ABI COMMISSION TO STUDY THE REFORM OF CHAPTER 11

Field Hearing, February 21, 2013

Las Vegas, Nevada

Transcript of Proceedings

Robert Keach: I want to start off by thanking VALCON and ABI’s co-host at this conference, AIRA and the University of Texas Law, CLE, for hosting this hearing today. Holding a hearing on the role of valuation in conjunction with this particular conference seems most appropriate, as this conference has always been at the forefront in examining cutting-edge issues and valuation methodologies in bankruptcy cases.

I also want to acknowledge and thank the commission’s Advisory Committee on the Role of Valuation in particular its Co-Chairs, the Honorable Kevin Carey and Barry Ridings, for helping to identify today’s witnesses and coordinating this Field Hearing.

Just as an aside, my full opening remarks are actually printed in our handout. I’m not going to read them in the record, and I mean by doing that, to be an example for everyone who comes forward. The remarks will tell you everything that we’re about and everything we’ve done in the past year.

We’ve held a number of these Field Hearings in 2012 and this, however, is the first Field Hearing of this year. It’s on the role of valuation in Chapter 11 cases.

Valuation, of course, plays a critical role in restructuring cases. What standard of valuation is to be applied and when and for what purpose, comprise critical questions in Chapter 11 cases and proceedings. In addition, the role of “Judicial Valuation” and the corresponding role of expert testimony, as opposed to valuation via the “market” is a hotly debated topic, as the 7th Circuit has recently reminded us.

However, the 1978 code, even as amended, provides little direct guidance on such questions. Thus, the development of standards valuation, and the role of valuation at critical times in Chapter 11 cases, has been left to the case law. The Supreme Court has weighed in on occasion, but its decisions left behind as many questions as answers.

Accordingly, the lower courts largely have been left to develop this area via the development of a common law of valuation. That development has been robust, but none the less remains a work in progress and at times in conflict. With the work of the Advisory Committee and with the help of the testimony presented today and in the future, the commission explores what, if any, changes to the

1978 code as amended should be made to assist the courts in this area and to advance the mission of furthering successful restructurings.

With that brief introduction, I want to introduce, one of the co-Chairs of our Valuation Advisory Committee, the Honorable Kevin Carey, United States Bankruptcy Judge for the District of Delaware who has a few words to say as well.

Judge Carey: Thank you Bob. Let me thank first the Commission for including members of the Advisory Committee in today’s field hearing. We very much do appreciate that opportunity. I also acknowledge the absence of my Co-Chair, Barry Ridings of Lazard in New York who’s eagerly awaiting the birth of a grandchild and could not be here.

With me today are the co-reporters for the Advisory Committee, Van Durrer, who sits to my right, who’s a partner in the Los Angeles office of Skadden in the firm’s Corporate Restructuring Group. To my left, Mark Scarberry, Professor at Pepperdine Law School.

The Advisory Committee has been considering a wide range of topics, all related to Valuation. Unlike in consumer bankruptcies, there’s no fixed Valuation formula or method for use in Chapter 11 proceedings. Should there be one, and if so, what should it be? Or should we just leave well enough alone? The appellate courts are telling us we should look to markets to determine valuations. Some experts, however, will tell you that it’s a mistake to assume that the markets are always right. What constitutes an appropriate market test anyway?

Today’s valuation contests in Bankruptcy Court are long, involved and very expensive. One of the consequences is important and complex valuation decisions are left to those who might arguably be the least expert in the court room, Bankruptcy Judges like me. I’ll speak for myself, I was a Political Science major in college, and outside of the court room, I was more likely to follow Jimmy Buffet than Warren Buffet.

Well, what changes should be made in the Bankruptcy Code, if any, to improve the valuation process? For example, should a debtor be required to make additional financial disclosures at the beginning of the case to aid other parties in reaching their own determinations of value? Should the court appoint its own expert to help bring some sanity to the process? Should any change be made in how valuation experts are compensated? Should they be permitted completion fees? Once taking their position on valuation, should a party later on in the case be precluded from changing its view of what value is? Do we need updated studies on the difference between the court-ordered valuation and what happens post-confirmation?

These are a lot of questions that we’re addressing. We’re hoping these witnesses and others will help us answer them, Bob?

Keach: Thank you, Judge Carey. With that, we’ll get started. With respect to those witnesses who did give us written statements in advance, we have read them. At least I have, and I know my fellow Commissioners generally do. You can feel free to not read the entire statement into the record but to summarize and condense. I do want to hear from and I think I would suggest we hear from the entire panel; there are two panels today. I want to thank our witnesses for appearing. We’ll let the entire panel give us their remarks and then there’ll be Q&A of the first panel. Then the second panel will give us their remarks and there’ll be Q&A with the second panel.

My suggestion for no better reason than it’s easy for me is we’ll start on my right with Mr. Kaufman, then Mr. Siegert, Ms. Horowitz and then finish with Professor Smith. Mr. Kaufman, if you’d like to get it started.

Peter Kaufman: Thank you Mr. Chairman. Judge Carey I’ve seen you in action. You always get it right so maybe Jimmy Buffet ought to be the required listening.

Valuation is a black art. It is not a science. Anyone who will tell you otherwise, I don’t think really understands valuation. I chose my topic on the issue of ‘Should there be a market test imposed when there are valuation disputes?’ My conclusion is that there should not. I think it’s not a good idea, I think it’s impractical, I think it flies in the face of the legislative intent of what Chapter 11 is supposed to be.

Taken to its very easy extreme, it presents really one of two choices; it’s either a false process, some market test, whatever that means, which unless you’re going to force a sale, every time there is a valuation dispute then you’re going to have false process of some market test of indeterminable mechanics and use.

In short, Chapter 11 is about rehabilitating a debtor. If every time there’s a valuation dispute, you’ve got to go sell the company, that is not going to lead to rehabilitation of a debtor. There are fundamental flaws on market evidence, with respect to a company in Chapter 11, and for ease of illustration, I’m really going to focus on a private company so that no one can talk about the price of securities and being able to look to the public market as evidence.

A market test under duress, which is almost by definition what a company in Chapter 11 is, versus the go-forward enterprise value of a rehabilitated debtor is really comparing an apple to a hotdog. Your forced-seller -- I don’t think that a forced-seller is going to bring the same market value as an unforced seller. I don’t think that it’s good for the company or its values and the harm that you’re

going to do to a debtor if you have to go to a market test every time there’s a valuation dispute.

Even if you are going to have a policy goal of a market test every time there is a valuation dispute, the values that you’re going to achieve are going to be so much less than if the company wasn’t in Chapter 11, and very likely less than if the company was allowed to rehabilitate and be valued on a go-forward basis.

Lost in all of the doctrine would be, what is there left for the creditors and potentially equity holders because you’re really going to the least common denominator? You’re forcing a sale at the nadir of a company’s value, very arguably and very often.

Finally, trying to be at least halfway consistent, the usual metrics of Valuation, Company Analysis, Comparable M&A Transaction and Discounted Cash Flow, we at Gordian feel very strongly that the Discounted Cash Flow is the most probative, the most accurate -- if you can ever use the word accurate in respect of valuation -- and certainly the most important because it lines up very squarely with the legislative intent of having a rehabilitated debtor because it permits the estate to look out into the future with projections, discount those back to the present and come up with a valuation view that we think takes advantage of all of the aspects of Chapter 11 that are supposed to be helpful to a debtor and its constituents.

That's a short summary of my view on this.

Keach: Thank you Peter, Mr. Siegert?

Eric Siegert: Thank you to the Commission for inviting me to speak this afternoon. As an opening comment, just for people who don’t know me, my name is Eric Siegert. I’m a Senior Managing Director at Houlihan Lokey. I’ve been in the Restructuring Group there for about 25 years, and I’m a co-Head of that group today.

I looked at the opening remarks and there’s a comment here that refers to a growing consensus that the Code needs to be changed. I think the word ‘overhaul’ was even used. I’m not sure where this consensus necessarily exists, but my own view of the existing Code is that it works pretty well. It certainly has its infirmities and as times have changed, we’ve seen the types of security holders change, securities themselves change; perhaps there is a need to revisit some of its provisions.

Changing things that people have relied on for a long time that has created market stability the investors rely upon, is a very touchy thing. It can lead to unintended consequences, and so I just would caution everyone that I don’t

know that there is a ground swell of need to wholesale change anything. We should be cautious with whatever we do.

As it relates to the specific questions that the Advisory Committee sent out, I was going to try and respond to four of them. I did not submit any written materials in advance. The four questions I was going to speak to was question 1, the Issue of Quick Sales or I think the Committee referred to it as Fire Sales; Question 4 on Information Disclosure; Question 5 on Court Appointed Valuation Experts; and Question 7 on Valuation Techniques themselves.

On question 1, the issue of Fire Sales, it seems that the question is does a Quick Sale on a bankruptcy necessarily lead to an inaccurate view of value or inaccurate realization of value? I think the answer is sometimes yes and sometimes no. What protects value is competition. If you can have a competitive process in a Chapter 11, even an expedited one, with the proliferation of distressed investors that we’ve seen in this environment, together with strategic investors themselves and their growing comfort to engage in a Chapter 11 process -- US Airways being the most recent and extreme example of a strategic investor giving up to their eyeballs in a Chapter 11 process -- there are natural protections in there for the valuation or the sales process.

You need to have the ability to sell things quickly. There is the issue of melting ice cubes. There is the issue of loss of management. There’re liquidity issues and so there needs to be the ability to move assets quickly. If the Code does anything, it should do its very best to protect the integrity of the sales process itself. Maximize the time that’s available, recognizing in some cases, if a company’s going to run out of money, you have to move the asset and get on with life, but it’s that timeframe and the openness, which the Code currently, and certainly what the legislative precedent encourages exactly what I’m suggesting.

The extent it could be bolstered, I think it would be helpful to ensuring that whatever sales process there is, be it an expedited one or simply an ordinary course sale in a Chapter 11, it’s the process that needs to be protected.

Question 4, should there be earlier dissemination of information in a Chapter 11? I’m generally frustrated with the notion of the confidentiality around a debtor’s business plan early in the process. I understand that there are competitive secrets and things of that nature that need to be safeguarded, but at the end of the day when you look at a Chapter 11 confirmation process, the business projections, almost without exception, are included in a disclosure statement, so they’re made public anyway.

It does strike me as odd that there’s so much concern earlier in the process about the release of that kind of information. I would not want to force

disclosure of something that causes premature development of a business plan. I think the development of a business plan, the opportunity to rehabilitate the company and really think through all the different possibilities to create value and turn the company into different direction need to be explored. I don’t want to expedite that process unnecessarily, but at the completion of that process, I don’t know why there can’t be more thorough disclosure and transparency to the investment community.

I think one of the things that drives that need is the fact that the way we see unsecured creditors committee formations these days, it’s not uncommon that you’ll have one that‘s made up of labor representatives, the PBGC, indentured trustees, a number of constituents who very well may not have any real financial skin in the game.

