates the business value as the sum of the values of its tangible and intangible assets less any liabilities. There are three common measures of solvency. A company is deemed solvent at a given point in time if: 1) the fair market value of its assets exceeds the value of its liabilities; 2) it was adequately capitalized; and 3) it had the ability to pay its debts. Finally, market evidence can take various forms including equity prices, prices of debt and derivatives, ratings, contemporaneous projections of revenues, management projections, and analysts' recommendations, among others.

In the 2005 Campbell decision, the lower court ruled (and the appeals court later affirmed) that a spin-off entity was solvent as of the spin-off date based on the market capitalization of the subsidiary after the market has learned the truth about a set of business problems, principally allegations of trade loading (VFB LLC v. Campbell Soup Co., 336 B.R. 81 (D. Del. 2005) and VFB v. Campbell Soup Co., 482 F.3d 624, 633 (3d Cir. 2007).) This was the first time we are aware of that a bankruptcy court used equity prices as a substitute, not as a complement, to the traditional valuation approaches such as the discounted cash flow method. A court similarly ruled in the Iridium litigation that the company was solvent, citing its market capitalization, bond market evidence, and contemporaneous valuations by various market participants among other market evidence (In re Iridium Operating LLC, 373 B.R. 283 (Bankr. S.D.N.Y. 2007).) Bankruptcy courts have ruled on many solvency disputes since then, but there has not been a consensus on the weight and relevance of market evidence to the question of solvency.

The table below provides a summary of recent cases where the courts have ruled on solvency issues and preferred either the market evidence or traditional valuation methods and gave more weight to one approach versus the other in determining valuation and solvency.

As presented in the table above, "equity markets" refers to the use of common stock prices as a basis for the valuation of equity at a given point in time. "Debt markets" refers to the reliance on debt prices or yields and/or issuance of debt or other fixed income instruments as a measure of market's perception of the value and credit worthiness of an issuer. "Acquisition or auction" refers to the use of the value of a sale of a company or assets via an auction or other process while a company is in bankruptcy as an indication of its value. "Credit analysts" refers to the reliance on contemporaneous views of rating agencies and analysts as an indicator of the value and credit worthiness of an issuer. "Contemporary projections" refers to the use of contemporaneous valuations by various market participants including management, equity analysts, and investment advisors. Finally a "retroactive approach" is the use of traditional valuation techniques such as DCF and market comparables that were developed during litigation.

On the one hand, a court in the Southern District Court of New York ruled in 2011 that the fair market value for the Lehman broker-dealer is the transaction price that Lehman had agreed to with Barclays at the time. The court ruled that post market valuation methods do not address the relevant question of whether certain undisclosed facts and inaccurate estimates at the time of the transaction would have affected the judgment that the transaction price was fair (In re Lehman Brothers Holdings Inc., 445 B.R. 143 (Bankr. S.D.N.Y. 2011).) On the other hand, the US Bankruptcy Court for the Southern District of New York relied primarily in the Chemtura litigation on traditional valuation methods including the market comparables analysis and the discounted cash flow as compared to market evidence (In re Chemtura Corp., 439 B.R. 561, 586 n.106 (Bankr. S.D.N.Y. 2010).)

Notwithstanding the appeal of relying on the assessment of market participants at the relevant time and the absence of possible hindsight, market evidence has its own challenges, especially in the context of solvency litigation. Consider equity prices as an example. According to economic theory, equity prices reflect the present value of the future cash flow of a company in an efficient market. There are various forms of market efficiency, but the one most commonly used in this context means that the equity price would reflect all publicly available information. Thus, reliance on equity prices as a measure of the fair value in a case where there was rampant fraud (as in the case of Enron, for example) would not necessarily reflect the future cash flow of the company. The US courts have examined various factors to evaluate market efficiency, such as the level of trading volume and other measures of liquidity, the number of analysts following a stock, and the response of the stock price to news. And, the question of whether a market is efficient is determined on a case by case basis after conducting various economic and statistical analyses.

However, a positive market capitalization is not necessarily evidence of solvency without additional examination of the financial conditions of the company in question, among other factors. Equity can be thought of as an option to purchase the company for the value of the liabilities. Equity retains a positive value even if the market value of the assets falls below the value of the liabilities. This is similar to a call option having value even when the stock price is below the strike price, the price at which the option is to be exercised. Therefore, it is important to analyze the equity prices of a company in the context of all the other factors affecting the value of the company to avoid misinterpreting the market evidence.

In addition to evidence from the equity market, data from the bond markets — including pricing, spreads, credit ratings, and bond issuances — could inform the questions of solvency and creditworthiness. Again, in the Campbell litigation, for example, the court ruled that the company's ability to issue debt well after the spin-off was evidence of its credit-worthiness at the time of the spin-off. On the other hand, the bankruptcy court in the TOUSA decision found that the company's secured bond issuance was not indicative of solvency (In re TOUSA, Inc., 422 B.R. 783, 813–14 (Bankr. S.D. Fla. 2009).)

Once debt is issued, courts have also used debt prices to inform their decision on solvency. In support of its conclusion regarding Idearc's solvency, the US District Court, Northern District of Texas noted that Idearc debt traded at near par for six months following the spin-off (US Bank National Association vs. Verizon Communications, No. 10-1842, 2013 WL 230329 (N.D. Tex. 2013).) Also, the court in the TOUSA litigation explained that some TOUSA bonds were trading at $0.45 around the valuation date, consistent with its opinion that the company was insolvent or inadequately capitalized (TOUSA, pp. 20, 118). Debt could be trading below par for reasons that have to do with lack of liquidity or concerns about the industry as whole, for example, and not necessarily evidence of insolvency. Valuation experts would need to examine the market evidence of each case separately as there are no quick and fast rules about interpreting bond prices and spreads.

We provide a hypothetical example to illustrate the importance of fact-specific analysis when valuing a company. Consider an example where we need to value a company with a face value of $30 million of debt. For simplicity, let's assume that there were only two possible outcomes of a restructuring of this company at a given point in time. Therefore, there was a 50 percent chance the company was going to be a success after the restructuring and be worth $90 million; and a 50 percent chance the company was going to fail and be worth only $10 million after liquidation. In the case of success, the debt would be paid in full and worth its full $30 million, and the equity will be worth $60 million ($90-30 million). In the case of failure, the debt-holders will receive the $10 million, and the equity will be worthless. The following graphic illustrates the example.

In this example, the value of the company is $50 million (based on an equal weighting for scenarios in which it is worth $90 million or $10 million). The value of the debt is $20 million, a 33 percent discount to the face value, even though the value of the company is $50 million and the company is solvent. This example shows the importance of analyzing the market data including bond prices in context of the facts at issue. (Example is based on Investment Valuation, Aswath Damodaran (2002).)

The debate over the relevance of contemporaneous market evidence in solvency litigation continues as more data on the debt and equity become available. While reliance on market data varies in solvency disputes, it is important for experts to explain the reasons for not relying on market evidence when it is not consistent with their DCF estimates, for example. In addition, experts would also factor in various limitations including illiquidity and industry-wide events, among others, when interpreting market evidence.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions