Best Practices for Bankruptcy-Related Property Appraisals

Part IV of IV

This article is the fourth (Read Part I, Part II, and Part III) and final part of a series related to the development of—and the reporting of—a bankruptcy-related appraisal of debtor company industrial or commercial property. This part considers (1) the valuation synthesis and conclusion process and (2) the reporting of the bankruptcy-related property appraisal.

Introduction

Property appraisals are a common element of most commercial bankruptcy proceedings. For purposes of this discussion, the term property includes real estate and real property, tangible personal property, and intangible personal property. This discussion is intended for valuation specialists (herein called “appraisers”) who practice in each of the appraisal disciplines.

This series of articles is intended to summarize what appraisers, parties-in-interest to a commercial bankruptcy, and their legal counsel need to know about the property appraisal process.

This article is the fourth and final part of a series related to the development of—and the reporting of—a bankruptcy-related appraisal of debtor company industrial or commercial property. This part considers (1) the valuation synthesis and conclusion process and (2) the reporting of the bankruptcy-related property appraisal.

Value Synthesis and Conclusion

In the value synthesis and conclusion procedure of the debtor company property appraisal, the appraiser considers the following question: Does the selected property appraisal approach(es) and method(s) accomplish the appraiser’s assignment?

That is, does the selected approach and the selected method quantify the intended objective of the debtor company property analysis, such as:

• A defined value,
• A transaction price,
• A third-party license rate,
• An arm’s-length intercompany transfer price,
• A damages measurement,
• A property bundle exchange ratio, or
• An opinion on the property transaction fairness.

Regarding a bankruptcy-related property appraisal, the appraiser also considers if the selected appraisal approach and method analyzes the appropriate property bundle of legal rights. The appraiser also considers if there were sufficient empirical data available to perform the selected appraisal approach and method.

The value synthesis considers if there were sufficient data available to make the appraiser comfortable with the analysis conclusion. The appraiser may also consider if the selected appraisal approach and method will be understandable to the intended audience for the bankruptcy-related property appraisal.

The appraiser also considers which appraisal approaches and methods deserve the greatest consideration with respect to the debtor company property’s expected UEL. The subject property’s expected UEL is an important consideration in each appraisal approach.

In the income approach, the expected UEL affects the projection period for the property income subject to either yield capitalization or direct capitalization.

In the cost approach, the expected UEL affects the total amount of obsolescence, if any, from the estimated cost measure—whether that be the property reproduction cost new, replacement cost new, or historical cost.

In the market approach, the expected UEL affects the selection, rejection, and/or adjustment of the comparable or guideline sale, lease, or license transactional data.

The following factors influence the appraiser’s consideration of the debtor property’s expected UEL:

• Physical factors
• Legal factors
• Contractual factors
• Functional factors
• Technological factors
• Economic factors
• Analytical factors

Each of these factors is normally considered in the appraiser’s UEL estimation. Typically, the life factor that indicates the shortest UEL conclusion typically deserves the primary consideration in the bankruptcy-related value synthesis and conclusion.

Ultimately, the appraiser applies professional judgment to weigh the various appraisal approach and method value indications in order to reach a final value conclusion. The appraiser’s weighting of the value indications (whether quantitative or qualitative) is based on:

• The property appraiser’s confidence in the quantity and quality of available data,
• The property appraiser’s level of due diligence performed on those data,
• The relevance of the appraisal method to the debtor company property’s life cycle stage and degree of marketability, and
• The degree of variation in the range of the value indications.

Based on the value synthesis, the debtor company property final value conclusion can be (1) a point estimate (which is typical for fair market value property appraisals) or (2) a value range (which is typical for transaction negotiations or proposed license/lease/sale transaction fairness opinions).

Attributes of an Effective Bankruptcy Appraisal Report

There are numerous objectives of any property appraisal report that is prepared within a bankruptcy environment. These objectives apply whether the bankruptcy appraisal relates to the debtor company real estate, tangible personal property, or intangible personal property.

First, the appraiser wants to persuade the appraisal report reader (whether the reader is a potential transaction participant, the DIP management, a creditor, counsel for any party, a judge or other judicial finder of fact, etc.).

And second, the appraiser wants to defend his or her property value conclusion.

To accomplish these objectives, the content and the format of the property appraisal report should demonstrate that the appraiser:

1. Understood the specific property appraisal assignment;
2. Understood the debtor company property’s and the subject property’s bundle of legal rights;
3. Collected sufficient debtor company financial and operational data;
4. Collected sufficient industry, market, and competitive data;
5. Documented the specific property’s economic benefits to the debtor company;
6. Performed adequate due diligence procedures related to all available data;
7. Selected and applied all applicable income approach, market approach, and cost approach appraisal methods; and
8. Reconciled all value indications into a final value conclusion.

The final procedure in the entire bankruptcy-related analysis is for the appraiser to defend the value conclusion in a replicable and well-documented property appraisal report.

The written property appraisal report will typically:

• Explain the debtor company property appraisal assignment,
• Describe the debtor company subject property and the subject bundle of legal rights,
• Explain the selection of (and the rejection of) all generally accepted property appraisal approaches and methods,
• Explain the selection and the application of all specific appraisal procedures,
• Describe the appraiser’s data gathering and due diligence procedures,
• List all the documents and data considered by the property appraiser,
• Include copies of all documents that were specifically relied on by the property appraiser,
• Summarize all the qualitative appraisal analyses developed,
• Include schedules and exhibits documenting all of the quantitative appraisal analyses developed,
• Avoid any unexplained or unsourced appraisal variables or appraisal assumptions, and
• Allow the appraisal report reader to be able to replicate all of the appraisal analyses developed.