In fact, in the case of an indenture trustee, it’s not uncommon that the US Trustee will appoint indenture trustees who represent, significantly, out of the money subordinated debts, simply because they’re indenture trustees. I take issue with that. I don’t think there’s any problem at all with having indenture trustees. I think they serve an important role in the Chapter 11 process, but because of the formation, it’s the structures of these committees, the way they’ve developed, you see far more developments of what people generally refer to as ad hoc committees or significant holders outside the formal Chapter 11 process who have a significant interest and I think important view as to how the case should proceed. They’re the ones who are actually going to vote on these plans. They’re the ones who are actually going to own these securities.

There’s always a difficulty, and certainly the WaMu decision did not help us. There’s always a difficulty trying to figure out how to get information disseminated to these parties and allow them to engage in appropriate way in the discussion to get to a consensual plan process. Having earlier disclosure, I think would help facilitate that.

By the way, I would include in the disclosure, not just the business plan but claims estimates, is absolutely critical. You don’t have to wait for the claims bar date. The debtor has a very good idea what the claims are, and where they are going to kind of shake out, and I think some earlier disclosure around that, without the debtor having to be panicked about – What if they’re wrong? They have to put the best information that they have in a market place. That would be helpful.

The last thing I would say on this subject is even if you have transparency there’s still the need for these holders, the significant holders I’m referring to, to get restricted. You can’t negotiate a plan on a public. You can’t have the debtor make a proposal public and then have people respond to it in a public way.

There needs to be some ability for these people to get restricted for some period of time. It’s become a very tortured process, whether that can be addressed in a Code or whether it’s SEC issues is probably not a subject for this particular discussion, but I’m telling you from a practical standpoint, we face this challenge in every Chapter 11 and it’s very, very … It’s a huge impediment to making progress in a number of cases.

Moving to question 7, Valuation Techniques, I agree with my colleague from Gordian Group that the Discounted Cash Flow is probably the best analytical tool to assess value. I authored a chapter in a book recently, called Contested Valuation in Corporate Bankruptcy, and the sole purpose of that chapter was the Discounted Cash Flow.

I agree because it’s forward-looking, you can look at the business without the impact and influences of the current financial distress that’s governing and impacting cash flows.

The problem with the DCF, however, is the projections themselves. It’s very subjective. I will tell you that it is inconceivable that the same business is worth something different because one management team says sales are going to go at 10%, and another management team says it’s going to go at 20%. It’s the same business. It’s worth the same thing. There seems to be a history here that management’s projections are sacrosanct that they should not be adjusted. Who are a bunch of investment bankers who start adjusting cash flows and making changes to projections?

Energy cases are good examples where you have endless streams of pricing experts and people going through and giving views as to projections but by and large, in my experience, this is 25 years of it, management’s projections are kind of what they are, which leaves the practitioner or the valuation practitioner in a bit of a conundrum.

There is a way around it, but unfortunately that has been shunned in large part by the courts. The traditional approach, I think the academics may speak to this later in the panel, but there is a history for developing discount rates – The capital asset pricing model and betas and principally that gets to systematic risk. The more subjective part is the unsystematic risk.

One of the unsystematic risks that I think exist in every valuation is an assessment of the projections – How aggressive are they? How aggressive are they not? You can’t start adjusting the projections. You’re left with simply value, a cash flow stream. You can look at the market comparables, you can develop the beta, you can develop a cost-of-equity, you can develop cost-of-debt; that’s actually pretty analytical.

I think most experts wouldn’t disagree too much with what those results lead to. Where the art comes in as opposed to the science is how you apply that to a stream of cash flows given the risk associated with those cash flows. That’s really what the risk is. You can look at risk relative, company to company, but when I look at a set of cash flows, I say, “Well, how much risk is in it in achieving that cash flow?” That’s what I’m really discounting.

The courts have frowned upon the use of non-systematic adjustments to the capital asset pricing model. Whether it’s cap M or something else, I think there needs to be flexibility within the valuation community to assess this risk and subjectively apply some adjustment mechanism to reflect what are just differing views on the same business. Again, I think that the current process is plagued with too many parameters and too many limitations.

Lastly, I was going to speak on the efficacy of having court appointed valuation experts. Consistent with my opening remarks, I don’t think that it’s particularly a good idea. When I said in my opening remarks, I’m referring to the existing system; it works well because there is a drive toward consensus. I think, each party having their own advocates in negotiating context leads to resolution.

I dare say, I’ve probably done more Chapter 11’s in the last 10 years than anybody, I do believe that. Well over a hundred, I think. Major bankruptcies … In less than probably 10 of them, have I seen any significant valuation litigation. We settle these cases. That’s what we do. That’s our job to do that.

It’s that consensus building, which I think the current process allows for. I think having a court appointed valuation expert, other than as sort of a special master, which, I think, under the current Code, I think that the court has the ability to do, maybe not; I hear judges shaking their heads. I certainly defer to you but I think if the court needs advice, needs help understanding bridging the gap between Warren Buffet and Jimmy Buffet, that’s fine, I think.

To have a court appointed expert who somehow opines that this is the right value, and this is what we’re going to use and that’s somehow governing on the parties, I think would be a disservice to a process that has proven itself well, not perfectly, but has proven itself well to reach consensus in the long term.

Those are my remarks, thank you.

R. Keach: Thank you, Mr. Siegert, Ms. Horowitz.

Sandy Horwitz: Thank you. My name is Sandy Horowitz. I’m a Managing Director and the Head of Successor Trustee and Default Administration for CSC Trust Company of Delaware. I appreciate the opportunity to be able to speak before you today. I do that as neither a lawyer nor as a Valuation expert but rather as a lay person who

has served as an Indenture Trustee for about nine years. I’ve been a member of over 25 Creditors Committees, in some cases as Chair or Co-Chair.

Some of those cases, particularly known for valuation disputes are Mirant, Calpine, also served in Abitibi and NuPage. I’m going to limit my remarks today to the importance of valuations strictly in the context of the confirmation process and also give you some of my personal observations regarding the challenges that official committees of unsecured creditors face in formulating their valuation analyses and also their ability, ultimately, to present their case to the parties in interest.

I’m going to state at the outset that I don’t advocate codifying either valuation methodologies, compulsory market testing except in the limited context of the so-called New Value Plans, as addressed in the Supreme Court's LaSalle decision. I also do not believe in codifying mandated court appointed masters or experts.

My views really come from my understanding that the Bankruptcy Court is a court of equity. As such, I believe that the presiding judge should have the greatest degree of flexibility and latitude based on the specific facts and circumstances of a case to determine the basis by which the fair treatment of all estate creditors is derived. I guess I have faith in the process, although it can be a very messy process.

With the predominance of secured debt in debtor’s capital structures, in my experience, all too often at the commencement of a case, there is a rush to judgment that unsecured creditors are out of the money. This is a view that can pervade the entire case to the detriment of unsecured creditors. I don’t believe this rush to judgment is in any way accidental.

Most senior creditors are very eager for quick exits and those strategies, at the end of the day, really neutralize unsecured creditors before the debtor has the opportunity to fix itself, sort of a classical restructuring process. What this leads to is really diverting away from unsecured creditors, the value creation that may result from a traditional, operational and financial reorganization.

There are a couple of issues that I believe indirectly influence the valuation process, again to the detriment of the unsecured creditor constituency. To the greatest extent possible, I believe that valuation issues should not be addressed prematurely in a case. While I understand why in DIP orders, debtors stipulate that the secured creditors first, potentially second, maybe even third lien creditors are over-secured for purposes of post-petition interest and also having their professional advisers fees paid. I’m troubled with that aspect of the stipulation though, that gives Creditors Committees a very short timeframe in which to object, usually 90-120 days.

In cases where the secured debt has liens on all of the debtor’s assets, by valuing the collateral, I would argue you’re in essence valuing enterprise value. Ninety to 120 days into the case is not sufficient time for a committee to develop a view on valuation. While vigilant Committee counsel will object to this timeframe, it’s not uncommon for a court to overrule and therefore we could be faced with valuation fight before anyone is prepared.

Another indirect concern I have relates to financial adviser fees and only with respect to the success fee component. In the context of that success fee being either implicitly or explicitly based on the outcome or certain valuation outcomes.

In my experience, I haven’t seen this as an issue with the financial advisors retained by Creditors Committees because courts have found in some circumstances that those are not appropriate structures for success fees. But I have seen it with respect to ad hoc committees and those committee advisors. I question whether or not a financial advisor whose success fees based on valuation outcome really is giving a tainted expert testimony at the valuation hearings? Is there a bias? Are there economic conflicts or issues of credibility? I really question the use or the acceptance of those kinds of structures for financial advisors who will be providing valuation testimony.

As everyone knows, I believe in this room, valuations are complex and very arduous undertakings for committees. Especially since committee members don’t have homogeneous skill sets or restructuring experience and they certainly don’t share common motivations. Committees though face a lot of hurdles before they can even embark on this very difficult and complex process. Those hurdles can be further exacerbated when at the outset of a case unsecured creditors are deemed by the debtors or the secured creditors to be out of the money.

One issue that’s been raised already is information flow. Creditors Committees are frustrated by the amount of time it takes for debtors to provide timely and thorough financial information. I don’t know if it’s due to the debtors wanting to maintain control or potentially it’s the influence of the secured creditors who are pushing the debtor for a fast exit.

As a result of this sluggish and time consuming process of getting information, I believe that committees are often stymied in fulfilling their fiduciary obligations. In many cases committees view themselves as really being marginalized in the case.

I wonder if potentially a court appointed valuation master or other expert could alleviate some of this behavior by establishing a protocol for the release of information and also the depth of that information.

The second challenge which has also been discussed is the growing use of a very quick section, 363 sales, which, again, undermine the efforts of committees to maximize recoveries for their constituents. I recognize that a sale can be viewed as the real value of the estate, and in some cases the only viable option available, but I would argue that this alternative usually benefits the secured lenders to the disadvantage of the unsecured creditors who very well may be able to recover something or more from, again, a more traditional restructuring.

I also wonder if there should be a higher threshold standard to obtain sales approvals. Again, I fear unintended consequences, if there is any codification of what that standard would be.

Those are my remarks.

Keach: Thank you, Professor Smith?

David Smith: Thank you. Thanks to the Reform Commission and to the Valuation team for inviting me to talk about valuation today. My name is David Smith and I’m a Finance Professor at the University of Virginia’s McIntire School of Commerce.

What I would like to comment on today is I want to focus on areas I feel most comfortable talking about and that is the empirical work we have, the academic studies of what do they tell us about valuation and what do they not tell us?

I think to keep my remarks brief I’m actually going to boil it down to … I am going back to what Peter said, referring to valuation as a black art and not a science. I don’t know if I’d go quite that far, but I do want to say is that they do basically agree that valuation, the rough challenges that you guys have to come up with a valuation in reality is mostly art.

Now, so where does the science come in? The science comes in from, we academics, who are trained to study for all the study valuations, to study things like cost to capital. I would like to start by stating what I think science, social science or empirical studies can do in these situations. There’re two things we can do.

