A federal bankruptcy court in New York has concluded that the market price of a company’s stock is the most reliable valuation to determine whether disputed transfers were avoidable. In re Iridium Operating LLC (Statutory Committee of Unsecured Creditors of Iridium v. Motorola, Inc.), 373 B.R. 283 (Bankr. S.D.N.Y., Aug. 31, 2007).
In so holding, the Bankruptcy Court for the Southern District of New York noted that the U.S. Court of Appeals for the Third Circuit recently reached the same conclusion in VFB LLC v. Campbell Soup Co., 482 F.3d 624 (3d Cir. 2007). In Campbell, the Third Circuit concluded that the market price of a company’s stock following a leveraged spin-off was the most reliable valuation to determine whether the transaction was fraudulent and should be set aside. See Commercial Restructuring & Bankruptcy Alert, June 2007, p. 1, “Market Price Used To Reject Fraudulent Conveyance Challenge To Leveraged Spin.”
Iridium was poised to operate global telecommunications from low-earth orbit satellites. Motorola was Iridium’s financial backer for the development and deployment of the satellites. In 1998, Iridium activated the service and nine months later it was in bankruptcy. Its stock was trading $48/share six months before the filing and about $3/share at the time of the bankruptcy filing.
Iridium’s Creditors’ Committee sued Motorola seeking to recover $3.7 billion in alleged avoidable transfers from Iridium that were made as milestone payments to Motorola under a contract.
The issue before the court was whether the transfers to Motorola were avoidable because Iridium was insolvent, or had unreasonably small capital during the four-year period prior to the petition date. The court concluded that the committee had not carried its burden. Valuationmarket research, forward-looking subscriber’s estimates and revenue projections, the reasonableness of Iridium’s business plan, and valuation questions of capital markets at the relevant time (all of which are discussed at length in the opinion).
Not surprisingly, there was conflicting expert opinion testimony regarding Iridium’s solvency and the adequacy of its capital, in light of its capital structure and business prospects. The contest was between two fundamentally different valuation theories and methodologies.
Motorola relied on Iridium’s success in the capital markets in raising large amounts of debt and equity, as well as the existence of an efficient public trading market in which Iridium’s securities traded within ranges indicative of substantial enterprise value.
The Creditors’ Committee disputed the market data—claiming that Iridium was not understood by Wall Street, that as a start-up company Iridium had no reportable earning history, that the industry was new, and that there was lots of hype but no real value. Hence, the Committee asked the court to disregard the market data as unreliable, and to accept the conclusion of expert witnesses who performed a discounted cash flow analysis using adjusted cash flow projections prepared in contemplation of litigation.
The court held that valuation judgments could only be made using the best information available at the time about future cash flows and business prospects, and concluded that contemporaneous market data for Iridium’s publicly traded securities were both consistent with substantial enterprise value and inconsistent with insolvency. The court found that even though Iridium failed fast, the public markets were well informed concerning Iridium’s operating characteristics and constraints.
Motorola did a better job of establishing that the market evidence was relevant, and was persuasive data that could not be ignored in determining insolvency, than the Committee did of establishing that the market was an unreliable measure of value that should be ignored.
The bankruptcy court joined other courts in rejecting the theory that evidence of insolvency after the petition date is indicative of the value of the company. In summary, the court stated:
“While it may be splitting hairs, the consequence of the analysis described in [this court’s] Opinion is not a determination that Iridium truly was solvent or adequately capitalized but rather that the evidence presented by the Committee is insufficient to establish insolvency or unreasonably small capital.
The Court is not bound to accept the value that has been ascribed to Iridium’s securities by the public markets and has the broad discretion to find that the markets somehow were distorted and did not fairly reflect the underlying enterprise value of Iridium, but to justify disregarding values placed on these 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.”