Accounting for COVID-19 in Valuation
The Bankruptcy Court Weighs-in In Re: Body Transit, Inc.
The Bankruptcy Court of the Eastern District of Pennsylvania In re: Body Transit, Inc. addressed how COVID-19 impacts valuations. On August 7, 2020, the Court heard and decided the case. This case proceeded under the Small Business Reorganization Act (SBRA) whereby the debtor’s objection to a creditor’s election to have its claim treated as fully secured under 11 U.S.C.S § 1111 (b) was sustained, and the claim was bifurcated into both secured and unsecured components to be treated according to the reorganization plan. The question of how to value a fitness club in the context of COVID-19, and the economic uncertainty that comes along with it, was the central theme of this case.
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The Bankruptcy Court of the Eastern District of Pennsylvania In re: Body Transit, Inc. addressed how COVID-19 impacts valuations. On August 7, 2020, the Court heard and decided the case. This case proceeded under the Small Business Reorganization Act (SBRA) whereby the debtor’s objection to a creditor’s election to have its claim treated as fully secured under 11 U.S.C.S § 1111 (b) was sustained, and the claim was bifurcated into both secured and unsecured components to be treated according to the reorganization plan. The question of how to value a fitness club in the context of COVID-19, and the economic uncertainty that comes along with it, was the central theme of this case.
Both parties’ valuation experts disagreed on the extent that COVID-19 had on the value of the business. The creditor’s expert failed to account for the current market condition due to the pandemic. The debtor’s expert valued the company based on a liquidation value of its intangibles. The Court rejected both experts’ valuations and performed its own.
Facts of the Case
The debtor owned three fitness studios in Pennsylvania and filed for Chapter 11 bankruptcy in January 2020. He asked the Court to proceed under SBRA and the Court had granted the motion. Two locations would remain closed; however, the debtor wanted to reorganize one of the fitness centers and he filed a Chapter 11 reorganization plan for one of the locations. In response to this bankruptcy filing, First Bank, which had an unpaid balance of $970,000, filed a claim to position itself as a secured creditor. The debtor objected to this election and, under its reorganization plan, offered to treat the bank as a secured creditor, but only up to $317,000. The debtor argued that the bank’s interest in the property is of “inconsequential value” and the bank argued that the value of its lien was not of “inconsequential value” when compared to the value of the creditor’s collateral. The Court found that the “inconsequential value” did not mean a “zero” value and that the Court would decide the value of First Bank’s secured position within the debtor’s assets.
Valuation According to the Debtor’s Expert
According to the debtor’s valuation analyst, due to the COVID-19 pandemic, the debtor could not sell the business as a going concern and its only value was in liquidation. His opinion was based on his views as he sees the fitness industry as it currently is. He also states that a traditional discounted cash flow analysis would not offer an accurate valuation because the historical data had lost its predictive power due to the COVID-19 pandemic. He emphasized two points: 1) that the ongoing operations of the fitness center could continue to operate in a limited capacity and 2) the need for significant funds to cover this shortfall. A fitness broker who did inspect the equipment found it to be worth $28,000–$30,000.
Valuation According to the Creditor’s Expert
The creditor had two experts, an appraiser of the fitness equipment and an appraiser for the business. The equipment appraiser offered a very brief and conclusory testimony. His report was a “desktop appraisal”, which is defined as “an expert’s opinion of value based on limited information and assumptions … and a limited appraisal of market conditions”. He did not inspect the equipment and relied entirely on the information provided by First Bank. Nowhere in his report is there a discussion or analysis of the research data he used. He valued the equipment at a worth of $130,000.
The business appraiser relied on several documents, including the 2018 tax return of the debtor, the reorganization plan, and the debtor’s disposable income projections that were filed with the Court on April 22, 2020. He opined that the value was $170,000 using a market approach—of that, $125,725 was the value attributable to the tangible assets. He considered two rules of thumb applicable to the fitness center and looked at sales of 30 fitness studios and yoga businesses between January 2019 and March 2020 and concluded that the median value was 60% of net sales. He assigned a weight to the SDE from historical data and stated that COVID-19 did have an impact on the value; however, the stock market recovered most of its losses. He is quoted as saying, “While uncertainty exists, there is optimism on the recovery.”
He applied pre-COVID-19 multipliers but used a 30% discount rate because of the uncertainty of the company achieving the presumed level of performance.
What does the Court Say?
The Court said that the value needs to consider the purpose and the proposed use of the property. Because the debtor intends to use the assets in the reorganization, the Court could not agree on the use of the liquidation value used by the debtor’s expert.
The Court further noted that the creditor’s expert did not fully consider the economic condition of the industry and the effects of COVID-19. The Court also could not buy into the nexus between the stock market recovery and the state of the fitness industry. The Court is quoted as saying, “It is not presently possible to project when public health and market conditions will support the growth of business revenue the debtor posits as the foundation for its reorganization.”
The Court stated it was unlikely that an investor would buy the debtor’s business as a going concern except at a substantial discount. Per the Court, neither side’s experts’ position was satisfactory, and both failed to factor in the impact of the pandemic as it relates to the valuation. The Court concluded that a buyer would be willing to pay $50,000 over the $30,000 value of the tangible assets. The Court found that the creditor’s interest in the debtor’s assets was worth $80,000, which did qualify as inconsequential when related to the total claim of $970,000 and, therefore, the Court said First Bank was precluded from making a § 1111 (b) election.
Kimberly Tavares, CVA, is the founder of PacWest Accounting, Inc., a full-service accounting/litigation support firm that provides outsourced CFO advisory services as well as business valuation and forensic accounting services. She has served as an expert witness in San Diego and Orange counties in California. She has more than 18 years of experience preparing valuations in numerous industries, including technology, construction, health care, professional services, trucking, and manufacturing. Ms. Tavares graduated from California State University Fullerton with a BA in accounting. She is CFO of the Newport Beach Chamber of Commerce Board of Directors, a 2016 NACVA/CTI 40 Under Forty honoree, and a nominee for the Connected Women of Influence 2018 President’s Award and the 2016 and 2018 Orange County Business Journal Women in Business Award.
Ms. Tavares can be contacted at (949) 873-3126 or by e-mail to Kim@pacwestaccounting.com.