The first thing we can do is we can check using the large amounts of information data that we have on publicly traded firms, and to some extent, privately traded firms, observing values through time. We can actually check to what extent do these valuation models in bankruptcy work. Work in the sense that, do the valuations that come up through a settlement or even as a judicial decision as for now come up a contested valuation, how close do those valuations look to what a firm at the exits, what it trades out, what its market value is, what its enterprise value is after it emerges from bankruptcy?

The first thing is we can just see do these models work? How well do they work and how well do they not work? The second thing that we can do is we can tell you, what kinds of things do not work. For example, we have nearly a hundred years of data on thousands of firms where we can observe stock price returns and to some extent bond returns through time, we can measure to what extent do investors get compensated for bearing different types of risks? We can tell you not definitively always what the best risk return model is, but we can prune things that we know do not work based on our empirical work.

I’d like to focus today on the issue of what we know about the accuracy of bankruptcy valuations and what we know about what kind of models we can prune in terms of what kind of risks are compensated for, in terms of returns through time on bankrupt firms.

In terms of accuracy, the accuracy of bankruptcy valuations, a similar study in this area by a colleague of mine, Edie Hotchkiss, who’s here at VALCON with two colleagues, Stuart Gilson and Richard Bruback from Harvard Business School. Edie and her colleagues looked at series of firms that in Chapter 11 bankruptcy emerge from bankruptcy were publicly traded after they emerged. They compare bankruptcy valuations … Actually they just look at the management forecast in the disclosure statement using their own process for discounting those cash flows back. They look at the implied enterprise valuations they get from the bankruptcy cash flows to what the implied enterprise value was for the company after it emerged from bankruptcy.

What they show is pretty interesting, they showed that actually on average, bankruptcy valuations are accurate in the sense that on average, the average of bankruptcy valuation, among the first they study is close to what the firm traded for after it emerged.

What it also shows is why dispersion around that average, so there is often times that the valuation that was done in bankruptcy is way overstated relative to what the actual valuation was according to the market after it emerged. In other times, it is way understated.

In a degree to which the valuation in bankruptcy is overstated versus understated depends a lot on who has the bargaining power in the process. There’s a tilt towards the junior claimants in the case in terms of bargaining power. The valuations tend to overstate the actual value on emergence. When senior creditors appear to have the stronger bargaining power, there is an under valuation.

A really interesting study, now the problem with that study is that they essentially examined 63 filings, 63 firms that filed for Chapter 11, the last of

which filed in 1993. The world in bankruptcy has changed a lot since 1993. I think that’s part of the impetus of the reform commission today.

It will be very interesting to extend the work that Edie and her colleagues did over through the 1990’s, through the 2000’s; we have a lot more firms that we could observe, just check and see if indeed the valuations that come out of bankruptcy are still on average accurate.

I know of some preliminary evidence that’s coming out of research that’s being conducted by my colleague Mark Jenkins at the Wharton School. Young professor, teaches restructuring there, is involved with the ABI. Mark finds, and this is very preliminary evidence, that they’re actually during the last cycle, it appears there is a tendency for the evaluations to be too low, relative to what happened, relative to what the firms are trading at exit.

Maybe because of the tendency for secured creditors to have some dominant deal with the process or because of the need for moving through the process more quickly, I’m not sure; evaluations appeared to be lower than what they were at emergence.

The second topic that I want to talk about is related to the subject Eric brought up and that is what do we know about the discount rates we should use in a DCF model? I agree that DCF models are a great basis to build and think about valuations and being able to forecast how a company is going to perform after it exits from Chapter 11, being able to discount those forecasted cash flows back today to get an enterprise value is the most financially sound way to go. However, what I think we have to be careful about is making arbitrary adjustments to the discount rate.

The discount rate in the DCF model is compensation that an investor earns for bearing the risks of taking on an investment. The compensation that they earned for bearing that risk is not necessarily just all risks or all exposures that they get that arise in the context of that investor, in the context of a bankruptcy restructuring, the risk that they get compensated for, the risks that are not easily diversified away.

The way to think about this is that the discount rate is an opportunity cost. It’s a measure of what the next best investment opportunity, what the earnings for the next best opportunity for investment would be if that investor chose another opportunity. There is a competitive sense for what kinds of risks are compensated when you make these investments.

Let me just talk about the empirical side of this. It could very well be that an investor gets compensated for taking on company specific risks or it gets compensated extra for investing in a distressed company. What the science

brings to this is the ability for us to see over time what kind of returns do investors earn for bearing risks? We can measure what kind of risks they are exposed to and how much they actually earn for bearing those risks?

What we can say, with a fair amount of confidence, is that investors do get compensated for bearing systematic risks, including more systematic risks than what we originally believed was just Cap M beta risks. We have multiple systematic risks that you might be compensated for.

Adjusting for those multiple systematic risks, the studies clearly show that you do not get compensated for any extra risks that any company’s specific risk is left over after controlling for the systematic risks.

My concern is that when you go to Discount Cash Flows, with the discount rate, where you first make your systematic risk adjustments and then add some ad hoc adjustment for some company specific risk or some bad management risk or something like that, that you’re getting away from what cost-to-capital measures.

The empirical evidence that we have suggests that you do not get compensated for that sort of risk. I think that concludes my remarks.

Keach: Thank you. I want to thank all the witnesses. We’ll now move to some questions Let me also just tell everybody in case they were wondering, we will definitely leave a plenty of time for the next panels, particularly since they are all judges.

I actually think our realistic timeframe is probably just before the Judges panel starts at 4:45, so there’ll be plenty of time for everybody. This Commission has a way of just appropriating the time it needs. We have a history of this, unfortunately.

I am going to ask one question of the entire panel and we can start with Peter because it actually picks up on something Peter said, and actually goes to something that came out of your quotation from the Hotchkiss research. This goes to an issue that I don’t think you’ve all addressed directly but you probably addressed indirectly. That is why we call the debate about Market Valuation versus Judicial Valuation.

You talked about this Peter from your testimony in terms of what you consider the unreliability of market valuation in bankruptcy to be. I want to ask this in a specific context, and I want to ask you each to comment and you can go in the same order.

There is a belief, I happen to be one of the people who believes it, that much of the original 1978 Code or much of the important Chapter 11 provisions in the '78

Code where premised on at least a threat of Judicial Valuation, cram down on being the example aspects of the 1111(b) election being an example, 506 being the linchpin. There is a belief, I think by some people, that as with the Supreme Court’s help in some instances, we have progressed towards a model that favors if not mandates “Market Valuation.”

We’ve also seen a shift in the bargaining leverage of various players in the process. That the inherent uncertainty that was created by the thread of Judicial Valuation assisted some players, perhaps the debtor, and that the issues around market valuation may favor creditor interest or at least capital interest more than others.

I’d ask you to actually comment both on the Market Valuation versus Judicial Valuation as Methodology, but also on whether or not choosing one or the other has an effect on the negotiating dynamics in a Chapter 11 case?

Peter: Am I allowed to change my seat?

Before I give my answer, I forgot to give my 45 second introduction. I’m a recovering lawyer. I’ve been in investment bankruptcy for 26 years. I am President of Gordian Group, head of our Restructuring Distress M&A Practice, co-author of the definitive book on Distress Investing Banking and I have donated … It’s not completely self-serving. I’ve donated all the, with my co-author, all the royalties the ABI.

I like uncertainty in the bankruptcy process, in the valuation process for the very reason that Eric had touched on. I’m not sure he’ll agree with this or not, but I like to create a spirit of negotiating dynamics where people are encouraged to settle. To the extent that things are black and white, if you say if it’s a public situation and the bonds are trading at x, and the stocks trading at y. Therefore you put it in a sausage grinder, automatically out comes a valuation. That is not going to help drive our folks to a consensual resolution.

I’ve already talked about using public market indicia I think you have to take it into account. You would be foolish not to take it into an account, but there can be all sorts of, especially in thinly traded bond issues, there can be a lot of false positives, a lot of false negatives. I think that those are inputs that the trier of fact needs to take into a account, but I'm old fashioned, I'm old school. I like the judicial determination because I think it's better for the process and you get a better result.

Keach: Mr. Siegert? Nobody's required to comment on this, but I'd like you all to comment, if you'd like.

Siegert: I tend to agree. I think over time reliance on publicly traded securities, even if there's a broad market for them, is unpredictable. There are influences up and until the confirmation gavel is thrown down that influences those very prices; sometimes more sometimes less but until the final outcome is known the security’s trading prices are necessarily influenced and almost have a circular argument if you have one driving the other one and maybe it would iterate to the right result. I don’t know.

I also agree that there is a relatively thin market oftentimes in some of the smaller credits and therefore you'd have an inconsistent application of a market test in situations where it would be more reliable than in situations where it was not.

One other comment on this market evaluation issue, which I failed to comment on before, goes to the empirical studies. The judicial evaluation that we’re all talking about in this seemingly consensus view that maybe the Discounted Cash Flow is the right answer. I think academics and M&A investors would all agree on that point. If you’re trying to figure out what the stock is going to trade at 10 days post-emergence, the discounted cash flow is not particularly reliable. You're not going to get that the answer. What you’re going to get is what the most current view of EBITDA is times a multiple. That's where it's going to trade.

If that's the answer that you want then you should drive valuation to that methodology. If you're trying to get the long term inherent value of the business that can be achieved through over the long horizon, then the discounted cash flow with an appropriate rate of return will give you that better indication of value -- what that company would be worth in more transactional oriented setting.

This market based test that you're referring to is a complicated one. There're two different kinds of value at some levelers, issues of control value versus minority value; lots of things play into publicly traded pricing and the desire to solve for that is one that requires a lot of thought.

Keach: Well, let me go with Ms Horowitz. Do you have a thought on that?

Horwitz: To be honest, my thoughts did not diverge on Peter's or Eric's.

Keach: I thought from your paper that would be true, but I didn't want to skip over you. Professor Smith?

Smith: Actually my thoughts don't diverge from theirs either. As an empiricist as an academic I love the idea especially as we can observe more secondary market trading more. We can observe the trading of claims across the capital structure. I love the idea of asking the question: Does some aggregate forecast to these

prices that we can observe from these prices, do they predict the confirmation values or do they predict the values at emergence? I think actually that's an interesting place to go and ask that question.

However, Eric and Peter are exactly right. The minute you said, let’s ‘suppose’ that I got to do this great empirical study, and I showed … Said that prepetition trading or petition trading and instruments during the bankruptcy process are good on bias predictors of confirmation value. Then we say, ‘therefore, now a judge or the participants of the bankruptcy case should condition the confirmation valuation on those prices.’

The minute you do that you're going to have a strategic interplay where everybody's now going to be gaming those prices through their trading to try to get some outcome for their confirmation.

There's exactly, what Eric said, there's going to be these circular or feedback mechanism between what people think, how the trading is going to affect the confirmation value and how that confirmation value then feeds back to the trading? I just don't think you can, at least at this time, go to that system with those problems and ignore the other methodologies and say that the market tests are the way to go.

