When is fair fair?

No valuation makes sense unless a clear basis, or definition, for the parameters on which it is based is provided. Many values are described using qualifying words such as “market”, “fair” or “investment” alongside “value”. However, similar shorthand titles can be applied to very different concepts. A recent decision of the English Court of Appeal serves as a useful reminder of the importance of providing a clear statement of the valuation parameters that are intended and not simply relying on a commonly used phrase.

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The decision in LBI EHF v Raiffeisen Bank * related to meaning of “fair market value” in context of a repurchase agreement between two banks. Repurchase (or “repo”) agreements are common between banks and basically are a form of short term secured lending where one bank sells a portfolio of securities to another subject to repurchasing them back at a future date for an agreed price plus interest. It is customary for these agreements to be made under the Global Master Repurchase Agreement (“GMRA”) issued by the International Capital Markets Association.

LBI EHF (“LBI”), formerly Landsbanki Islands, went into receivership in October 2008 at the height of the financial crisis. In doing so it defaulted on a number of open repo agreements with Raiffeisen Bank. These agreements were made under the GMRA. In simple terms this requires the defaulting party to pay the non-defaulting party the agreed repurchase price for the securities minus their value. The GMRA allows for this value to be determined by the non-defaulting party actually selling the securities, obtaining commercially reasonable quotations from market makers or, if neither of these is possible, by establishing their “Net Value”.

The GMRA definition of Net Value can be summarised as the amount which, …”in the reasonable opinion of the non-defaulting party, represents their fair market value, having regard to such pricing sources and methods … as the non-defaulting party considers appropriate, less, in the case of receivable securities, or plus, in the case of deliverable securities, all transaction costs…”

Due to a procedural failure concerning the service of a required notice, the issue before Court was to determine what Net Value would have been determined had the non-defaulting party, Raiffeisen Bank, carried out a valuation following the default in 2008.

Raiffeisen Bank determined that the Net Value would not have been less than a figure of approximately €75m for the portfolio in question. In 2017 the High Court dismissed the claim by LBI that Raiffeisen Bank had incorrectly interpreted and applied the default provisions in the GMRA in arriving at this figure. LBI appealed on the grounds that that the judge had erred in finding that Raiffeisen Bank’s assessment of the fair market value of the securities could be based on prices achieved or quotations obtained in a distressed or illiquid market.

LBI had contended that the interpretation of fair market value should be limited to "a consistently recognised concept … involving a willing buyer, willing seller, knowledge of the asset in question and a lack of compulsion". Readers familiar with the International Valuation Standards (IVS) will recognise this as paraphrasing of the definition of Market Value in those standards. Indeed, other definitions were cited by the appellants in support of their interpretation, including those in the International Financial Reporting Standards (IFRS), the American Society of Appraisers' Business Valuation Standards, and in the United States Treasury Regulations. Some of these definitions were of “market value”, some of “fair value”, and others of “fair market value”. LBI argued that the common concept underlying all these various definitions meant that prices achieved in a distressed market had to be excluded from the fair market value.

Counsel for LBI also referred to decisions in the higher courts of Australia and Canada in support of their contention that the addition of the word “fair” to market value signified that it must also be assumed that the effects of undue duress, market stress, panic or illiquidity should be ignored.

Raiffeisen Bank defended its approach by referring to the wide discretion given to the non-defaulting party by the GMRA to determine the pricing sources and methods used to determine the Net Value. Given this wide discretion, the appellant had provided no explanation of how it was that this determination must not reflect the liquidity issues in the particular market on the relevant date. Its Counsel pointed out that the appellant's interpretation of fair market value did not actually give any indication as to how the non-defaulting party is supposed to carry out the assessment if it excludes any reference to information derived from the particular market in which the notional transaction is deemed to take place.

It further argued that because the requirement to assess Net Value only arose if the non-defaulting party had been unable to buy or sell or to obtain commercially reasonable quotations for the securities in the relevant market, it was illogical to suggest that the theoretical value should take no account of whatever information was obtained in the course of its attempts to buy or sell or obtain quotations. To do so would be to attribute an artificially high value to the securities.

The Court of Appeal dismissed LBI’s appeal. It found that LBI’s contention that the assessment of fair market value must disregard any illiquidity or distress in the market is not one found in the express terms of the GMRA. Neither is there any basis for its implication, because it is contrary to the wide discretion conferred on the non-defaulting party.

It also observed that the GMRA requires the assessment of fair market value not just in those cases where the securities could not be sold, or a commercially reasonable quotation could not be obtained, because of illiquidity or distress in the market. In those cases where there is no illiquidity or distress in the market, fair market value will have regard to prices of securities in the market at the relevant date. It was not persuaded that the same words could also be held to ignore actual market conditions under different circumstances and the fair market value estimated having regard to conditions on some other date.

Neither did it find the cited definitions of similar bases of value or the claimed precedent of the Australian and Canadian decisions to be relevant. The meaning of fair market value in this case was a matter of construction of this particular contract in its particular context.

An irony of this case is that the appellant tried to invoke the IVS definition of Market Value in support of its argument. However, if it had read the “conceptual framework” that supports the short definition that it had paraphrased it would have seen that this states, among other things:

• The valuation amount will reflect the market state and circumstances as at the valuation date, not those at any other date;

• The (willing) buyer is one who purchases in accordance with the realities of the current market and with current market expectations;

• The willing seller is neither an over eager nor a forced seller prepared to sell at any price, nor one prepared to hold out for a price not considered reasonable in the current market.

Even although the Court dismissed the relevance of other definitions in favour of the proper construction of the agreement between the parties, had it looked that the IVS definition in full this would also have led it to the opposite conclusion to that claimed by LBI. Likewise, there is little support for its contention in IFRS 13 Fair Value Measurements which assumes a transaction at the measurement date under current market conditions.

While this decision was based on the construction of the GMRA it is a useful reminder to valuers of any type of asset for any purpose that the words they use to describe types of value commonly used in their market have no intrinsic meaning. They have to be interpreted and applied in accordance with any supporting detail in the standards, regulations or contract which apply to the valuation exercise in question. For bases such as IVS Market Value and IFRS Fair Value there is a significant amount of application detail in the relevant standards. However, this is not always the case for other bases. Where these have to be used then the valuer should first satisfy themselves as to the intended meaning behind the shorthand title and then make sure that this is clearly communicated alongside the valuation figure to ensure that it is not misinterpreted.

* LBI EHF v Raiffeisen Bank International AG [2018] EWCA Civ 719