Chapter 9 Valuation of Special Properties and Industries

• Jurisdiction: United States

Chapter 9: Valuation of Special Properties and Industries

A. Health Care or Pharmaceutical Company Valuation

In the last few years, there have been a number of bankruptcy filings related to companies in the health care services, the medical and surgical products, and the pharmaceutical products industries. While the recent number of bankruptcy filings in these industry segments is less than the record numbers of annual filings in the late 2000s, the recent data indicate that there are still a number of health care industry-related filings. A number of industry factors may contribute to these health care, medical products, and pharmaceutical industry bankruptcies. These industry factors include the gradual rate of the recovery of the economy since 2008, an increase in foreign competition, overcapacity (and the related price competition) in the domestic market segments, price pressures due to public and private insurer reimbursements, continually increasing R&D expenditure requirements, and the increasing costs of debt and equity financing. It also seems likely that anticipated legislative changes to the Affordable Care Act in 2017 and beyond by the incoming Trump Administration and the Republican-controlled Congress will only increase financial pressures on already troubled health care, medical product, and pharmaceutical industry companies.

The bankruptcy of a health care or pharmaceutical company often involves the valuation of the assets, properties and business interests included in the bankruptcy estate. This discussion summarizes some of the bankruptcy-related reasons for conducting a valuation of the health care, medical products, or pharmaceutical company business or assets. This discussion does not provide a comprehensive listing of all of the reasons to conduct a bankruptcy valuation. This discussion also summarizes some of the industry-specific factors that the analyst should consider in the bankruptcy valuation of a health care, medical products, or pharmaceutical company.

Reasons to Conduct the Debtor Company Valuation

Adequate Protection of Creditor's Security Interests

Under the Bankruptcy Code, a creditor with a secured claim is entitled to adequate protection of the property interests when that creditor requests relief from the § 362 automatic stay. Immediately after the bankruptcy petition, the § 362 automatic stay generally bars all debt-collection efforts against the debtor company in the bankruptcy estate. Adequate protection for the creditor property interest is also required before the DIP or the bankruptcy trustee can use, sell or lease certain kinds of collateral.

One of the provisions related to creditor "adequate protection" concerns the value of the creditor's collateral. If the value of the creditor's collateral property is expected to decrease during the bankruptcy proceedings, then the bankruptcy trustee may be required to make payments to the creditor in order to provide for that adequate protection. However, with regard to this creditor collateral valuation, the Code does not specify either (1) what valuation approaches or methods are appropriate or (2) what valuation date is appropriate.

"Splitting" Undersecured Creditor Claims

This claims "splitting" procedure occurs when the fair market value of a secured creditor's claim is less than the amount of the creditor claim. In that event, the creditor claim is effectively divided into two parts: (1) a secured claim to the extent of the collateral actual value and (2) an unsecured claim to the extent of the collateral value deficiency. This collateral property valuation typically considers both (1) the current use of the collateral property and (2) the proposed disposition and use of the collateral property.

Under the Code, the determination of the factors that affect collateral value may relate to either (1) the disposition or use of the subject collateral assets or (2) the proposed reorganization plan affecting the creditor's security interest. The collateral valuation may affect the creditor's voting power to accept or reject a proposed reorganization plan. In addition, the collateral valuation may affect the amount of distributions made to the creditor under the proposed plan of reorganization.

Determining Debtor Company Insolvency

The debtor company insolvency is a required condition for certain actions under the Code. For example, one condition for certain payments to creditors to be considered preference items or fraudulent transfers (and therefore voidable) is that the debtor company is insolvent at the time of the transfer. Under the Code, the term "insolvent" means that the debtor company's liabilities exceed the debtor company's assets, at fair value (exclusive of fraudulent transfers), at the time of the transfer. Accordingly, the determination of insolvency requires a valuation of both the debtor company's assets (both tangible and intangible) and an analysis of the debtor company's liabilities (both recorded and contingent). The solvency-related valuation is typically performed as of the date of the alleged preference payment or fraudulent transfer.

