The determination of the appropriate “standard of value” when performing business valuations and other valuation related analyses for bankruptcy purposes is critical. While a standard of value is often specified, it is frequently the case that the specific standard of value is not well defined in either the Bankruptcy Code, applicable state statutes, or in judicial guidance. Further, the standard of value terminology used in valuations for bankruptcy purposes often differs from the terminology used for other (non-bankruptcy) purposes.
Traditional business valuations (those for purposes other than bankruptcy) are typically performed using one of the three basic standards of value: (1): fair market value, (2): fair value, or (3): investment value. While some might argue that a fourth standard of value – intrinsic value – is available to business appraisers and should be included among the typical, standards of value, use of this standard of value is rarely mandated by valuation guidance, statues, or law. Furthermore, intrinsic value (also referred to as fundamental value) is not as well defined as the other standards of value, and while mentioned in certain case law, such references rarely provide a specific definition of the standard. As such, intrinsic value is not addressed in this article.
The most recognized and accepted standard of value in relation to business and securities valuation in the U.S. is fair market value. Fair market value applies to nearly all federal and state income and corporate tax matters and is either the specified legal standard or guidepost of value for many other valuation purposes. Additionally, alternative standards of value are also frequently equated to their functional equivalents under fair market value. Although multiple definitions of fair market value exist, they are quite consistent and functionally almost identical.
The definition established for fair market value in tax regulations by Treasury Regulation Section 20.2031-1(b) is as follows:
The price at which the property 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.
A second definition of fair market value is available from the International Glossary of Business Valuation Terms as:
[T]he price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
Yet a third definition of fair market value is provided within Section 3(18) (B) of the Employee Retirement Income Security Act wherein adequate consideration in the case of an asset for which there is no generally recognized market (e.g., stock of a closely held corporation) is defined as the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with the regulations promulgated by the Secretary of Labor. The term “fair market value” is defined in proposed section 2510.3-18(b) (2) (i) as follows:
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, and both parties are able, as well as willing, to trade and are well-informed about the asset and the market for that asset.
It is widely recognized that these definitions are in general agreement, particularly in regard to their common references to (i) willing buyers and sellers, (ii) lack of compulsion, and (iii) reasonable knowledge of relevant facts. While International Glossary of Business Valuation Terms definition includes reference to (i) the hypothetical nature of the parties to the exchange, (ii) the arm’s length nature of the exchange, and (iii) an open and unrestricted market, it is widely held that these differences in the definitions are immaterial in most situations. As such, while three commonly used definitions exist, fair market value is the most well and consistently understood of the standards of value.
The fair value standard of value is also commonly used by business appraisers. Unlike fair market value, however, fair value’s different definitions are intentionally fashioned for different purposes. Within one purpose (financial reporting), the application of fair value is quite consistent due to now well-established standards codifications issued by the Financial Accounting Standards Board (“FASB”). In the broader legal and financial environment, the definition and or application of fair value can vary significantly from one state to another.
Within the American Institute of Certified Public Accountants’ (AICPA) Statements on Standards for Valuation Services (SSVS), fair value is described as having two commonly used, albeit distinctly different definitions.
For financial reporting purposes, fair value is defined under the FASB’s Accounting Standards Codification (ASC) glossary as:
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
This definition is further discussed in ASC 820 as the price being based upon a hypothetical transaction for the subject asset or liability at the measurement date, considered from the perspective of a market participant. According to ASC 820, a market participant is: (i) an unrelated party, (ii) knowledgeable of the subject asset or liability, (iii) able to transact, and (iv) motivated but not compelled to transact.
This standard of value and the definition for this standard of value is universally used for financial accounting purposes within the U.S. Although quite similar to the definitions for fair market value in many respects, the definition of fair value for financial reporting purposes has distinct differences from the definitions for fair market value – particularly in the application of the market participant perspective.
In many states, fair value is the standard of value applicable by statute in regard to cases involving dissenting shareholder rights and is frequently used state minority oppression cases.[1] However, in these settings there may be no single definition or understanding of the fair value standard of value. Alternatively, or as an adjunct to ambiguous state statues, legal precedent may provide the primary guidance for defining fair value.
Investment value is much less commonly utilized by valuation practitioners than fair market value, or fair value. Unlike fair market value and fair value, investment value is rarely a required standard of value. It is most often used to support merger and acquisitions, or other business transaction related matters.
While there is more than one definition of investment value, they are generally considered to be materially similar in meaning, albeit in part due to the definitions’ intentional lack of specificity.
The International Glossary of Business Valuation Terms defines investment value as:
[T]he value to a particular investor based on individual investment requirements and expectations.
Note the intentional generalities and lack of constraints relative to the definitions of fair market value and the definition of fair value in regard to financial reporting matters.
Similarly, albeit somewhat longer, in real estate terminology investment value is defined as:
The specific value of an investment to a particular investor or class of investors based on individual investment requirement; distinguished from market value, which is impersonal and detached.[2]
These two definitions of investment value are generally considered to be equivalent.