Keach: Okay, thank you. I know I have a number of commissioners who are begging to ask questions so I'm actually going to … I know Professor Klee has a question so let me start with him and then I'll let commissioners just indicate to me the that they have questions and we’ll let that just be as free flowing as we can make it.

Ken Klee: Thank you Mr. Chairman, although I have about a half hour of questions, I'll be brief. It seems to me for the …

Keach: I’ve heard this warning before.

Klee: It seems to me for the committee that there are some essential policy issues that need to be addressed here, and they are the same that needed to be addressed 40 years ago. Who bears the cost of delay in the Chapter 11 case? Can the unsecureds gamble with the secured creditor's money?

Second, is it true, as one of the panelists testified that the evaluation of the secured party's collateral is the enterprise value? I don't think it is. I think they’re aspects of the business on which the secured party in America cannot take a lien. The labor, for example, if that's true that’s important to know.

Third, when should value be determined? Back in the 1930's and 40's when courts and lawyers were looking at these issues, the SCC waffled on the answer to this question depending on whether they were supporting public debt or

public equity. If they were supporting public equity they wanted the valuation to take place after a period of normalization, a few years after the emergence from bankruptcy because of the depressed value of the business as it emerged.

Creditors, on the other hand, want to be able to take their pieces of paper and sell them in the marketplace right away and monetize it. They want to determine value right on the effective date, and that can have a depressing effect.

These questions, I think, need to be answered as a matter of policy. The only thing that's changed in 40 years is that the virus known as law and economics has perpetuated a myth first on academe and now on the bench that the market is perfect; its sales are the answer and that this is what we should be doing. It doesn't answer the question about what happens when you have a 2008 market crash, where there is no credit. There are no sales. Is the value than zero, which is a question I've asked before and the answer I've gotten from some economists is yes, the value is zero; if there's no buyer the value is zero.

How can it be that the very next day the value can be a 100 million dollars when a buyer appears? That's something we have to grapple with. The imperfection of markets and the fact that the law that you're going to be passing, or recommending to pass, is going to apply to small enterprises that are privately traded as much as publicly traded enterprises.

I guess my question for the panel is do you have views on whether the value should be determined as of the effective date of the plan, should there be a correction period, normalization period? Afterwards, who should bear the risk of delay in the case? Is this something that secured creditors should bear as well as unsecured creditors? If so, I think there are ways to get it done that we don't have to address on this panel.

Then I would ask for both Sandra and Eric, should indentured trustees be serving on Creditors Committees when they have a fiduciary duty to particular bond holders who may be sub-debt? Can they also undertake the fiduciary duty to the creditors as a whole?

Kaufman: This is Peter I'll jump on ...

Keach: You can take any one of those.

Kaufman: I'm going to leave aside the ones earmarked for Sandra and Eric. To one of your later questions or points, I'm not sure which. If the test is willing seller and willing buyer – yes, it's true that on this day there could be no value and tomorrow there could be a 100 million dollars. I think that the key issue there is what's the test that you're going to apply? Because in the world that I like to live in, you get to look forward and discount back to determine value as opposed to

on a specific date the markets are frozen, there's no credit, everybody's sitting on their hands, but if the tests is willing buyer, willing seller on a particular date, you could have a situation where the result of applying that test would be zero, and I think that's a terrible result.

Who bears the risk? Well, I would flip that and say who's going to fund the time delay? If somebody is stepping up and saying, “I will fund the debtor and its professionals and the other professionals and everything else” then you could perhaps get to where Sandra wants to be which is the unsecured would like the things to roll out longer, not have the senior secured creditor force a sale, et cetera. I think that it all starts with whose going to pay for it because who bears the risk? It's arguably the people whose value might be eroding the longer that you have delay.

Collateral versus enterprise valuing, I'm just chaired a panel about that. I'm going to be simplistic but I think pragmatic and say unless the senior secured lender has a blanket lien on every asset of a company that would be the only time conceptually the collateral value and enterprise value could be deemed to be coterminous.

Klee: Even though they don't have a lien on the people? Take a service business, they can have a lien on all the assets. If they don't have the lien on people, where's their value?

Kaufman: I said arguably.

Klee: I’m arguing.

Keach: Bettina, go ahead.

Bettina Whyte: Let me ask the question. I get tired of hearing from everyone that the risk is the burden of the secured, the risk is … The risk is the burden of the company's future success; and so if there … I think Bill would agree 100 percent being in the business we’re in, and therefore I think the part of that question's how long can the company itself if there is going to be a future for it, survive? Part of that is how much funding can it get, blah, blah, blah. That's highly important because in a lot of cases there is no funding and therefore you've got to do something very, very quickly.

Even if there is funding, I think there is a, not necessarily rush to haste, but I think there is a reason to assume that the company can, underline the word ‘can,’ lose valued employees, reputation and sales. Especially depending on the type of company it is and it can't … You are ruining the future value of the company by delay in the outcome.

Kaufman: There's no question that that's true, and the smaller the enterprise you have, the more true that that is.

Keach: Let me take some of these comments and actually turn them into a direct question. Mr. Siegert, why don't you pick this up because it actually goes to something you said earlier about the need to maximize the time available if we are in a sales setting?

Let me put it simply, the speed of the case or the velocity of the case, and this goes to some of the results you were talking about Professor Smith; the velocity of the case have a depression of value, in other words, does that actually affect the value or does that actually really just determine who realizes the value? In other words, is the reorganization value in a fast case being recognized post-confirmation as opposed to pre-confirmation and does that have distributive impacts in term of who realizes it?

Siegert: It depends largely on the nature of the business and I agree, size of the business as well. There's no doubt that a contentious, long term bankruptcy can have a profound impact on enterprise value even going so far as to destroy the organization.

Larger companies that are rarely the case they are more focused, I think, or the larger impact there is probably just the cost of the bankruptcy, there's some impact but they recover and rebound from that. Speed is critical; speed always will lead to greater value. Going to Ken's question on timing, I have a very strong view of this. It's inconceivable to me that we would have a bankruptcy code that would entertain valuation test states, it points well beyond the effective date. It's inconsistent with financial and investment theory that you're going to test prospective value in the future, which necessarily if you believe that there's rolling value, will be higher than it is today, all of those being equal there's going to be something pushed at rated return.

You put yourself, and then in the future if you have grown it's your, whatever the correct discount rate is you should be even worth, generally speaking, that much more at that point of the future. Then you would value it in the future then discount it back? It just seems that the value that's available on the effective date is what there is to be distributed, and while it may not be perfect, I think we need to do our best to value it on that date and distribute the value accordingly.

Klee: Is the answer that the discount rate and the terminal valuation rate don't have to be the same then?

Siegert: I’m not sure I understood your question.

Klee: If the business is normalized after 5 or 10 years, you could use a different rate for terminal value than you could for the discount rate while it's ramping up in the first 5 years, couldn’t you?

Siegert: Yes, of course, you could. Notwithstanding the Professor's view that you shouldn't be replying arbitrary things to discount rate if you are looking at … Putting aside the academics from this, and practically speaking, I'm trying to get my arms around the risk of a casual stream; I might have one view of a risk and one period versus like you've risked in a different period, so that conceptually, yes, how you get at that discount rate there may be academics can argue but practically speaking from an investment’s standpoint, absolutely.

The last question that you touched on is this issue - Who bears the risk? Ken, I think you got it pretty good the first time you wrote the Code. It already provides for a mechanism for adequate protection. If we going to delay the case, you have to protect that secured creditor and if you can't demonstrate that there is reasonable cushion, then the secured creditors have rights to step in and prevent things. Is it perfect? No, but you certainly thought about it. I don't think it shouldn't be the ability for the junior constituents be it equity, unsecured … whoever it is, to roll the dice from the lottery and hang around forever waiting for things to get better, absolutely not.

That said, if you’re legitimately restoring the business, cutting cost, closing locations, whatever it is you are doing to increase that value using the provisions of the code will allow you to do that, you need time to do that. If you can adequately protect the secured creditors to facilitate that refurbishment, then you actually should do that.

Keach: Just to pick up this time issue because it is important not to leave it. One of the reasons that the role of valuation’s too important in our deliberation is that we use valuation for lots of reasons in bankruptcy. This goes to Ms Horowitz's point in her paper about premature valuation.

If we identified parties as out of the money early, what does that mean? It means they don't have standing, for example. It means they have less of a position at the table and we all have cases, the AMR may be an example of a case where equity was out of the money early and maybe in the money now. We've all had different cases.

Siegert: I did not stipulate to that one.

Keach: Yes, I understand, nor did I. We can both not do that.

Kaufman: GGP would be another one.

Keach: I mean there are examples with that. I guess this goes to the issue of timing. When should we be valuing the company for purposes of determining the participatory rights of parties versus the distributive rights of parties that the end of the case? Isn't there a risk, frankly, of declaring parties out of the money too early in the process by virtue of either an early market test or otherwise?

Siegert: Of course, it's directed at me.

Keach: It's directed to all panelists.

Siegert: You have to do the best you can. Maybe American Airlines is a good example. Harvey [Miller] went to the US Trustee early in the case and said the company's view was that there was no value for equity and so there was no equity committee appointed. Facts have changed and now there may be one. So as facts change, I think the process is sufficiently able to adjust and conform that they can change some circumstances and facts. Things change.

One thing we do know for instance that whatever value we choose, it is wrong. It will be something a little bit different one way or the other. Whatever projections we do choose, the one thing we know is that they are wrong. We're just trying to get this close as we can as best as we can.

Keach: I would argue for not having a definitive lockout of that like an early sale that would actually lock in the conclusion that equity's out of the money.

Kaufman: There are facts and there are judgments. If someone goes day two of a case and says, “There's no equity value.” That's a judgment; that's not a fact. I think that when a company goes into the Chapter 11, it is early on before everybody around the table has a chance to vet, test, discuss and analyze; I think it's a very wrong thing to do to make a declaration about who’s in and who’s out of the money.

Keach: Let me make sure that we've allowed the rest of the commissioners to ask questions.

Jim Millstein: One of the reasons that the focus is on contested valuations and how you bring that process to a more speedy resolution is that, while it may be right that there aren’t that many cases in your career, where there have been contested valuations; but in the circumstances where there are, where you have competing expert testimony, what I think we’re struggling with is what evidence can we bring to the judges, who have to make a decision where there isn't going to be a consensual settlement?

A lot of the Code is directed to the threat of the judicial evaluation, which sometimes leads to a consensual settlement of the case; but in circumstances

where that threat of that judicial determination is not producing consensus, why couldn’t we require the debtor, now that we’ve had a disclosure statement and transparency as to its projections, why can’t we provide for, given the development of highly liquid secondary market with huge institutional pools of capital specifically raise to make these kinds of investments, why can’t we provide for a market test and require, not the whole company to be sold because that clearly create friction cause associated with it, but have 10% of the equity sold so as to resolve dispute between competing Houlihans and Blackstones?

