The ultimate goal in the determination of the proper amount of damages is the ascertainment of "just compensation" to the injured party. Said another way, the goal of damages is to put the injured party back in the position they would have been in "but-for" the harmful acts. When assessing damages in the litigation arena, the concept of value or lost value often plays a key role in this assessment.

Starting at the most basic level, the Oxford Dictionary defines value as "the regard that something is held to deserve; the importance, worth, or usefulness of something." This definition only serves as a starting point though, as it does not indicate how such "regard" is measured or who makes that assessment.

From a financial standpoint, the definition of value or standard of value used can vary from situation to situation according to the purpose of the valuation exercise.1 Value can be defined using a number of different, more specific, terms including the following:

  • Fair Market Value
  • Fair Value
  • Market Value
  • Investment Value
  • Intrinsic Value

FAIR MARKET VALUE

In litigation, the standard of value most often utilized is Fair Market Value. However, Fair Market Value can be defined a number of different ways. The definition typically used in U.S. federal courts is as follows:

The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.2

In Canada, the Canada Revenue Agency defines Fair Market Value slightly differently:

[T]he highest price, expressed in dollars, that property would bring in an open and unrestricted market, between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other.3

Notably, the Canadian definition indicates that Fair Market Value is the "highest price," which arguably may result in a higher value than the U.S. definition, which does not qualify the term "price" in its definition.

In most international arbitrations, yet another, slightly different definition of Fair Market Value is utilized:

[T]he estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.4

This definition makes reference to the amount being "after proper marketing," which the American and Canadian definitions do not directly address. Clearly, two parties in litigation may differ in opinion as to what constitutes "proper marketing."

To add yet another definition, the World Bank defines Fair Market Value as:

[A]n amount that a willing buyer would normally pay to a willing seller after taking into account the nature of the investment, the circumstances in which it would operate in the future and its specific characteristics, including the period in which it has been in existence, the proportion of the tangible assets in the total investment and other relevant factors pertain to the specific circumstances of each case.5

The World Bank definition notes that the "specific characteristics" of the investment and the "specific circumstances of each case" should be considered when determining the Fair Market Value. While this component is not found in any of the previous definitions, it does tie back nicely to the goal of damages assessment because considering the specific circumstances of a case should better capture "just compensation" to the injured party. The World Bank definition also includes an assessment of the period of time the underlying business or asset "has been in existence." Clearly, this is a reference to the New Business Rule, which considers the certainty, or lack of certainty, of an entity's future profits.

While each definition of Fair Market Value above differs, the following key terms can be found in each definition:

  • Willing buyer and willing seller that are independent of each other
  • Arm's length transaction
  • No compulsion to buy or sell
  • Both sides are knowledgeable and prudent of the relevant facts as of the valuation date

Regardless of the commonalities and differences in these definitions of Fair Market Value, facts and circumstances specific to the parties, ex-post information, and other market considerations may cause two experts to offer differing opinions on Fair Market Value by arriving at dramatically different values. For example, the treatment of the following situations can result in substantially different valuation results by two experts who are both opining on Fair Market Value:

  • If the value requires significant future investment, how do you consider the ability of the plaintiff/claimant to fund that investment? Is it enough to assume that a "hypothetical buyer" would be able/willing to make the investment? Does the investor have access to capital outside of operating cash flows?
  • Do you consider significant events that occurred after the date of harm (valuation date)? For example, if the events of the COVID-19 pandemic significantly impacted the subject asset, should that be factored into the Fair Market Value even though the valuation date was prior to the pandemic outbreak? Certain courts have allowed subsequent events to be considered when calculating value for purposes of damages.6 Other courts have allowed the consideration of subsequent information in order to test the reasonableness of ex-ante information utilized in a valuation.7 In U.S. federal courts, the use of subsequent information is referred to the Book of Wisdom and its use is often hotly contested between the parties.
  • How do you address a situation where there are no apparent willing buyers for a unique subject asset? Does the lack of apparent willing buyers indicate that the Fair Market Value is zero?
  • How do you appropriately assess an immature or new business? What is reasonable certainty with respect to the future profits of such an entity?

