Calculating Legal Fee Awards

When legal fees are awarded based upon a percentage fee, we believe the correct calculation is to divide the damages awarded by one less the legal fee percentage (1 - .xx). This provides a gross-up such that the actual damage award is not reduced by part of the legal fees. Let's use an example: the judge or arbitrator awards $1,600,000 of actual damages plus attorneys' fees; the attorneys' fees are 25% by agreement. If one calculates 25% of $1,600,000 she arrives at $400,000 for a total award of $2,000,000, but 25% of that total award is $500,000, meaning $100,000 of legal fees would be reducing the actual award. The correct methodology divides $1,600,000 by .75 (1 - .25) to arrive at $2,133,333.33, 25% of which is $533,333.33, leaving the original award of actual damages going to the client at $1,600,000.

We greatly value any insight we obtain as to how our opinions are perceived in litigation or arbitration by the fact-finder. Recently, we performed a business valuation and testified regarding the loss of business to a company in the oilfield service industry which shut down after it lost a key license agreement. We prepared for the plaintiff a full, written valuation report for the entire enterprise, not the license, that we believe complies with all relevant valuation standards. The defense expert did not prepare an alternative valuation report but rather a critique of our methods.

This was an unestablished business founded and briefly operated by principals with considerable experience in the industry who had sold, profitably, a comparable business in the past. The business was not novel. The arbitration panel cited management's experience as crossing the threshold away from speculation to allow damages. We used written surveys of actual and potential customers to develop revenue figures. The arbitration panel considered the surveys "some evidence" of future sales but was concerned about their hearsay nature.

The panel criticized our valuation for the following reasons:

• one of the specific products expected to be sold did not have sufficient evidence of likely sales in the surveys;
• revenues were not adequately risk adjusted or the discount rate was too low;
• our effort to estimate sales beyond the specific survey responses was rejected.

The panel addressed the first point by removing all sales of the specific product in question from the calculations, the second point by increasing the discount rate from 25% to 33% and the last point by only accepting the specific survey responses and then only the minimum range from the survey responses.

Our guideline transaction approach was rejected entirely by the panel as irrelevant to an unestablished company.

Reference was made by the panel to the defendant’s internal valuations and negotiations for a non-arm's-length sale to further reduce the valuation. We understand and respect the panel's discretion as to all the other points but literally do not see the reasoning for this final reduction.

While the panel agreed with the defendant that the "but-for" method should have been employed, our assignment was not to address mitigation and the defense did not provide evidence of the post-harm value of the plaintiff.

Your questions and comments on this process are invited.

"Fairness" Opinions

Investment bankers involved in the lucrative and thinly policed business of offering "fairness opinions" of the value of corporate mergers and acquisitions may face tough new rules for disclosing the financial incentives that they and the company executives they advise have for pushing through deals. According to a recent article in the Wall Street Journal, the NASD, the main self-regulatory body for brokerage firms, has begun a potentially far-reaching inquiry into the fees, methods and possible conflicts of interest connected with such opinions.

Fairness opinions are provided routinely on a host of corporate transactions, including initial public stock offerings, takeovers and spin-offs of company units. In mergers and acquisitions, corporate boards commonly seek these opinions to protect against legal challenges over a decision to do a deal. These opinions are sometimes done by investment bankers whose firms have no other role in the deal. But they also can be prepared by bankers from the same firm that suggested a deal take place and that stands to collect a "success fee" that is a percentage of the deal’s price at completion.

Bankers who provide fairness opinions tend to rely heavily on public filings and information that corporate insiders give them regarding assets and liabilities. While bankers sometimes do extensive additional work, the potential to win investment-banking business from their clients gives them an incentive to accommodate management and declare that the terms of a proposed deal are fair. NASD could propose more fact-finding, including requiring that bankers examine the financial rewards that senior officer may received by doing a deal.

CPAs are often asked to provide "comfort" or solvency letters attesting to the fact a borrower's assets exceed his liabilities or her income is within a certain range. This practice has become common among mortgage lenders seeking a short cut to income verification for self-employed individuals. We are concerned about the extent of this practice because the professional standards prohibit such letters and a default by a borrower on whose behalf such a letter was issued could result in disciplinary action against the CPA based upon Attestation Interpretation 1 - Responding to Requests for Reports on Matters Relating to Solvency (AT §9101.23-.33). There are alternative attestation reports available in these circumstances but the procedures are more complex and expensive.

Oren Benton, Petitioner v. Commissioner of Internal Revenue Service (May 14, 2004): The taxpayer sought to use NOLs that arose before and during his bankruptcy proceeding. Under §1398(i), the taxpayer would succeed to his bankruptcy estate’s tax attributes upon the termination of the estate. The issue hinged on whether the Chapter 11 bankruptcy estate "terminated" at the time of confirmation of the plan of reorganization or, upon entry of a final order closing the bankruptcy proceeding. The court held that the "termination" occurred at the time the debtor’s plan of reorganization was confirmed. The second issue concerned whether the NOLs could be carried forward from the commencement of the bankruptcy proceeding, or were limited to the period beginning with the termination of the estate. §1398 and §172 did not circumscribe the taxpayer’s ability to carry forward pre-petition NOLs that he succeeded to from the bankruptcy estate. Thus, the taxpayer was entitled to carry forward losses inherited from the bankruptcy estate and those to which the debtor was already entitled in accordance with §172 and the underlying regulations. The taxpayer could apply those losses for the year of the commencement of the bankruptcy and later years. Please contact Allen W. Wendler of J.A. Compton & Co. if you have any questions related to utilization of tax attributes and related planning in individual bankruptcy matters.