Siegert: Well, I think it’s unfair Jim that you would require stakeholders who have a rightful interest in the value of those securities to have to sell them. People may disagree as to the value and selling at a given time if some people think that value is too low, they will not want to sell, you are forcing them to sell their securities. I think that is a bad way to go.

Millstein: As opposed to having a judge try and sift through competing valuations and what could be an arbitrary determination based on academic literature suggests the bargaining power of the parties?

Kaufman: If I can jump in here, Jim you’ve just caused another problem, respectfully. So now we’ve sold 10% of the company’s equity. Is that what you’re …

Millstein: Just take 10% off.

Keach: Yeah, I understood that you mean, should we test market the …

Millstein: To test the value of the company in the market.

Kaufman: Okay, so …

Millstein: Rather than having to rely on you and Eric to tell us what’s it worth.

Kaufman: When you were a Gordian’s lawyer, you had a lot more faith in us than this. [Laughter]. If you sold 10% to market, now the judge is going to have to hear competing testimony about what is the appropriate extrapolation from the price of that 10% - minority, discount versus majority. You have not solved the problem, respectfully.

Horwitz: I think the problem has only been compounded plus the sale of securities, there can also be tax implications involved for the debtor from the sale of securities. But I think Calpine was a good example. Judge Lifland hired an expert to help him evaluate the valuations and helped reach a consensus with the parties.

Keach: I want to leave that there because we are going to get to that, I know with Judge Peck’s testimony. Let me just interrupt and …

Siegert: If I might just add one thing which I think is …

Keach: Sure, then I want to get the questions from anybody else.

Siegert: The problem Jim is, I think, it may work more effectively. I still think it’s fraught with issues, but it’s … In a large Chapter 11, it would work. What you do in a $50 million company? You sale 10% of that and now you start arbitrarily saying, ‘well, if the companies revenue is 500 million, well what if it’s the distributor. The distributor’s still not worth very much and its $500 million. Is there a threshold evaluation question? How and when would you do it? Then assume the Code is going to be written for all companies not just big companies so …

Keach: Well, there may be different ones.

Milstein: I think the bankruptcy code as it currently exits has, in most cases, prompts settlement because of the threat of a judicial determination that puts the party out of the right to a distribution in the case, so that’s great.

In the large cases were there have been big evaluation dispute going on for six months and have consumed enormous estate assets, the question is what other provisions could we add to the Code besides the threat at the end of a long contested discovery laden hearing of a judicial evaluation, what other things could we add to prompt settlement sooner?

I guess the question that I am asking is if you knew that the debtor was going to conduct an offering of securities to test the enterprise value, to prove out the enterprise value at the confirmation hearing effectively at or around the confirmation hearing, would that prompt more compromised and more settlement because it would be a market determination?

Kaufman: Well, again Jim, I think that that will raise more questions than it solves, number one. Number two, I think there is an implication in a lot of these questions and issues that somehow the man or woman in a black robe is not capable in this and armed with enough tools to actually deal with valuation, I really don’t find that to be true. Those in front of Judge Carey in Spansion two years ago which was one of the most hotly contested evaluation fights at least in Delaware in years - big case, big fight. He got to the right decision.

That’s what judges do. You … Eric testifies, Peter testifies, you weigh the probity and evaluate the testimony and what they presented and you make a decision. I think the system works really well.

Keach: Let me give it to Bill Brandt for right now.

William Brandt: I’m a non-valuation person on the panel. I just … Two things, and they’re observations more than questions. One, I’m not sure everybody believes Eric,

that this works well. I think there are a lot of people who believe it works well for some and that 'some' has been a decreasing cohort of the population on the economic industry for some years. I don’t know that I agree with that but we, the Commission, have now heard both in print and in testimony that “What are we doing here? Everything is fine, then nothing to see, move along please.” There are a lot of folks who’ve asked us to look at this.

We do not have any preconceived notions as to whether massive changes or any changes are necessary, but it is the feedback we are getting that it works well for some. To the second point. You mentioned that there are bunch of people, hangers on, I think that might have been your words. I call them economic bystanders; the employees, the unions and the others. If anything, over the last 30 or 40 years since the Code was changed, they are not traditional creditors in the standards that we use for valuation for example, but they are clearly traditional stakeholders in the political sense of what these cases have become.

I wrestle, I don’t have an answer, but I think one of the things that myself and fellow commissioners are going to wrestle with is how do we give these people, these cohorts of interest, voice in this debate? Whether it can be done? But these are some of the issues that we have to look at. So it does not work for everybody. It works for some and that is the feedback all of us are clearly getting. Thanks.

Horwitz: The communities do have, excuse me for interrupting.

Keach: No, that is alright. Can you lean into the mike …

Horwitz: Sure, I’m sorry. Committees are comprised of a variety of constituencies, and I have been in some many committees where labor, PBGC, are members of the committee and certainly have a voice around the table. I guess, I want to take the opportunity,since the question was put out there and I’m the only Indenture Trustee on the panel for better or for worse ...

Keach: I was going to let you to duck this question in favor of …

Horwitz: Well, I guess I have some courage whether or not I am smart, is another story. There are a couple of issues, why Indenture Trustees are prevalent members of committees. One is, and maybe the main reason, holders don’t want to be restricted. They don’t want to be inside the tent and, without insulting anyone who maybe in the room, a lot of times holders want it both ways.

Keach: You mean restricted in terms of trading?

Horwitz: Absolutely. They want representation but they don’t want to be restricted. Indenture Trustees are accustomed to acting as fiduciaries because once there is

an event of default under the indenture, the Trustee’s duties now go to the holders, so they are accustomed to acting in this fashion. I guess I would throw the question back and say, ‘why would a Committee have any unsecured creditor or there is a natural, I shouldn’t put it that way, there is a natural attention.’ Anybody serving on the committee has an economic stake. Now the Indenture Trustee is one-step removed, it’s not its own economic stake. It’s those of the holders.

A trade creditor and labor union, they all have specific economic interests that are specific to them and yet brought together under the committee structure, this body acts as a fiduciary representing the entire unsecured constituency. I don’t know why Indenture Trustee seem to be the focus of a lot of consternation and questions lately, I find it very interesting.

Keach: Well thank you for that response and Bettina, do you have further questions?

Whyte: Well I do think …

Keach: Or comments?

Whyte: Yeah, I do think that there is some concern here in my mind that we keep focusing on large cases, because most of the cases filed are not large cases. While those are the ones that get the press, there are still plenty of fights, valuation fights, in small cases. I think that one concern I have about the testimony that I heard today, and I understand why, I mean, a smaller company may not be able to afford some of you at the table, but I do think that we, as Commissioners, have to look at the whole realm. If in any way you would like to amend your statements, not right now but in writing, to include thoughts about smaller cases, and I’m not talking about tiny ones; there are a lot of big cases that are not public companies and are not considered the “American Airlines” of this world; so I think it would be helpful to understand the Commissioners’ perspective how you might view … What your thoughts are, If they differ at all, for a smaller entity or a not such a humungous case.

I would also say that as it relates to the judges, I have great respect for every judge that I’ve ever been in front of, but if they are not … If some judges are not used to hearing cases like New York, Delaware, Dallas, California … I mean, there are lots of areas where you have huge cases filed all the time; but there are a lot of areas where large cases aren’t filed and they are less used to hearing valuation fights, and so therefore they may be less accustomed to being able to analyze those themselves very easily.

Again, I’d like you to put these sorts of things into a hat and I would as you if you have any additional comments, to please send them to us.

Keach: Thank you Bettina, Judge Gonzalez, nothing further, Geoff?

Geoffrey Berman: If I can, just two thoughts or comments. Miss Horowitz, you made the comment about the bondholders want to stand behind so they can freely trade, but doesn’t that create the conflict for you as the Trustee sitting on a committee? I mean you’re representing all of the creditors and their interests, and yet the people who you represent individually want the flexibility to move in and out of the system, and isn’t that a conflict?

Howritz: It certainly can pose challenges for the Indenture Trustee because we don’t know who is trading, what are they trading? Where are their real economic interests in the capital structure? There’s …

Berman: But you ….

Sandra: There’s also … oh sorry.

Berman: I’m sorry, go ahead

Horwitz: There’s also a segment though of holders that we typically call “Moms and Pops,” people who bought in at par, who never sold their bonds. Those people don’t have the same kind of voice. They don’t have the same kind of financial expertise. Their interests are also being represented by the Trustee and the greater committee.

Berman: Maybe that leads to the question of should there be a split? Should the people who want to freely trade not be sitting through the Indenture Trustee? That’s for another time.

Keach: Yeah, we’re going to leave that one there …

Berman: The only other comment, and I second what Bettina has just said, and Eric, you made the comment about the law of unintended consequences, but carrying this across for the large case needs to take into account the vast majority of cases that aren’t in New York, aren’t in Delaware and are being faced by the same rules that don’t necessarily work as well.

Siegert: I couldn’t agree more.

Keach: Alright, thanks. Professor Scarberry, you had a quick question and I’m going to ask you to be quick, I’m going to ask that the responses be brief because we’re going to move on to the next panel.

Mark Scarberry: Absolutely, I wonder if the sale of 10% would lead to the same feedback effect that we’ve talked about before. That’s just ... I wonder about that. Now I’m wondering, Professor Smith, about the relative contributions of errors in

cash-flow projections versus perhaps errors in discount rates, and how those may affect what we might ultimately see as an error in the valuation when you compare it to market values later?

We’ve had some suggesting cash-flow projections may be a bit “hand waving” and perhaps, is there also a selection effect in the empirical studies if the cases you study are the ones that successfully emerged, but yet perhaps some of the valuation problems may have occurred in companies where the case cratered?

Smith: So, first off, the potential for any fiddling you do with the sensitive three inputs cash flow, forecasts, the terminal value of the discount rate to have a big impact on value; I’m one who believes that if you’re careful about calculating your cost of capital and you remain conservative, based on what we know about what kind of returns investors get in terms of required rates of return, that then what’s left over are shoddy or uncertain cash-flow forecasts, or overly optimistic terminal values.

Scarberry: Okay.

Smith: The second one, that was with respect to …

Scarberry: For empirical studies, mostly studying the companies that have successfully emerged and you compare the value that was determined in the case with market value, but then we’re missing all the cases that somewhere in between there, there was a failure and there may have been difficulties in valuing, but we don’t catch those in those empirical studies. I’m wondering if there is a selection effect.

Smith: You don’t use a confirmation valuation on someone who gets liquidated, you don’t do a confirmation valuation on somebody who gets liquidated anyway, right?

Scarberry: I guess we could ask a similar question ...

Keach: I’m going to let you guys duke this outside the hearing room or at the next faculty lounge, but I do need to stop. Number one, I want to thank the panel, it’s been very insightful and I appreciate your testimony and your patience with the questions, so thanks very much.

