In Re Pullman Construction Industries Inc.

107 B.R. 909 (1989)

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Text Box: SYNOPSIS Pullman Construction Industries (“Pullman”) started out as a simple Chicago sheet metal fabricating company in 1942. During the post-war construction boom, however, the company grew rapidly—venturing into the heating ventilating and air-conditioning (“HVAC”) construction business and participating in huge construction projects around the country, including high-rise commercial buildings and nuclear power plants. By the mid-eighties, Pullman’s excessive growth and poor management caught up with the company. It had hemorrhaged millions of dollars in losses following a downturn in construction, forcing the company to file a petition for relief under Chapter 11 of the Bankruptcy Code. See 11 U.S.C. § 101 et seq. Cases filed under Chapter 11 are strictly for corporations that, though under severe financial distress, feel they can reorganize the company so that they can repay all or part of their debt and reemerge as a viable going concern. In this case, as in most Chapter 11 cases, the company continued to operate under its current management (referred to as the “debtor-in-possession”) while the management worked with a committee of its creditors to develop a reorganization plan. After a final plan is presented by the debtor, the creditors then voted whether to accept or reject the plan. Once accepted by the requisite majority of creditors, the bankruptcy court would then decide whether to “confirm” the plan—that is, putting it into effect. (The voting scheme is slightly complicated because creditors are grouped and vote according to “classes of interest.” This is fully explained in § 1126 of the Code.) In this case, one of Pullman’s largest creditors, Wells Fargo Bank, voted to reject Pullman’s proposed plan. The Bank held over $3 million in secured claims against Pullman. Under the proposed plan, the Bank’s secured claims would be fully satisfied by payment of roughly $1.8 million. Of course, it is not unusual for creditors to receive only a fraction of the total debt they are owed in bankruptcy. Special protections do obtain, however, for secured creditors like Wells Fargo: They are entitled to at least the present value of the collateral that secures the debtor’s obligation (i.e., the value of the collateral if the company’s assets were simply liquidated). See § 1129(a)(7)(A). Wells Fargo argued that the collateral securing its claims would be worth substantially more than $1.8 million in liquidation. Because Wells Fargo’s liens covered essentially all of Pullman’s assets, the task was to value Pullman’s business outright, which the court took up as the primary issue. Pullman and Wells Fargo presented competing valuation reports and expert testimony to the court. The court explains and analyzes each at length. Pullman relied upon a discounted cash flow (DCF) analysis. Accordingly, its valuators began by projecting future cash flows from the date of the proposed reorganization in 1989 through the end of 1993, when the experts concluded Pullman would gain “maximum market share” and “not experience further economic growth.” 107 B.R. at 920. After 1993, the court applied a terminal value (referred to as the “residual value” by the court. Once these cash flows were projected, an appropriate discount rate had to be applied. Here, the valuators used a sophisticated analysis based on several methods: primarily relying on the Capital Asset Pricing Model (CAPM), but also employing the Arbitrage Pricing Theory (APT), the Weighted Average Cost of Capital (WACC), and a survey of alternate investments “evidencing rates of return currently expected by investors.” 107 B.R. at 921. In countering Pullman’s valuation, Wells Fargo did not perform its own independent analysis, but rather relied heavily on accounting and business information from Pullman and then attacked the inputs and assumptions that formed Pullman’s valuation. The court was not at all impressed. For example, Wells Fargo argued stridently that the company would continue to grow at 2 percent in real terms indefinitely—applying the Gordon Growth Model. The court excoriated Wells Fargo for intentionally selecting data inputs that resulted in an inflated, unrealistic valuation, and the court criticized as well the use of the Gordon Growth Model in the first place because the model “was formulated to forecast the prices of publicly traded stocks assuming that dividends grew at a constant rate into perpetuity. Not only is the model subject to several restrictive assumptions which are not satisfied by Pullman, but it also ignores the highly competitive nature of Pullman’s business and fails to identify any source of growth for Pullman after 1993.” Id. at 930. Ultimately, the court adopted Pullman’s basic approach, but it was critical of and consequently adjusted several assumptions used in Pullman’s analysis. Most significant among these was the “wild leap of faith” embodied in Pullman’s forecast of large increases in commercial construction contracts it would obtain following confirmation of the reorganization plan. The court found only tenuous grounds for this prediction and accordingly scaled back the forecast for that particular revenue stream. Other, more technical, adjustments the court makes are summarized in section 35(g) of the opinion.