As with fair value, the legal terminology describing the applicable standard of value for bankruptcy is not clearly defined in the U. S. Bankruptcy Code, or in applicable state statutes.[3] Unlike standards of value outside of bankruptcy, standards of value within bankruptcy are numerous, lacking in clarity, and inconsistent. Among the standards of value for bankruptcy purposes referenced in the Forensic & Valuation Services Practice Aid – Providing Bankruptcy and Reorganization Services, 2nd Edition Volume 2 — Valuation in Bankruptcy (F&VSPA) are:[4]
The sources for these standards of value include the U.S. Bankruptcy Code, The Uniform Fraudulent Transfer Act (UFTA), and The Uniform Fraudulent Conveyance Act (UFCA). Guidance as to the definitions for these terms, or the application of the terms, are minimal, and often nonexistent, within the Code, the UFTA, or the UFCA. Guidance as available within the Code, the UFTA, or the UFCA is as follows:[5]
Section 101(32) of the U.S. Bankruptcy Code defines insolvency as a:
…financial condition such that the sum of such entity’s debt is greater than all of such property, at a fair valuation…
Fair valuation in this context is generally interpreted by bankruptcy case law, albeit not specifically defined, as fair market value.[6]
Within the UFTA, Section 2(a) indicates, “A debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation.” The UFTA provides no definition of fair valuation, however, fair valuation is frequently analyzed similarly to fair market value when evaluating solvency.[7]
Section 548 of the U.S. Bankruptcy Code explains that a fraudulent transfer has occurred if a debtor has “received less than a reasonably equivalent value in exchange for such transfer or obligation.” No definition of reasonably equivalent value is provided, although the Code does define value to mean “property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor.”[8]
The F&VSPA indicates that the courts have historically considered fair market value exchanged when evaluating reasonably equivalent value.[9] However, the U.S. Supreme Court has noted that, reasonably equivalent value is not always evaluated against a fair market value benchmark.[10]
When evaluating whether a transfer was fraudulent to present and future creditors the UFTA considers whether “a reasonably equivalent value [was] exchange[d] for the transfer or obligation.”[11] The fair market value of the assets or debt exchanged is commonly considered. However, as previously referenced in regard to the U.S. Supreme Court, reasonably equivalent value is not always evaluated against a fair market value benchmark.[12]
The U.S. Bankruptcy Code mandates that a Chapter 11 plan must be fair and equitable to all holders of secured claims. In circumstances where the debtor’s reorganization plan is accepted over the objections of a secured creditor, the court must ensure the plan provides that secured creditors receive the indubitable equivalent of their respective claims.[13]
Section 2(1) of the UFCA includes a reference to the present fair saleable value of assets in considering insolvency. Some jurisdictions have interpreted present fair saleable value to be similar to fair market value, although other jurisdictions have taken a position whereby the present fair saleable value standard imposes a reduced marketing period.[14]
UFCA’s Section 3 indicates that fair consideration is given for property or an obligation
Therefore, fair consideration is characterized as a good faith transfer whereby the debtor receives reasonably equivalent value.[15] The fair market values exchanged are commonly used when evaluating fair consideration in states that have adopted the UFCA, as they are under the Bankruptcy Code.[16]
There is simply no clear standard of value that can be universally relied upon in the context of bankruptcy proceedings. Standard of value terminology, definitions, and guidance within the bankruptcy realm are significantly lacking in comparison to that available to business appraisers engaged in tax and financial reporting related matters. In the absence of clear standard of value definitions and guidance, precedent must often be relied upon. It is therefore crucial in bankruptcy endeavors that a business appraiser have knowledge of these standard of value considerations and work closely with experienced bankruptcy attorneys in order to apply the correct standard of value to best serve their client.
[1] Valuing a Business, 5th edition (Pratt, Reilly, Schweihs), p. 45
[2] The Appraisal of Real Estate, 11th edition (Chicago Appraisal Institute, 1996), p. 638.
[3] Forensic & Valuation Services Practice Aid – Providing Bankruptcy and Reorganization Services, 2nd Edition Volume 2 — Valuation in Bankruptcy
[4] Ibid.
[5] Ibid.
[6] See Andrew Johnson Properties, Inc., CCD Dec. ¶ 65, 254 (D.C. Tenn. 1974); Briden v. Foley, 776 F.2d 379, 382 (1st Cir. 1985)
[7] F&VSPA
[8] F&VSPA
[9] Barber v. Golden Seed Co., 129 F.3d 382, 387 (7th Cir. 1997)
[10] BFP v. Resolution Trust Corp., 511 U.S. 531, 548 (1994).
[11] UFTA Sections 4(a)(2) and 5(a).
[12] BFP v. Resolution Trust Corp., 511 U.S. 531, 548 (1994).
[13] USC 1129(b)(2)(A).
[14] F&VSPA
[15] HBE Leasing Corp. v. Frank, 48 F.3d 623, 633 (2d Cir. 1994).
[16] F&VSPA
