SAM J. ALBERTS, Trustee for The DCHC Liquidating Trust, Appellant,
HCA, INC., GALEN HOSPITAL ILLINOIS, INC., and WESTERN PLAINS CAPITAL, INC., formerly known as C/HCA CAPITAL, LP, Appellees.
Royce C. Lamberth, Chief Judge
This case is before this Court on appeal from the United States Bankruptcy Court for the District of Columbia. Appellant Sam J. