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Arbitration In Asset Valuation And Distribution Cases

Arbitration is regarded as a procedure in which a dispute is submitted before an Arbitration Tribunal, by agreement of the parties guided by the arbitration contract or a clause in the contract. By this, the parties opt for private dispute resolution procedure instead of going to court. It is outside court settlement thereby saving time and resources at the same time.

Either the parties themselves appoint an arbitrator, or by an application to the court or in case of institutional arbitration appointed according to the rules and regulations. Asset valuation is the process by which we can determine the current value of company's assets, such as buildings, stocks, equipment's, goodwill, equipment etc. we can calculate the net worth of the by adding up the current value of its assets deducted by its liabilities. In this article we shall discuss how arbitration can play an active role in determining asset valuation and distribution cases.

Arbitration and Asset Valuation

There has been an increasing trend where the parties/clients are in need of someone with a good background in asset valuation and distribution, they often look for a professional arbitrator who has a sound background and unique skill set to deal with the same. The process of arbitration is similar to a litigation where the evidences and testimony are presented and there is an arbitrator who decides the case on merits.

While it is not a civil court but if functions like a civil court and governed by the Arbitration and Conciliation Act, 1996. The Arbitrators are governed by the Act who act as the Judge with qualifications mentioned under the Act. The parties are in ore control of the process in a sense that, whether the award given in Arbitration will be absolutely binding or there is any limitation to it. Moreover, the process of Arbitration can also be decided whether ad-hoc or institutional.

There are various factors which an arbitrator looks and considers before valuing the assets and dividing them. One of the factors is how long both the parties are connected to each other i.e., the term of their relationship. Longer the time duration, there are more chances of providing a more equalized decision. Another factor which plays a crucial role in determining is income and separate property of each party. It varies from case to case and relationship to relationship. It is the responsibility of the arbitrator to act fairly.

For example, there is a case where the assets are valued between husband and wife, if one of the parties has better source of income due to better education, age, health and other factors, the arbitrator may provide more property to the spouse who is at disadvantage for any reason. In the same way assets can be valued between any individuals, HUF, or any organization. The arbitrator can also take into consideration the non-economic factors along with the monetary ones. The arbitrator can also consider the effects on the award on any other connected parties.

In determining any award, the arbitrator uses his expert of knowledge of law and uses his experience to arrive to a conclusion. The arbitrator like civil courts can also take various evidences into the consideration pertaining to the case.

Approaches for Asset Valuation

Sometimes it may happen that the sum of company's net assets and liabilities shown in the financial statements are not reliable or fair to indicate the company's true market value or its capacity to generate profits. Therefore, arbitrators may find it a little difficult to determine the valuation of the company as it becomes difficult to forecast the future cash flows. In such situation, it may be appropriate to consider the asset-based approach.
  • Asset-Based Approach:

    It is regarded as a correct method of valuation when we are dealing with an issue of controlling interest over a business. If there is any minority shareholder who has no control over the assets of the organization, the valuation shall generally revolve around the value of the future dividends which the minority shareholder is expected to receive. There is an exception to the effect that sale of a minority shareholding in order to give another shareholder overall control of the business.

    It is the duty of the valuer to see whether the asset-based approach will solve the purpose and whether it is the appropriate method of valuation where the company to be valued is going concern and generates positive cash flows. For this purpose, the arbitrators shall have a good understanding of the assets and liabilities of the company.

    To further understand this approach, suppose the value of the organization is company said to be the net amount of its assets and liabilities. So, the company shows the assets side as Rs. 100 in total, and the amounts owned to its banks and other creditors is Rs. 80, the company has net assets of Rs. 20 in that case. However, it shall be noted that not all the assets are recognized and measured for the purpose of financial reporting.
     
  • Investment Spend Approach

    The valuer simply aggregates all expenditure/ sunk-costs incurred in developing a given project or business and the total amount is used as a proxy for the value of said project. The cost of investment may cover not only the expenditure incurred to acquire or develop fixed assets but also all other costs involved in developing the project including the cost of financing, market research, salaries, administration etc. at certain times, the given the passage of time, the current value of an investment may be very different form the costs that were incurred to acquire it.

    In short, an award made on the basis of actual investment spend can lead to either over or under-compensation. In the case of the latter, tribunals have sometimes sought to avoid treating claimants unfairly by adding an amount to the sum invested to represent the likely future return on the investment absent the given breach/ action.

Impact of the financial crisis on the application of the asset-based approach

A deep analysis of the relationship between business's accounting net worth and financial crisis is not within the scope of this article. Financial crisis has a very major impact on the company's balance sheet (usually Negative). Let's have a look at some of the examples of the financial crisis.
  • There are chances of increased counterparty risks, credit risks that may not generally be reflected in the measurement of financial crisis.
     
  • If there is a requirement where relevant accounting standards are to be stated on the balance sheet at their €˜fair value' asset values have often been written-down to reflect their recoverable amount. It is also considered relevant where the accounting conventions require non-current assets such as plant, long term investments, machinery, property etc. needs to be recognized at the historical cost & recoverable amount.
     
  • It is also stated that billions of dollars of goodwill have been written-off companies' balance sheets in accordance with the Financial Accounting Standards for calculation and accounting for goodwill. Purchased goodwill arises when an organization is acquired, it may be defined as the excess of the purchasing price of the business over the the fair market value of the net assets which have been acquired.
     
  • Due to the financial crisis, under certain accounting conventions, many businesses have discovered that their existing provisions for defined and other benefit plans are now insufficient to cover their likely eventual exposure. Whilst some businesses have made additional provision on their balance sheet to cover these deficits, due to a certain degree of flexibility allowed under accounting conventions, much of this deficit is off-balance sheet. It was recently reported in the UK Daily Telegraph, for example, that the deficit at all UK private sector pension schemes rose to £176bn.

Conclusion
While the asset-based approach is considered to be one of the most generalized form and may appear to be conceptually simple, it is often misunderstood. Although, this approach seems to be a better option but it requires proper application of this approach inter alia dealing with complex concepts such as recognition and measurement of the assets for the purpose of asset valuation and distribution. It also counts for competitiveness, inflation and dynamics of the markets, the role placed by the replacement costs, the true economic costs of replicating assets. When the asset-based approach is applied, one should be careful about the relative weight provided by its results.

References:
  1. Kluwer Arbitration Blog, April 10, 2012 available at http://arbitrationblog.kluwerarbitration.com/2012/04/10/asset-based-methods-part-3-valuation-and-the-financial-crisis/ (Last Visited 22 May 2021)
  2. Arbitration Forum, 21 July 2021, available at https://www.arbitration.com/blog/tag/asset-distribution/#:~:text=An%20arbitrator%20can%20help%20resolve,facts%20that%20clarify%20ownership%20rights.&text=Another%20situation%20which%20may%20call,particular%20asset%20is%20in%20question. (Last Visited 21 May 2021)
  3. Grant Thornton, Dispute Insights, available at https://www.grantthornton.in/globalassets/1.-member-firms/india/assets/pdfs/dispute_insights-perspectives_on_arbitration_and_disputes.pdf (Last Visited 22 May 2021)

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