Valuation and Litigation

The Deloitte & Touche Real Estate Newsletter for Attorneys

Published Spring, 2000

Considerations for

Valuation and Litigation

By Mark Pomykacz

Perhaps today, litigating our differences has become a normal business venue. Certainly, experience indicates that even the best intentions and the most prudent management practices can offer no guarantee of avoiding litigation. Given that real estate is one of the most expensive business and personal activities, it is not surprising that subtle differences between parties lead to disputes over large dollar amounts.

Disputed real estate valuations often range in the millions of dollars and sometimes in the $10’s of millions. Even leasing disputes can amount very large, disputed valuations. Over a seven-to-ten-year lease period, many aggregated lease payments will exceed the value (sale price) of the property. Furthermore, the complexity of real estate valuation unfortunately leaves room for dramatically different opinions of value, rent, and damages. The scale of real estate valuations and the complexity of such valuations require the use of real estate valuation experts.

Some sample valuation for litigation issues include:

  • Bankruptcy and Reorganization Issues
  • Property Tax, Estate Tax, Transfer Tax, Other Tax Issues
  • Contract Disputes, Contract of Sale Issues, Landlord-Tenant Issues
  • Partnership Disputes, GP Mis-management, Partial Interest Issues
  • Environmental Damages, past and future lost income, stigma and cost to correct
  • Condemnation and Takings
  • Insurance Claims

Once a dispute over real estate valuation is recognized as possibly destined for court, our advice is to prepare earlier, prepare intensely, use the right professionals, and interact deeply with your litigation team. Presented below are basic considerations when working on litigation involving valuation issues.

While some disputes are centered on a valuation, most are cases where valuation issues arise in the context of proving a contractual default and/or where once a default has been established, the dollar damages must be estimated.

The term “valuation” herein is intended to also include income and yield analysis and estimation. Many of the biggest cases never require a value (sale price) estimate. Partnership disputes, insurance claims, poor management and the resultant poor yield, and lost income often involve disputes over expected income and yields, all of which real estate appraisers are suited to handle.

Also discussed below are some of the more common mistakes made by clients, appraisers, and litigators. The considerations below are not arranged in order of either chronology or priority, except for the paramount consideration, which immediately follows.

It is paramount to maintain the appraiser’s independence and objectivity. Even the perception of tainted objectivity could destroy their effectiveness as an expert witness.

Identify and Clarify the Valuation Issue

Unless a client and/or their attorney are experienced with the particular valuation issues at hand, the valuation experts should be consulted as early as possible. Also, unless the appraiser is experienced with the particular valuation concerns surrounding legal issues at hand, the attorney should be consulted as early as possible. Neither the appraiser nor the client and their attorney should make assumptions about the appraisal methodology, the scope of the problem, or the legal strategy without first consulting the other.

♦ The “Full Narrative, FIRREA” type report is often not appropriate for litigation purposes. Appraisals prepared for one purpose and use (or for one litigation case) are often not appropriate for (another) litigation. Appraisal methods and reporting formats vary dramatically and this is appropriate as appraisal issues vary dramatically from case to case.

♦ A preliminary analysis is often helpful for measuring the scope of the problem and testing valuation and legal strategy, but great care must be exercised to avoid the reality and perception of an expert with tainted objectivity.

♦ Different practical appraisal problems require different appraisal methodologies, procedures, and reporting formats. Often the supply of data to be analyzed in the appraisal, or lack thereof, drives the appraisal methodology. Thus, the expert appraiser and the attorney experienced in one type of case may not be able to predict the valuation needs of another case, at the outset.

♦ There must be a continual dialogue beginning in the earliest stages of the case, between the appraiser, the client, and their attorney to resolve and sharpen the legal strategy and appraisal methodology.

Protect Client-Attorney Privilege

Clients should not hire the appraiser directly and should limit their discussions until the attorneys have hired the appraiser. All working documents prepared by the appraiser for a case should be labeled “draft”, “confidential”, or “prepared for counsel in connection with litigation”.

Select Valuation Experts that Meet the Needs of the Case and Round out the Team

♦ Is a designated (MAI) appraiser required?

♦ Is a state licensed appraiser required? Will the expert’s report need to be USPAP and/or FIRREA compliant?

♦ Will other types of experts be needed to support the valuation opinions, e.g.: accounting, environmental, engineering, architectural, zoning, financial or brokerage.

Ensure that the Legal Strategy Matches the Most Defensible Valuation Methodology

Some valuation methodologies preferred by investors and owners, like the discounted cash flow (DCF), are commonly disbelieved by judges and juries. Conversely, sometimes legal precedents vary sufficiently from the circumstances in the case at hand to warrant another methodology.

♦ Valuation theory can be elaborate. Valuation models are sometimes highly complex and sensitive. Seemingly minor changes in methodology and modeling can dramatically change the conclusions.

♦ Ensure legal instructions are appropriate. Hypothetical assumptions are appropriate and acceptable in some situations, but not all. Maintain an attorney-expert relationship that’s conducive to the free exchange of ideas, questions, and concerns, since it is common that neither the attorney or the appraiser will fully understand initially the impact of their instructions to the other.

♦ Ensure that appraisal terms match the definitions in law and to the layman. If not, care must be exercised to keep communications clear to all, especially to the judge and jury.

Give the Valuation Experts Enough Time and Resources

For example, it takes 4 to 6 weeks to complete a “full analysis” appraisal on a single asset. Some require less, others a lot more.

♦ Remember that beyond the essential correct methodology, a valuation is dependent on market data, which takes time to collect when it must be gathered from third party sources.

♦ Also appraisers, if given the opportunity, can sometimes substantially increase their accuracy over that of nonlitigation appraisals by employing techniques that, due to their obscurity, complexity and/or cost, they are rarely asked to provide. These techniques should be considered early in the case for best results.

Involve the Valuation Experts in Deposing and Crossing of the Opposition’s Experts and in Analyzing the Testimony of the Opposition’s Experts and in Analyzing the Opposition’s Valuation Strategy

♦ Recognize that most cases settle. Then employ the valuation experts in establishing the case’s probability of winning a valuation judgment or verdict and in setting appropriate settlement terms.

♦ Involve the appraiser in the search for, review of, and interpretation of valuation related documents.

Research the Judge’s history on Valuation Issues

Does the judge have experience with valuation issues? Does the judge dislike certain valuation techniques, such as the discounted cash flow or others?