To encourage the reader’s acceptance of the appraisal report conclusion, the property appraisal report should be:

• Clear, convincing, and cogent;
• Well-organized, well-written, and well-presented; and
• Free of grammatical, punctuation, spelling, and mathematical errors.

In summary, the effective (i.e., persuasive) debtor company property appraisal report will tell a narrative story that:

1. Defines the property appraiser’s assignment;
2. Describes the property appraiser’s data gathering and due diligence procedures;
3. Justifies the property appraiser’s selection of the generally accepted property appraisal approaches, methods, and procedures;
4. Explains how the property appraiser developed the value synthesis and reached the final value conclusion; and
5. Defends the property appraiser’s property value conclusion.

Summary and Conclusion

Due to the impact of recent economic factors, some industrial and commercial company managements may consider the implications of a bankruptcy filing, particularly a Chapter 11 reorganization filing. Typically, the intention of such a bankruptcy filing is that it would allow the debtor company to reorganize and to emerge from bankruptcy protection with (1) a lower-cost capital structure and (2) a lower-cost operating expense structure.

Property appraisals are a common element within most commercial bankruptcy proceedings. The first of this four-part article described many of the reasons for conducting a property appraisal within a bankruptcy context. This second part of the series summarized the bankruptcy-related property appraisal process. The third part of this series summarized the generally accepted property appraisal approaches and methods that are typically applied within a bankruptcy environment. And this final part of the series considered (1) the valuation synthesis and conclusion process and (2) the best practices for the reporting of the bankruptcy-related property appraisal.

This discussion considered the various types of debtor company property analyses that an appraiser may be retained to develop within a commercial bankruptcy environment. For purposes of this discussion, the term property includes the debtor company real estate and real property, tangible personal property, and intangible personal property.

For all debtor company property appraisals, it is a best practice for the appraiser to consider all the generally accepted property appraisal approaches—including the cost approach, the market approach, and the income approach. Each of these property appraisal approaches has the same objective: to arrive at a defined value indication for the debtor company’s property.

Within each of the generally accepted appraisal approaches, there are generally accepted appraisal methods and procedures that may be appropriate for the debtor entity property appraisal assignment. As a best practice, the appraiser’s selection of the specific appraisal approaches, methods, and procedures for the debtor company’s property is based on:

1. The characteristics of the debtor company property,
2. The specific bundle of legal rights subject to appraisal,
3. The quantity and the quality of available data,
4. The property appraiser’s ability to perform sufficient due diligence related to that data,
5. The purpose and the objective of the specific appraisal, and
6. The relevant professional experience and the informed judgment of the individual property appraiser.

The final value conclusion is typically based on the appraiser’s synthesis of the value indications from each applicable property appraisal approach and method.

The generally accepted appraisal approaches, methods, and procedures summarized in this discussion are generally relevant to bankruptcy-related property appraisals performed for transaction, financing, strategic planning, taxation, accounting, litigation, and other purposes. Accordingly, it is a best practice for both the client party-in-interest (and the client’s legal counsel) to the bankruptcy proceeding to be familiar with the generally accepted property appraisal approaches and procedures for purposes of:

1. Selecting the appropriate appraiser,
2. Relying on the appraiser’s value conclusion, and
3. Defending the appraiser’s value opinion and appraisal report.

This four-part article summarized what the appraiser, the debtor company management, the various parties-in-interest to the bankruptcy, and the legal counsel to the parties need to know about property appraisals developed within a bankruptcy environment.

The opinions and materials contained herein do not necessarily reflect the opinions and beliefs of the author’s employer. In authoring this discussion, neither the author nor Willamette Management Associates, a Citizens Company, is undertaking to provide any legal, accounting or tax advice in connection with this discussion. Any party receiving this discussion must rely on its own legal counsel, accountants, and other similar expert advisors for legal, accounting, tax, and other similar advice relating to the subject matter of this discussion.

---

Robert Reilly, CPA, ASA, ABV, CVA, CFF, CMA, is a Managing Director in the Chicago office of Willamette Management Associates, a Citizens company. His practice includes valuation analysis, damages analysis, and transfer price analysis.

Mr. Reilly has performed the following types of valuation and economic analyses: economic event analyses, merger and acquisition valuations, divestiture and spin-off valuations, solvency and insolvency analyses, fairness and adequacy opinions, reasonably equivalent value analyses, ESOP formation and adequate consideration analyses, private inurement/excess benefit/intermediate sanctions opinions, acquisition purchase accounting allocations, reasonableness of compensation analyses, restructuring and reorganization analyses, tangible property/intangible property intercompany transfer price analyses, and lost profits/reasonable royalty/cost to cure economic damages analyses.

Mr. Reilly has prepared these valuation and economic analyses for the following purposes: transaction pricing and structuring (merger, acquisition, liquidation, and divestiture); taxation planning and compliance (federal income, gift, estate, and generation-skipping tax; state and local property tax; transfer tax); financing securitization and collateralization; employee corporate ownership (ESOP employer stock transaction and compliance valuations); forensic analysis and dispute resolution; strategic planning and management information; bankruptcy and reorganization (recapitalization, reorganization, restructuring); financial accounting and public reporting; and regulatory compliance and corporate governance.

Mr. Reilly can be contacted at (773) 399-4318 or by e-mail to RFReilly@Willamette.com.