Valuing a Distressed Claim: Law, Security, Debtor and Time

A distressed claim is worth less than its face amount, and the question for a buyer, a seller or a lender considering a settlement is how much less. The answer is not a formula. It rests on an assessment of the law, the evidence, the debtor's assets and the time that recovery will take. This note sets out the factors that a careful valuation considers. It is general information, not advice on a particular claim, and no price or range is suggested.

The legal strength of the claim

• Enforceability. Whether the debt is evidenced by documents that a court would accept, whether the contract is valid and whether there are defences, such as part performance, set-off or a counterclaim.
• Limitation. Whether the claim is within time, and how much room is left. A claim close to the limit has little value unless it can be kept alive by an acknowledgment or a filing.
• Evidence. Whether the records are complete, whether electronic records can be proved in the form the law requires and whether the witnesses are available.
• Amount. The principal, the interest claimable and the costs, each tested against the contract and the law.

Security and priority

A secured claim is worth more than an unsecured claim of the same amount, if the security is valid. The valuation should confirm that the charge is registered, with the Registrar of Companies and, where relevant, the Central Registry, and should identify any earlier or competing charge. In insolvency, the waterfall in Section 53 of the Insolvency and Bankruptcy Code places secured creditors who relinquish their security, and other classes, in a fixed order. A claim's rank therefore decides how much it is likely to receive from a given pool of assets.

The debtor

• Capacity to pay. The debtor's assets, income and other liabilities, as far as they can be ascertained from public records and the file.
• Conduct. Whether the debtor has paid anything, acknowledged the debt or contested it, and whether assets have been moved.
• Guarantors and third parties. Whether there are guarantors with assets, and whether the guarantees are enforceable.
• Insolvency risk. Whether the debtor is, or is likely to be, in a process under the Code, and what that would mean for the claim.

Forum, time and cost

The expected recovery should be reduced by the time it will take and the cost of getting it. A suit and execution may run for years. The Debts Recovery Tribunal and the process under the Code have their own timelines, which in practice are often longer than the statute contemplates. The legal costs, the expense of tracing assets and the cost of holding the claim in the meantime each reduce the net return. A valuation should state its assumption about the forum and the period.

Building the estimate

1. Set out the realistic outcomes: full recovery through settlement, recovery through enforcement, recovery in insolvency, and little or nothing.
2. Estimate for each outcome the amount, the timing and the cost, using the evidence and not hope.
3. Assign a probability to each outcome, and state why.
4. Discount the expected amounts to present value at a rate that reflects the risk and the time.
5. Test the result against the alternatives, including the price of a comparable claim, if known.

The method will not remove uncertainty. It makes the assumptions visible, so that buyer and seller can argue about them, and so that a price can be defended afterwards.

What changes the value

A valuation is a snapshot. A new payment, an acknowledgment, the discovery of an asset, a judgment or the debtor's admission to insolvency can each change it materially. A holder of a claim should revisit the valuation when such events occur, and a buyer should ask for a warranty that the seller has told it of any that have.