We’re not going to take a break, we’re just going to shift panels. We’ve got new name tents for these people, and we thank the judges for their …

I want to thank our panel, the Honorable James Peck, the Honorable Robert Drain and the Honorable Gregg Zive, for being willing to testify. So without any further delay, I want to get started with your prepared remarks and then we’ll do questions.

Judge Peck? Or if you have preferred order, I’ll do that.

James Peck: We were just talking about that so maybe I’ll start only because you called on me.

Gregg Zive: We’re going to try to mix the small guy in with the two-big course.

Keach: You do whatever you want. As long as you tell me ahead of time, I'm good. Judge Peck, go ahead.

Peck: I'm not going to read my prepared remarks. In fact, I'm surprised that they ended up in everybody’s hands. This is the magic of email. I sent Judge Carey something that I had drafted on Monday and all of a sudden, it’s everywhere.

Keach: It’s very good so I wouldn’t worry about it.

Peck: Oh, I'm not …

Carey: It had to be shared.

Peck: I'm not worried about it but I'm not going to read from it. I just want to comment about it.

When Judge Carey asked me if I would say a few words here, I tried to think about some of my own experiences in dealing with major valuation problems and I've had some very, very big ones. As a result, I have become educated because some truly spectacular experts representing parties that were in conflict over value testified sometimes for days, presented expert reports and I had what I think is a relatively unique experience as a sitting bankruptcy judge not completely unique of getting an education while on the bench in the subject of valuation. It’s my perception, and I picked up some elements of this in listening to the discussion earlier, that because I'm sitting in New York and because I have a number of very large cases, that I have an experience that is different from the experience of many of colleagues, who would be perfectly capable of being educated in the same way that I was, had they been exposed to the kind of Socratic method that I experienced.

Now, part of what I also experienced is extraordinary waste and delay. Not that these cases could’ve been settled, they came to me in a form in which they were not capable of settlement. They were also cases that made headlines. One is Iridium, which deals with market valuation and I have my own view of that case and it’s not necessary the view that everybody espouses. Another is the Lehman 60-B trial, where we were dealing with the issue that Ken Klee was talking about, what happens when a market is broken. But we were dealing with billions of dollars in assets that were also hard to value. I'm not suggesting that my experience in these unusual cases are normative experiences but rather

exceptional ones, but based on those exceptional experiences, I have come to the conclusion that our system, as it relates to valuation, is a little bit broken in part because everybody is gaming the system and I'm in the middle of it.

I was teaching a course last evening and it was coincidental, totally coincidental, on valuation and the students were MBA candidates at the NYU Stern school. Some JDs were mixed in but it was mostly MBAs. I had a guest lecturer and following the guest lecturer, I went into some prepared slides that dealt with DCF, comparable company. I was actually teaching valuation but I was teaching it to an audience that was very sophisticated because many of these students had worked on Wall Street or had worked for hedge funds and had done valuations themselves and they had also all taken a prerequisite course in valuation. I asked the rhetorical question: How many of you believe, regardless of methodology, that the valuation process is unbiased? Nobody believed that the valuation process is unbiased, so one of my takeaways is that we have a system of perverse incentives. There are perverse incentives to game the system for those parties who are bond holders to argue that the enterprise value is large enough to make them pretty whole or maybe more than whole. We have secured creditors who may be motivated to have a quick exit and to liquidate and we have equity holders that are mostly out of the money unless they’re lucky enough to be in the company … while in bankruptcy that gains value. Sometimes, that happens. Regardless of where you are in the capital structure, there’s really nobody, except for the judge, that has no skin in the game.

What I came up with is an idea … and it’s partly because of the judicial panel that I'm on at 4:45 and I will not be late for that, and I know that Greg …

Keach: I promise we will not make you late for that.

Peck: … and I know that Greg Zive is on the panel with me, but one of our panelists is a judge from Canada, Jeff Morowitz. I had the experience, also I recognize an unusual experience, of being involved in a cross-border case with Canada is large bankruptcy. I had the Chapter Elevens and Justice Robert Mongeon in Montreal had the CCAA cases. As a result of that experience … and I know some judges have had this as well … I was involved in joint hearings where we would have simultaneous hearings in the United States and in Montreal that were televised and the report of the monitor was regularly filed in our docket in the Southern District of New York. I discovered that I learned more about what was going on with the case from reading the periodic reports of the monitor than I learned from any other party in the case and I found the reports to be very valuable.

My written remarks in effect combine the three experiences that I’ve described and I come up with the suggestion that is really more for discussion purposes than a fervently held view. It is that, in some instances it may be appropriate, in much the same way that we have a provision for the appointment of an

examiner, to have a provision for appointment of a monitor, although it’s not really a monitor. It’s a valuation ombudsman. The valuation ombudsman would be available to provide perhaps mediation services, apropos of what Tony Schnelling did in Calpine. Although he was Judge Lifland's expert witness, but I know that in practice he was more than that, and provided it remarkably constructive role in bringing consensus in that case. Jim Millstein was talking during the last panel about what we can do to encourage consensus. My thought is that if there were a provision such as this, which would certainly not be routine, it wouldn’t be employed in every case, it would be employed rather in a extraordinary case, that there would be multiple advantages flowing from that.

One would be, that there would be a perhaps most credible voice with respect to contested issues of value. The second would be, that before that voice had a chance to speak, there would be additional pressure brought to bear on the parties that already had their polarized positions on valuation and that that might bring about a negotiated resolution, thereby suppressing the urge to have a contested valuation that a judge would decide. Finally … and this is really I guess the most controversial aspect because it goes to questions of ex-parte communications and how the judge would use his expertise with consent. There would be the ability, in my hypothetical, for the judge to have access to his own or her own valuation tutor, a tutor with respect to the issues that are actually in the case.

Now, this is a very nuanced question and it raises, in my mind, a couple of other questions. One is, to what extent is valuation an issue which differs from any other contested matter that comes before a bankruptcy court? One could argue that I think both ways. My experience is that it’s different. It feels the same but it’s different. It’s different because … and I think we all know this … there really is no one pure objective right answer. Regardless of the valuation methodology, it’s an art, it’s not a science. It’s an assessment of risk, risk relative to future cash flows. I can make factual determinations about all kinds of matters and I can make legal determinations about all kinds of matters and I have. But there’s something … and I know there’s going to be some disagreement on this … there’s something awkward about converting a valuation determination into a classic trial of an issue of fact when in fact, it’s something else. It’s a nuanced judgment.

And so here’s where I go a bridge too far, and this is intended to be a for discussion purposes only. One could posit as a hypothetical that valuation issues are perhaps not best presented in contested valuation hearings before a bankruptcy court but perhaps might go to other finders of fact or determiners of what value really is. For example, there could be an ADR process in which a judge might refer to binding arbitration the question of valuation and the members of the arbitration panel would be valuation experts or a single chosen valuation expert. That’s an alternative I didn’t mention in the paper but I thought of it after

writing the paper. Another possibility … and I don’t advocate this, I just identify it … is that there is something like an administrative process rather than the judicial process to deal with contested valuation. That may or may not be a good idea and I can understand people objecting to that. But when I consider the waste in terms of judicial resources, the burden in terms of enormous administrative expenses on the parties and what I can only describe as ‘shameless gaming of the system’ that so often goes on especially when it comes to valuation, it seems to me that some of these out-of-the-box thoughts maybe worth considering.

Keach: Thank you, Judge Peck. Judge Zive, are you going next?

Gregg Zive: Thank you. Thank you for inviting me to speak today. My name is Gregg Zive, I'm bankruptcy judge in Reno, Nevada, where it’s difficult to get to so we don’t get all kinds of these large complex cases but we’ve had a few. We’ve had a few with over five billion dollars in debt, 2.54 of which was out of the money. We’ve had large disputes. But when I was asked to speak today, I was somewhat surprised. I did prepare some written remarks but the last panel seems to have beaten them all up so I promised not to read them all. I'm not an economist, my colleagues are not economists. We’re not appraisers, we’re not financial advisers, we’re not investment bankers. We are judges. We’re triers of fact. I think it is our responsibility to provide due process to all parties, to provide all parties with a fair and thorough opportunity to present their cases if they can arrive at a consensual resolution to make a decision and as quickly as possible while providing the sufficient time to consider the evidence in the argument, to provide the parties with findings and conclusions so those decisions can be reviewed and to ensure a complete and accurate record for that review. That’s our job. Before we delegate any portion of that job to a non judicial officer, I think you need to give sufficient consideration to what the results might be.

Now, unlike other speakers today as I've indicated, most of my judicial colleagues are like me. We do not routinely have responsibility to preside over cases that involve debtors that are large publicly traded corporations with millions of billions of dollars in equity or debt. While I've had that responsibility in several occasions, the overwhelming majority of Chapter Elevens in my court, and I believe in most courts in this country, are really closely held corporations, limited liability companies, small businesses, single asset real estate cases. In fact, the Code has carved out some of these cases with special provisions. I am not sure that one size continues to fit all. I don’t know that that should be the model to continue in the future. Maybe it’s a mixture of what Judge Peck has touched upon that is not necessary for what at least, I would guess, is more than 90% of the Chapter Elevens that are filed. Remember, we’re only talking so far about Chapter Elevens that involve business disputes.

We’re now having a great uptick in filling of individual Chapter Elevens and they’re also valuation issues in those cases. Of course, I happen to believe that individual Chapter Elevens really don’t fit in the Chapter Eleven model whatsoever for a number of reason but I think that’s beyond the scope of this proceeding today. Valuations in many of these other cases generally involve real estate appraisers, sometimes financial advisors.

Debtors have limited funds and creditors seem to be reluctant to spend a lot more money in what they’ve already considered to be bad debt so you’re not going to get a lot of sophisticated testimony. It’s tough enough to get a good testimony when trying to figure out a formula approach for the Till application. I do not know then why the Code should not be looked at to see if there is a potential for addressing some of these valuation issues that arise in what I consider to be the extraordinary rather than the ordinary case.

Now, as a judge, what strikes me is really unusual, and as a practitioner for 23 years. I did not come to the bench with a broad bankruptcy background. I was a commercial litigator, I did some bankruptcy litigation. So for me, it’s been 18 years of on-the-job training and there is not a colleague in this country that can do the same thing I did. I happen to be a cheerleader for the bankruptcy court system. Merit selection works and I think that my colleagues prove that. But when the parties have not been able to arrive at a consensual resolution, I wonder what are they thinking about. I don’t remember a single one of my clients that would want to surrender their business discretion to some third-party who may be the least sophisticated person in that room to make a decision. They don’t want to lose control. So I think that’s really the responsibility of the financial advisers and those consultants.

