Judge Peck Rules in Iridium's Bankruptcy That Stock Market Valuations Are No "Fool's Game"
As every blogger will agree, "thank goodness for guest bloggers!" (especially with my wife now 37 weeks and counting--laboriously so--with twins).
Today's guest blog is from my colleague at The Coleman Law Firm, Elizabeth E. Richert, who has been at my side--for better or for worse--since her graduation from Duke Law School in 2001.
If you're wondering how I had the time to blog, it's in large measure because Elizabeth does a lot of the spade work for me. If you're also wondering why I'm not blogging as regularly, well, Elizabeth's starting to do that for me too. Unfortunately, I don't think she does diapers (but see training video here).
So thanks Elizabeth for stepping up to the plate, and congratulations on your first of what I hope will be many more excellent posts!
Once upon a time, the investment world was jazzed about the possibilities of a global telecommunications system based on radio contact with low earth-orbiting satellites. The pursuit of this dream resulted in the catastrophic business failure of Iridium, whose lightning collapse--in turn--raised the following central question in fraudulent transfer litigation filed against Motorola in Iridium's bankruptcy case:
Is evidence of value from the public markets the proper valuation tool in determining the market value of a business even when the market turns out to have been spectacularly wrong about that business’s prospects?
Here's the background to the case (see also WSJ Law Blog post): In the early 90’s, Motorola developed a global telecommunications concept called “the Iridium System.” In 1993, Motorola spun-off the Iridium System into a separate entity, Iridium, Inc. (later Iridium LLC), which was owned by private investors. Motorola contracted to serve as Iridium’s prime contractor for the development of the space-related portions of the Iridium System and for the development, licensing, and sale of certain handsets and gateway equipment systems. Under these contracts, Iridium paid Motorola between 1995 and 1999 the tidy sum of approximately $3.7 billion.
In November of 1998, Iridium activated its global satellite communications service with much fanfare. Some nine months and--as Judge James M. Peck described it in this opinion--a “business failure of epic proportions” later, Iridium landed in bankruptcy. (Op. at 5). On behalf of the Iridium bankruptcy estate, the Statutory Committee of Unsecured Creditors sued Motorola for fraudulent conveyance and preference claims seeking to avoid the $3.7 billion in transfers from Iridium to Motorola.
In a (not entirely successful) attempt to keep the litigation of this contentious case under control, Judge Peck, from the United States Bankruptcy Court for the Southern District of New York, bifurcated the trial—limiting the first phase to the questions of whether Iridium was insolvent or had unreasonably small capital. In a 111 page "Opinion Regarding Insolvency and Unreasonably Small Capital,” Judge Peck held that the Committee failed to prove that Iridium was insolvent at the time of the challenged transfers.
While the Court supports its ruling with over 50 pages of factual findings, its holding was essentially a foregone conclusion once the Court determined that it agreed with the reasoning of VFB LLC v. Campbell Soup Co., 482 F.3d 624 (3rd Cir. 2007) (pdf), that “the public markets constitute a better guide to fair value than the opinions of hired litigation experts whose valuation work is performed after the fact and from an advocate’s point of view.” (Op. at 4). Indeed, Judge Peck concluded, “[g]iven the overwhelming weight of th[e] market evidence, it may be that the burden of proving insolvency and unreasonably small capital simply could not be met under any circumstances, regardless of the evidence adduced, in the wake of the Third Circuit’s VFB decision . . .” (Op. at 110)
In VFB—which Steve Jakubowski reviewed early on here—the issue was whether VFB received reasonably equivalent value for the $500 million it provided to Campbell for Campbell’s Specialty Foods Division. The district court found that VFB had, based on the significantly positive market capitalization of the Specialty Foods Division after its spin-off from Campbell. VFB appealed, arguing that the market capitalization did not accurately measure the value of its assets because Campbell manipulated the Specialty Foods Division’s sales and earnings prior to the spin. The Third Circuit upheld the district court’s ruling, validated the district court’s use of market data for valuation purposes, and found that that “[a]bsent some reason to distrust it, the market price is ‘a more reliable measure of the stock’s value than the subjective estimates of one or two expert witnesses.’” VFB, 482 F.3d at 636 (quoting In re Prince, 85 F.3d 314, 320 (7th Cir. 1996)).
