Valuing Individual Assets Bundled Together In A Distressed Sale - Insolvency/Bankruptcy

This week's TGIF considers McCallum, Re Holdco Pty Ltd (Administrators Appointed) [No 2] [2021] FCA 377, a Federal Court decision that provides guidance on the approach to valuing different classes of assets when assessing competing entitlements of creditors to the net sale proceeds when a 'global' price for all assets was achieved.

Key takeaways

Each class of assets sold must be valued individually to determine the fair market value.
It will be necessary to consider whether the distressed nature of a sale may have affected particular classes of assets more or less than other classes, thereby affecting the relative value of each category.
When valuing a particular asset, evidence of a prior offer to buy the asset may be admissible but the offer may not give any indication of the asset's fair market value if one of the parties was distressed at the time.

Background

The plaintiffs were appointed as voluntary administrators on 29 January 2020 to certain entities in the Sargon Group which conducted a series of financial planning, corporate trustee, responsible entity, superannuation and related financial services businesses.

The administrators had previously obtained court orders under sections 442C and 447A of the Corporations Act 2001 (Cth) in a case examined in one of our earlier TGIF articles to sell certain assets of the Sargon Group over which third parties claimed security interests.

The administrators then completed a sale of the Sargon Group's assets to the Cloverhill Group. This included shares in certain subsidiary companies, intellectual property, plant and equipment and other assets, with the net sale proceeds totalling $29.6 million.

The case involved a number of 'interested parties', including Westpac and Sargon Capital, the ultimate holding company of the Sargon Group to which receivers had been appointed, who had security and other interests in specific assets.

These interested parties had previously agreed that the net sale proceeds be paid by the administrators into a controlled account to be apportioned by the Court across the different asset classes by reference to the relative value of each asset class to the total sale proceeds.

Decision

The main task before the Court was to assess the value of each of the separate asset classes given the global purchase price that had been paid.

The interested parties engaged different expert valuers (three in total) who used a range of different approaches to value each asset class, and it fell to the Court to determine the proper method of valuation.

Ultimately, his Honour Justice O'Bryan did not side entirely with any of the three valuers, preferring to rely on aspects of each of expert reports before him, in conjunction with his own calculations. Some of the more interesting aspects of the Court's assessment of value are outlined below.

Relationship between a distressed sale and fair market value

The Court rejected the argument that the sale price should be assumed to reflect the fair market value of the bundle of assets. It instead determined that it was a distressed sale given the administrators were concerned that if the sale to the Cloverhill Group did not proceed, certain subsidiaries would be in breach of their Registerable Superannuation Entity, Australian Financial Services and credit licences which would result in suspensions by APRA.

The Court then considered whether the reduction in value brought about by the distressed circumstances of the sale should be applied proportionately across all of the assets. It ultimately decided that it should, given the particular factual circumstances of the case.

The Court examined the negotiations that played out between the administrators and the purchaser concerning the sale of the intellectual property assets. The Court held that, despite the fact that the purchaser had expressly required the inclusion of the intellectual property for any sale to proceed, there was insufficient evidence that intellectual property was deemed to be more important than other asset classes by the purchaser and should be ascribed a higher value accordingly.

Evidence of a prior offer to buy an asset

The Court was asked to consider whether evidence of a prior offer to buy an asset could be used to set its fair market value. In this case, the administrators had made an offer to Sargon Capital to buy the intellectual property assets for $4 million.

Sargon Capital argued that this offer should set a lower bound on the fair market value of the intellectual property assets. Other interested parties argued to the contrary that High Court authority in McDonald v Federal Commissioner of Land Tax (1915) 20 CLR 231 (McDonald) precluded courts from looking at unaccepted offers to determine the value of an asset.

On this point, the Court ruled that McDonald is not authority for a blanket prohibition on evidence of unaccepted offers. Rather, the admissibility of evidence of such offers will depend on the particular facts and what exactly is sought to be proved.

In the present case, however, the Court rejected Sargon Capital's argument about the relevance of the prior offer. The administrators needed to acquire the intellectual property assets from Sargon Capital for the Cloverhill Group sale to go ahead. The Court deemed the offer made by the administrators to be more reflective of the need to prevent the wider transaction failing than the fair market value of those intellectual property assets.

For a prior offer to be said to determine the fair market value of an asset - being the price that would be paid by a willing but not anxious buyer to a willing but not anxious seller - evidence of an offer made by an anxious party, as the administrators were deemed to be, was held to have little if any probative value.

Proper approach to valuation of the shares in the subsidiary companies

His Honour stressed that the proper approach to valuing the subsidiaries is a highly fact-dependent question influenced by the type of asset, the nature of the available evidence, and the state of the market.

In this case, the Court accepted that a capitalisation of earnings methodology should be applied to determine the fair market value of the subsidiary companies.

However, the experts did not have any forecast financial information available to them on which to perform the usual calculations as to future maintainable earnings, and differed in their approach to adopting a capitalisation of 2019 calendar year earnings.

In assessing the reasonableness of the approaches adopted by the experts in the particular circumstances of this sale, the following points of dispute were determined by the Court:

when allocating the costs of centrally-procured services among the subsidiary companies, the costs should be allocated proportionally based on revenue rather than on an equal division between each company;
valuing each subsidiary based on a 10-times multiple of its earnings before interest and tax (EBIT) was to be preferred to a revenue-based calculation; and
valuing the subsidiaries based on the net value of its assets, where the EBIT multiple returned a negative value, was preferable to a capitalisation of revenue approach.

Comment

The valuation of individual asset classes sold as a bundle is a fact-intensive exercise, but this decision provides some guidance to the approach that may be adopted when assets are sold in distressed circumstances.

In cases of a distressed sale, evidence of unaccepted offers to buy an asset will have limited probative value in determining the fair market value of an asset.

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.