Now, sometimes it’s a simple matter in a valuation situation. What, with a willing buyer pay a willing seller in an arm’s length transaction that’s free from collusion or fraud or other inappropriate circumstances. Sounds simple but it’s not. We know that there are many methodologies. We know that often they’re conflicting. When I hear some of the testimony and read some of the data, and I've read Professor Smith's writing, what strikes me is I'm not sure that there is any one right system for any particular case. Then you need to look at the number of methodologies and you test them. The court’s got to be aware and we must be made, I think, persuaded what is the most reliable. That’s the job of counsel. I happen to think that the advocacy system does a pretty good job at testing those various theories. I don’t know what the multiples are, what’s the weighted average of cost of capital. Let’s find out what’s the proper discount rate, what’s the proper cap rate. That’s the job of counsel. That’s the job of your experts, is to educate my colleagues and me. It should be a teaching process.

Now, is it being gamed? I'm not sure. I know it’s expensive. I know when I get … and I've had this happen … pre-confirmation hearing and I get affidavits from the experts and they’re nearly a billion apart regarding enterprise value, I begin to wonder what’s really going on. As I said, I litigated, I had a number of jury trials, I understand that generally experts are going to render an opinion that favors the party that hired them. I've yet to have an expert testify that didn’t do that. If the parties are really seeking to provide an economic recovery, then they should sit down and be able to work it out and talk to people that understand their language. Sometimes, perhaps, the courts aren’t the best way of accomplishing that. If that breaks down and if they have to come to court, then part of what we’re going to be talking about at our next panel I think people should pay attention to is how to try this matters and how to get judges to make the best decision they can.

I read Jim’s statement and I've listened to Jim and I’ve great respect and I actually understand, I think, the predicate upon which he makes his recommendation. I'm not ready to agree that we should delegate our fact-finding and decision-making responsibility. Then, we’ll just become another administrative process. Maybe that’s what needs to occur. I’ll let that be your decision. Maybe it should only be in a limited number of cases. Clearly, a contested matter is not a transactional process.

When I look at, and I've had to, comparable transactions, are they really comparable discounted cash flows, leverage refinancing, what’s the terminal value, how do you compute all those, what are the different components of the equations … they are difficult. But I understand that’s my job and what I expect to do is make a decision based upon the evidence that are provided to me and I still trust that process. We’ve heard, and I think it’s correct, that valuation is more of an art than a science. Then what you need to do is convince me that the artist who is testifying in support of his or her opinion really is a good artist, and I'm one to do that.

Now, we were asked some questions, maybe we could respond to some questions and I thought about them. As I said, I'm not sure that one size fits all for Chapter Eleven is the appropriate model any longer. I did think about court-appointed experts. I don’t have a problem with a court-appointed expert in a certain situation. I think it would be extraordinary. I think that the expert’s opinion deserved to be tested by the other parties in interest just as their experts would be tested. We do delegate some things in the bankruptcy court as long as we remain with the ultimate responsibility for making decision, I'm thinking of fee examiners. I've appointed fee examiners because I did not think that I could do my job, fulfill my responsibility to review all of those fees and arrive at a decision, so I've used a fee examiner.

Perhaps, the expert would be helpful in this circumstance as well. Certainly, using an expert as a mediator I think makes a great deal of sense because then I think that the financial advisers, the economists, they could speak the same language and they might be able to accomplish something that the court might not be adequately prepared to do.

The other thought that I had, and it came up about 10 years ago at a large case conference meeting that was convened at the Federal Judicial Center, somebody made a comment that perhaps what you need is sort of a national specialty court for some of these very complex, difficult cases. In other words, it sort of relates to the one size doesn’t fit all. There are some problems with a specialty court, they exist in other’s theories, but that maybe one way of approaching the problem without sacrificing what I think is an essential judicial function.

Keach: Thank you. Judge Drain?

Robert Drain: Good afternoon. I want us to step back a second because it seems to me that this Commission, which I think is performing a valuable function, is looking at valuation to see what works and doesn’t work and what can be improved, but there are levels to that. I have been a judge for over 10 years now, it’s clear to me … and I practiced in the bankruptcy area since 1984 … it’s clear to me that if you measure success by the parties’ agreement or self-determination, valuation and bankruptcy generally works. As I said, I've been a judge for over 10 years. I've had in all cases, not just large Chapter Elevens but in consumer cases, Chapter Sevens, I think I’ve had five contested valuation hearings and I think for judges who served that long, that maybe more than they generally have. It hardly ever happens.

I've had two in large Chapter Eleven cases. Almost always, these matters are settled, and they should be settled as Judge Zive said for any number of reasons. I think that’s important to preserve, that success is important to preserve. What we’re talking about I think is giving judges and the parties a tool or tools that they can use to make that small percentage work better without encouraging people to go to more litigation at the same time. I think that’s really something you really need to factor into. Having been a practitioner as well as a mediator, I can tell you that one of the best arguments to get people to settle is not only the fact that you’re leaving it up to a third-party but also the time and expense and the effect on the company of a long contested valuation hearing. It's maybe a little perverse to make it work more smoothly because I don’t think you’re going to get much more to the truth than you would. All you’re really doing I think is reducing cost and time. By making it easier for that one percent, you may get 20 or 30 percent being litigated which changes the practice too much.

You also may want to measure success though, by whether the case which is avoiding a valuation hearing is fair, and that’s been raised also by some of you

and also people on the previous panel. I think that there are things that could be done to make cases more fair rather than just better lawyering and better advising and better judging when it comes to valuation. I would echo Eric Siegert’s comment that … considering how to make the determination of the facts for the parties more transparent is a good thing.

My thought would be to perhaps make a factor in terms of extending exclusivity the ability of the company or the proclivity of the company to prepare its projections, a business plan and do a claims analysis. That might, in particular, help those in mid and smaller cases who don’t often … which don’t often have creditor’s committees or have committees that have very small budgets to at least put some pressure on the debtor to have more information available. I understand, and Eric mentioned this also, concerns about making a company’s secrets public but there should be ways to get around that with confidentiality agreements and the like for those who really want to get under the tent and should be under the tent. I'm not sure it should be a separate requirement but I think I’d recommend tying it to the determination on exclusivity and maybe the determination on conversion under 1112.

I don’t want to let pass also one other thought that I had that hasn’t been touched on at all today, although Judge Zive did mention that Chapter Eleven includes individuals. Part of the genius of the Bankruptcy Code is that it does highlight valuation throughout as it should because that’s the function of bankruptcy, to get everything to its value. There’s one area where it doesn’t do that and you all should take that on, which is the Home Mortgage Exception.

I understand why it wasn’t dealt with in the height of the economic crisis, it was too political, but the really effective amendments to bankruptcy Code throughout history have been after crisis when people can step back, look and see what should’ve been done. We still have 10 million homes that are under water; 1/5th of the housing market. It’s not really an answer and we all know it, to say people should pay their debts. If that’s the case, we shouldn’t have a bankruptcy code.

You all should think about that, and if you could have a neutral empirical person to test that, which I think, though we pretty much know all the answer, we should deal with that issue.

Addressing the point that Judge Peck raised, I think that it’s important to distinguish between the two elements of a valuation hearing. I mean, I’m really not talking about valuing a business, a large business because I think this proposal really works best for really large, complicated trials.

At these conferences, people generally ignore what I think of as what is actually at issue in the trial that I actually do in the trial which is the facts of the business

itself, underlying the projections. How does this company make money? What is its future if it’s the right size in the capital structure?

That really is a fact-finding exercise that I think is brought out by the adversarial system. It’s not something that an investment banker feels comfortable with. Usually the investment banker is taking that data and then applying his or her different methodologies to it.

In my experience, you don’t really get to the bottom of those issues, if you ever get to the bottom of them, unless you have a well developed adversarial process. You don’t have the ability to probe management about what works in the business and what doesn’t work, who your competitors are and what your Cap X needs you are going to be in the future. Not the cost of the capital but when are you going to have to invest X million dollars for your next generation of your product? Those are things that I think Judges are quite comfortable and quite able to determine.

In my experience, I admit it’s limited to valuations in big company cases, that’s what drove the valuation. That’s what affects the underlying base that then the experts apply their multiples or whatever methodology that you are going to apply to it.

I worry about a neutral, and there’s a benefit obviously in having a neutral person, but I worry about a neutral person being able to go through that exercise. I think it worked in Calpine because the neutral person was a truly exceptional, professional who combined both understanding businesses with understanding investment banking.

That’s a very rare person, I noted one other instance where a Judge tried something like this, it happened many, many years ago in a large case where I was representing creditors, it did not really work. The person was on paper, very qualified but he was lost in the bankruptcy setting and didn’t really know how to deal with the people that we all deal with who often have pretty sharp elbows and basically just pushed him away.

I think that there may well be a purpose to be served by bringing in someone neutral either to assist the Judge where he or she has the feeling that both sides are throwing garbage at him, which happens sometimes. At that point you should stop the trial and say, “Wait a minute, neither of you are making any sense to me.” Or where the area really is over his or her head; although I agree with you, I think the vast majority, if not all, the bankruptcy Judges in the country can get it and get it right and quickly if it issues are presented to them. The Judge may not feel that way.

I worry about how to go about choosing this person because just as I may not know the way to value regulated assets to the utility business, for example. I probably don’t know who the people are who are good at that. My choice of that person might be a problem from my get go.

I think that courts are moving more and more in this area because we all recognized that when it does come to a contested valuation fight in a big case, it’s really not helping anyone. To try to short circuit that process, I think I would recommend first, going to something like meditation to do that before I appointed an expert. I think I also want to see the party’s submissions to see whether they were credible before appointing an expert.

I actually did, in one case, have an investment banker admit, “I just can’t get there, I’d like to” he represented the equity, he said “I just can’t get there.” Well, he got points actually for that but you can only get there if the facts were such. In other words, he could not get there with multiples beyond what he was willing to do.

The good investment bankers, I think, do that. The ones that don’t, do get punished for it. If you read, for example, I’m just picking their other opinions like Judge Gerber’s opinion in Camptura; I mean, clearly there were investment bankers and investment bankers in that case, it affected the outcome.

I think it should be a tool that is available, and maybe adopting a special master approach which we don’t have would make that tool easier rather than experimenting because there is prescedent there and there is guidance on how other courts deal with special masters; but I think it should be clear, I guess this would be legislative history that it should be a last resort.

Just briefly on a couple of other points, I was interested in the discussion about the perception at least that senior creditors hijacked cases more frequently. That’s clearly something that’s been affecting your views not just on valuation, but your inquiries in other hearings.

Obviously, it is easier to hijack a case if you are the only source of money; if that’s the case then there’s not really an answer for that because there’s nothing else to do then. I think that there is a reality check also that encourages lower valuations which is the exit financing. If you cannot get the exit financing then obviously the valuations too high.

On the other hand, if you can get the exit financing, the valuation may still be too low; so that maybe one reason that the data is coming out the way it is more recently. I think that if you have some teeth in getting the company to provide the underlying information to the constituents, and you deal with process issues in sales and in DIP orders, it’s not really the valuation that’s the problem I think it

is in the process. I view my job, by and large, is not doing valuation hearings because that’s not what I do, but in trying to make the process run fairly within the constraints that you have to operate under it for the company’s cash needs and the like. One point on that, Ms. Horowitz talked about DIP orders validating liens with fairly tight look back periods.