FAIR VALUE

Moving on to yet another definition of value, Fair Value drops "Market" from Fair Market Value. Fair Value takes on different definitions based on the specific usage and/or venue. Some, like the Financial Accounting Standards Board (FASB), seemingly use the terms Fair Value and Fair Market Value interchangeably. For others, the difference between Fair Value and Fair Market Value lies in the application of discounts for lack of control (DLOC) and marketability (DLOM). These discounts are often contested in dissenting shareholder cases; however, the applicability of these discounts varies between venues. For example, Fair Value in some states includes DLOC and DLOM, while other states do not deduct DLOC and DLOM when determining Fair Value.

MARKET VALUE AND INVESTMENT VALUE

Dropping "Fair" from Fair Market Value, we arrive at Market Value, which is generally defined as:

[H]ow much an asset or company is worth in a financial market. It is mutually determined by market participants and is interchangeably used for market capitalization when dealing with assets and companies.8

While Fair Market Value, Fair Value and Market Value speak to the value of an asset or liability to hypothetical parties or many different buyers and sellers, the term Investment Value focuses on the value of an asset or liability to a particular investor or owner.9 The Investment Value and Fair Market Value of the same asset can potentially differ significantly if the owner (or investor) feels that synergies exist between the subject asset and other assets held by the owner, or if the owner manages the subject asset in a way that is inconsistent with other similar assets.

For example, an oil and gas operator in Texas may hold mineral development rights in a particular field that it places significant value on because the mineral rights are contiguous with its other producing acreage and the oil and gas operator can develop all of its acreage at a lower cost than it would be able to if its acreage were not contiguous and spread across a much larger area. In a case involving said development rights, consideration may be given to the value that the oil and gas operator derives from its contiguous acreage position. That consideration may cause the value to differ from the value as defined by Fair Market Value, which considers a hypothetical willing buyer who does not hold a large tract of contiguous acreage in the same area as the subject asset.

For many owners and many litigants, value is often thought of through the lens of Investment Value. Additionally, many courts often use Fair Market Value and Investment Value interchangeably, which by itself can lead to differences in opinions between parties. Thus, it is important to clearly identify the value definition, assumptions and inputs utilized in a valuation exercise.

INTRINSIC VALUE

And finally, to touch on yet another definition of value, Intrinsic Value is defined as:

The value that an investor considers, on the basis of an evaluation or available facts, to be the "true" or "real" value that will become the market value when other investors reach the same conclusion.10

As noted in the definition, Intrinsic Value is derived according to a valuation professional's individual assessment and thus is highly specific to the valuation professional's personal approach, knowledge and biases.

In summary, value goes by many different names, which can vary depending on the specific circumstances, parties involved and the valuation expert. As renowned hedge fund manager Seth Klarman has noted, "Value to some extent is in the eye of the beholder. It is very hard to pin down what the value of a future set of cash flows from a business, be it cable TV or biotechnology, is going to be."11 Ultimately, a valuation professional needs to be knowledgeable of the facts surrounding the asset to be valued and must develop supportable assumptions based on those underlying facts and accepted valuation methodologies.

Footnotes

1. Collier on Bankruptcy, n. 13, at §1129.06[2].

2. United States Treasury Regulations §25.2512-1; United States v. Cartwright, 411 U.S. 546.

3. Canada Revenue Agency.

4. International Valuation Standard Council.

5. World Bank Guidelines (Definition of Fair Market Value).

6. Kantor, M. (2008). Valuation for Arbitration: Compensation Standards, Valuation Methods and Expert Evidence, p. 63.

7. Ibid.

8. Corporate Finance Institute.

9. Kantor. supra, p. 32.

10. Weil, R. L., et al. (2017). Litigation Services Handbook, Sixth Edition, The Role of the Financial Expert, p. 11-7.

11. Barron's, Nov. 1991. "Value Hunter in a Sky-High Market."

Originally published 27 April 2023

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.