Hindsight Part 2 – Exceptions to the Rule
Through the Hindsight Looking-Glass – Exceptions to the Rule
Part 2 in our Hindsight series discusses the potential caveats and exceptions to the use of hindsight when determining value.
In a February, 2018 posting The Fine Art of Retrospect – Hindsight Part 1, we’ve discussed that courts typically don’t allow the use of hindsight knowledge when valuing a business. If the business’s value is to be determined at a certain date (for example, December 31, 2016), then only information available by December 31, 2016 can be used to determine the value. Even if it’s now known that major changes happened after December 31, 2016 (e.g. the business went bankrupt or struck gold by hiring a new world-class CEO), valuators are restricted to only using the information that was available by December 31, 2016.
But are there any exceptions to the general rule? Although courts have held that hindsight knowledge cannot be used to determine the value of a business, they have allowed valuators to use this knowledge to test the validity of projections and assumptions.
In a 2006 Ontario Court of Appeal case (DeBora v. DeBora, 2006 CanLII 40663, ON CA), former husband and wife David and Miriam were disputing the value of the husband’s companies on July 20, 1994 (the marriage date). At this date, one of the companies was facing charges under the Competition Act and the court had to decide what impact the charges would have on the company’s value.
Standard valuation practice would be to consider the facts that should reasonably be known at the marriage date, regardless of what actually occurred in the future. In this case, the following major facts were reasonably known at the date of marriage:
- Between the company and three of its key distributors, 11 charges were pending under the Competition Act;
- Each charge had a maximum penalty of $200,000 and/or imprisonment;
- The company relied heavily on its distributors; and
- These charges were the first of their kind ever laid under the Competition Act.
Based on these facts (and whatever else was known at the time), the valuator must determine the impact of the charges on the company’s ongoing business.
There was one other key fact that was known by the time the valuations were being prepared, but wasn’t known at the marriage date: two weeks after the marriage date, the company and its distributors reached a settlement agreement. The company would pay a charge totalling $35,000, and all charges against the distributors were dropped.
It would be unacceptable for a valuator to use the actual outcome of the charges to help determine the impact on the company’s value. The information is still useful, however, because it can be used to check the reasonability of the valuator’s projections for what was expected to happen at the date of marriage.
Navigating the use of hindsight information is not easy. Although generally unacceptable, there are caveats and exceptions. If you’re involved in litigation and wondering whether your value determination can use hindsight knowledge, give the experts at Davis Martindale a call.