DIP orders should never valuate valuation, whether it is an interim order or a final order, it just should not happen. I know that there’s language in standard form DIP orders that I get that try to get that in there, but it just does not make any sense. Whether it is in a rule or the statute, since it’s in these lot of orders I guess it snakes through you that you all should address that.

Anyway, thank you for letting me speak.

Keach: Thank you Judge Drain. We’ll go right to questions. Mr. Brandt you have a question?

Brandt: I do. I’d like to weave some of this together. Some of you know, I serve as the chair of the nation’s largest state sponsored bond issuing agency. I was summoned to Washington at the start of the crisis and in the meeting was Becker and Krugman, two eminent economists. They’re probably as good as you get in terms of valuation, but they couldn’t agree. I’ve come to the opinion that if you have a variety of different valuation people, you are not going to find an agreement other than as you say by competing facts.

My concern is that is part of my effort in learning the business in over for 40 years, I have served as a monitor in Canada Judge Peck, and as the Administrator in the UK. One of the things that strikes me is it’s less adversarial there. I don’t mean that in terms of consensus, I mean institutionally, less adversarial.

The monitors that are provided you in Canada, Judge Peck, come from the Department of the Government of Canada that oversees bankruptcies, which is not equivalent of Ministry of Justice. It’s Industries Canada. Their goal is to get people’s money back not to prolong the fight.

One of the thoughts I had in weaving this together is because I very much buy into your argument. We have a number of panels and a variety of agencies. The Department of Labor has the Federal Mediation Service and others. It wouldn't be difficult to involve them or the Department of Commerce and perhaps have a panel of monitors available in cases like this for valuation. And if there were a federal mediation service or anyone else or you can refer without worry of a particular nuance of one side or the other to the government in this kind of process.

I think one of the issues has to do with respect to the Code is think outside the proverbial box. I think the US Trustee program, for example, came into existence after the Code was created in '78. It’s has the life of its own. There's no reason as we see these complex cases not to incorporate some of the arguments, in not so much adversarial system or an advocacy system, but in administrative system. I recall the Code's goal was to split judicial and administrative functions, and we've somewhat done that.

Perhaps one of the things we should look at, and I've looked to the three of you for comments, is if we shouldn't broaden in the concept of what is an administrative function? Maybe some type of monitor as you suggest, Judge Peck, or monitor panel where Commerce would provide one, could be that type of administrative function.

Judge Drain, I don't know if the best way to valuation is always through an adversarial process. I'm not saying that certainly some on the bench, many on the bench, don't have the minds to accommodate that but if you have a group of people who were, by definition, not having a stake in the fight and who routinely solve these issues; perhaps you, as Judge Zive says in essentially a commercial court transaction, could refer the question of valuation to this kind of a panel.

Zive: Some of that I doubt that I'd have any objection to. My concern is that it will be well considered, because I think there is a real benefit to having a judicial as opposed to administrative system. That does not mean that you can't have some administrative overlay. Having a board such as the Federal Mediation System that would solve Judge Drain's issue who could be the monitor, who could be the mediator or whatever you would call this body.

I think there's one benefit that perhaps nobody has touched on. Sometimes I get the feeling, and maybe it's just because it's in my courtroom and because I'm the judge, that somebody may be in the parlance of the State of Nevada, willing to roll the dice, that they might be able to fool me and they might not be able to do that with somebody who came in with a certain amount of expertise which may lead in a more serious thing to earlier settlement negotiations and consensual resolution, so I think there's some benefit to that.

When I took this job, as I said, I was not a bankruptcy practitioner. I went back and did some reading. I really think that the underpinnings of the creation of Code and the separation of the administrative from the judicial functions made a great deal since then, and makes a great deal of sense now. I do think that there are issues with regards to valuation, perhaps some large cases. Look at it, maybe that is one of those solutions. I think you've got to keep those concerns in mind.

Brandt: Gregg, I'm not suggesting you take away the final decision from the judge, I'm just suggesting … I think very much in line with Judge Peck’s suggestion that … I

always have a problem speaking to lawyers because you always want to do better lawyering; and using that old GE thing better progress to better whatever. It's not always better lawyering sometimes it's not conducive to adversarial system. Perhaps if you step back and look at administrative function, which still reports to the judicial function in the end for decision, maybe that's the way to go.

I suspect, Judge Peck, and it’s just a thought, if you had recourse to such a panel maintained by the Department of Commerce, for example; if you send people over there to have their valuation arguments heard, one side or the other might get a little gun-shy about the prospect of actually having somebody do that and might be settling, as you suggest, Judge Drain.

Peck: That's entirely possible but I'm going to note that my big valuation fights all occurred in the context of ligation.

Zive: You mean like fraudulent transfer or …

Peck: What I'm really talking about, as the inspiration for this proposal, is not for example, a big valuation tussle leading up to contested confirmation hearing that affects the company. The Iridium case, as anybody who’s read it, involves the creditor's committee that was suing Motorola. I'm going to say this because I said I was going to say it, the case is often mis-cited for the proposition that the markets are a better barometer of determining value than traditional methods of valuation.

What the case really is, is a burden proof case because there was a failure on the part of the committee's expert to account for the market data that when considered, suggested solvency. Given that setting which was an incredibly prolonged trial, the only person who could have decided that was me. I was perfectly happy to do it, I think I was capable of doing it, and I think the result was correct. Oh, I wasn't appealed either, so I guess it's at least in that setting, final.

Like my colleagues on this panel, I'm an advocate of the system we're in and I think that bankruptcy judges are quite adept at solving basically every problem that's thrown our way.

Brant: Is that a good use of your time?

Peck: I'm not quite done. As I was thinking about what I might say to this Commission and this committee, I reflected on valuation and I was also preparing to teach a class in valuation at the very same time that I was doing this; It occurred to me, and I'm agreeing with Commissioner Brandt's position on this, that valuation may be an exception in certain cases, not in every case. That the adversarial

process might not necessarily illuminate the right answer because for example, adverting back to Iridium; the right answer might have been different if I wasn't dealing with this as a burden of proof question. If I wasn't dealing with this in the classic sense that judges deal with lawsuits.

In a sense the choice you make may also determine outcomes. There's the old saying "If you are a hammer, everything looks like a nail." We are judges, so everything looks like a contested hearing in which we're determining the facts and we're applying the law and we're doing the job that we are educated to do as lawyers. Valuation might not necessarily be that most perfect kind of dispute for us to handle the way we handle every other kind of dispute.

Keach: Professor Klee you have follow up and then I do want to the front row.

Klee: Yeah, this just in line with Bill Brandt's question, but I think it crystallizes a little bit. The European system for years has had an inquisitorial system of justice. I think the only place we see that in the United States is when we have examiners who actually go out and conduct, investigate and try to determine the facts by ferreting them out. What about a court appointed expert who can go out and try to interrogate the parties and determine value and report back to you bearing in mind that it's ultimately your decision? Would that be better than the adversary system and have any of you appointed court-appointed experts?

Drain: In one of my two contested valuation hearings it was preceded by an examiner who did a reality check on whether the debtor might be solvent. He came back with enough to say that it might be. That led to a contested valuation hearing in which I found the debtor was not solvent; although just barely. I'm not sure whether it was that helpful in the end because it took several months to get to the valuation hearing.

Keach: Well, just a related follow up because it goes to the monitor example, I mean a major difference between the US and Canadian systems and monitors and examiners is that results are not evidence; they’re by definition not evidence, right? In case of monitors, I gather from my friends in Canada, the monitors reports are considered evidentiary and can be considered evidentiary in Canada. Would it have made a difference if your expert was an examiner whose outcome could have been put into evidence as post simply reporting to you?

Drain: It would but again, I think that would lead to a process that takes the matter out of the party’s choice, and I think ultimately they prolong the process.

Keach: Okay, we’ve got probably time for one question, we have one in the front, so go ahead.

Van Durrer: Thank you. Question I had is in some of the comments that we put out to panelists; we ask about the relationship between the prevalence of section 363 sales, quick sales and the impact or relationship with value.

In my experience anyway, I’ve observed the judges are sometimes put in a position of having to decide between the fate of the company or a sale on a very short timeframe. Would it serve your function if there were statutory restrictions around how fast Section 363 sales could be conducted?

Zive: I would question how you would do that.

Klee: You draft a statute that would say the court may not enter an order consummating the 363.

Zive: We could do that.

Klee: Before 90 days after the order for release.

Zive: That’s fine. If it’s really the melting ice cube, then maybe you have deprived parties in interest of value. You can do whatever you want. What I’m saying is, I think it would probably better off allowing us to deal with those situations when they arise and to exercise our discretion.

I think, to quote some lawyers at some point about 20 years ago, we are not potted palms. I think we can make those determinations in the appropriate cases. That’s my problem with that Professor Klee, it really is.

Keach: Let me just throw a variation on that in the middle and say, would a statute that essentially reinstituted the pre-Lionel standard for sales of substantially all the assets be better than the current system. In other words, require genuine emergencies, and follow up to that is of course …

Zive: What we try to do …

Keach: How would we distinguish between genuine emergencies and the ones that lenders create or some other party create; unions, whoever it is?

Zive: That’s my point. We try to do that now. We hear that it’s really not the melting ice cube. Well, what is going on? I had a case that Mr. Durrer worked on that was maybe the shortest pre-packaged case ever, and it worked. Now would that have worked in any other situation? Probably not, but they followed the rules, we did … They had the right prepetition solicitation; the Code had been changed to allow us to continue the solicitation post petition, so it worked.

Would that mean I’d do it in many cases? Absolutely not, but I had the ability … They flew in the witness from New York; we did an evidentiary hearing. We did the job. That’s my position.

Peck: I'm completely oppose to what you just suggested as a concept. It’s yet another example of an arbitrary limitation upon judicial discretion. We’ve had enough of that already. I believe that bankruptcy judges, to the extent, we are in fact exercising a judicial function, to be able to exercise full discretion applying a law to the facts.

My own experience with approving a 363 sale in less than a week, when it had to occur, demonstrates to me that the system is incredibly flexible and anything that you come up with that reduces that flexibility, makes it more brittle, is a really bad idea.

Keach: Judge Drain, would you like to have the last word on that or would you like to …

Drain: I turned down one in three days, and approved the sale in eight days, and the price went up; but I was convinced that it wasn’t going to go up anymore so I agree with Judge Peck and Judge Zive.

Keach: Not the least because I agree with you and I’d love to give you time to do that but we really have to let these guys get to the next panel because right now they have five minutes to do so.

I’m going to cut it off here, exercise my prerogative and even overruling the President of ABI, so there’s really going be a penalty for me to suffer on this, especially since they’re funding the panel.

I want to thank the judges for their time. I just want to give them time to get to their judicial panel. I want to thank everybody for your patience and your interest as we as we continue forward. Let me remind everybody that we take written submission on a continuous basis so if anybody wants to follow up with the writing including panelist, we’re happy to receive it, that includes members of the audience. Otherwise we look forward to your involvement as we move forward. Thanks.