In Iridium, the Court was presented with two quite different approaches to the presentation of valuation evidence. Motorola, led by the veteran (non-bankruptcy) litigator, Garrett Johnson of Kirkland & Ellis, took the position—endorsed by Judge Peck—that market capitalization is the best indicator of value unless proven otherwise. Motorola presented multiple witnesses to support the theory of the case that the public trading market for Iridium’s securities was well-informed and that the collective judgment of market participants confirmed the enterprise's significant value.
The Committee, represented by another veteran (non-bankruptcy) litigator, Greg Danilow of Weil, Gotshal & Manges, espoused the view that “the market, in retrospect, could not have been a reliable reference point in light of subsequent events that proved the market to be so plainly wrong in measuring Iridium’s fair value.” (Op. at 25). The Committee asked the Court to disregard the historical market data entirely as manifestly unreliable, and to rely instead on the Committee’s expert valuations based on discounted cash flows and restated cash flow projections.
Unfortunately for the Committee, the Court started from the proposition that public market data was the best indicator of value, and concluded that “to justify disregarding values placed on [Iridium’s] securities in an efficient public trading market, the Court needs a substantial reason to depart from that standard and find that the value implied by an efficient market is not a trustworthy benchmark.” (Op. at 26). The fact that “the market was plainly wrong as an indicator of future value and badly misjudged the likelihood of Iridium’s success,” Judge Peck concluded, did not provide such a substantial reason. (Op. at 25).
The Court thoroughly analyzed Iridium’s market capitalization, management’s contemporaneous projections of future cash flows, the contemporaneous valuations prepared by various third-party analysts, investors, and lenders, and the expert testimony by both sides and found that the market was well-informed regarding Iridium’s business plan, financial situation, and system capabilities and limitations, and that market capitalization was a reliable benchmark for value.
Judge Peck’s opinion is especially notable for trial advocacy junkies because he provides interesting observations on witness and expert credibility in valuation disputes. The Committee’s failure to deal with the market evidence head-on and rebut its contradictory valuations, for example, hurt the credibility of the Committee's expert and rendered their valuations unreliable in the Court's eyes. Judge Peck stated in this regard:
A solvency analysis lacks credibility when an expert uses projections that “fly in the face of what everyone believed at that time.” VFB, 2005 WL 2234606 at *30 n. 71. Here, Messrs. Reiss and Spragg’s conclusions of insolvency and inadequate capital do not correlate with the market validation of Iridium’s business plans and the positive value attributed to the business during the relevant period. This failure of the Committee’s experts to reconcile their conclusions with the prevailing market judgment or to cast serious doubt on the reliability of that market judgment provides sufficient reason for this Court to seriously question the reliability of their opinions. (Op. at 109)
The Court also expressed frustration that neither party attempted to parse the four-year valuation period into smaller blocks of time or to concentrate on discrete smaller testing periods relevant to a preference and fraudulent conveyance analysis (such as the ninety-day or one-year period before bankruptcy). (Op. at 22). This failure too, the Court concluded, contributed to the Committee's failure to prove insolvency and rendered their conclusions “most obviously suspect.” (Op. at 24).
Another important practice pointer is found in a footnote, where Judge Peck noted that all the witnesses for the Committee, with the exception of four experts, "testified" through spliced video-taped segments drawn from their deposition testimony. (Op. at 10 n.3). In contrast, Judge Peck found, “Motorola contributed greatly to its defense by having live witnesses whose credibility could be assessed by the Court.”
Didn't someone once say that stock market trading is a "fool's game"? Well, don't call him to testify in your next fraudulent transfer case.
(Ed. Note: The inset picture shows some phones still being offered by the now reorganized Iridium. You sure have to wonder how Motorola's projections that about half the world would own Iridium phones were ever taken seriously.)
© Steve Jakubowski 2007