An explanation of § 547 (for preference items) and § 548 (for a fraudulent conveyance) is beyond the scope of this discussion. Analysts who perform solvency analyses related to preference payment or fraudulent-transfer claims should review §§ 547 and 548.

Determining the Best Interest of a Creditor under Chapter 11

Under the Code, a creditor will either accept a plan of reorganization or receive/retain property under a reorganization plan that is not less than the amount the creditor would receive/ retain if the debtor were in liquidation. The appropriate valuation date for this purpose is the effective date of the plan of reorganization. With regard to determining the best interest of the creditor, valuations are typically performed under the premise of value in exchange on an orderly disposition basis — and not under the premise of value in exchange on a forced-liquidation basis.

For this purpose, the premise of value in exchange (as compared to the premise of value in use) is usually used to determine whether the plan of reorganization (as compared to a liquidation plan) is in the best interest of the creditors. However, the valuation premise of value in continued use, as a going concern, is usually used in determining whether a creditor class should accept or reject the proposed plan of reorganization.

Determining whether a Proposed Plan of Reorganization Is Fair and Equitable to a Dissenting Creditor Class in Chapter 11

To determine whether a proposed reorganization plan is fair and equitable to a dissenting creditor class, values are typically determined for the creditors' security interest. In addition, the present value of expected future payments under the proposed plan of reorganization is typically quantified. The present value of the expected future payments is typically determined by discounting the dollar amounts expected to be received under the proposed reorganization plan to a present value.

If the existing shareholders are to receive nothing under the proposed plan of reorganization, then a valuation of the debtor company equity may be required. This valuation is used to demonstrate that the existing stockholders have no equity left in the debtor company.

Alternatively, assume that the existing shareholders will have control of the debtor company after the bankruptcy. In that case, the shareholders either demonstrate that the unsecured creditors will retain or receive property with a present value equal to the amount of their unsecured claims (to satisfy the "absolute priority rule") or contribute sufficient new value to repurchase control of the debtor company.

In addition, the debtor company's equity value is typically important to the determination of whether the proposed plan of reorganization is eligible for a "cramdown." A "cram-down" occurs when the court confirms the chapter 11 (or chapter 12 or 13) plan or reorganization notwithstanding opposition from the creditors.

Determining the Feasibility of the Proposed Plan of Reorganization

The feasibility of the proposed plan of reorganization relates to the soundness of the proposed capital structure of the debtor company. The proposed reorganization plan feasibility also relates to whether the debtor has a reasonable prospect for financial recovery.

Confirmation of the proposed plan may not be approved by the court if the reorganization plan is likely to be followed by (1) the liquidation of the debtor company or (2) the need for further financial reorganization of the debtor company. Accordingly, a debtor company valuation may be required to demonstrate the feasibility (or reasonableness) of the proposed plan of reorganization.

Bankruptcy Estate Property of Inconsequential Value

The concept of inconsequential value is important in several bankruptcy-related instances. A secured creditor will lose its election to forgo the unsecured deficiency claim in exchange for considering all of the claims secured in a chapter 11 proceeding (the so-called "§ 1111(b)(2) election"). This situation occurs if the secured creditor's interest in the debtor's property is of an "inconsequential value."

The trustee may abandon (or may be required to abandon) property of the bankruptcy estate that is of "inconsequential value" to the estate. Accordingly, a valuation of the debtor company assets may be required to demonstrate which debtor assets are of "inconsequential value."

Planning Corporate Transactions During the Bankruptcy Proceeding

Debtor company valuations may be needed in situations where the DIP (or trustee) is planning a significant corporate transaction, such as a merger or acquisition. Similarly, when assets of the bankruptcy estate are to be transferred in other than an arm's-length transaction, a valuation of the debtor company's assets may be necessary. Valuation issues often arise during a § 363 sale of...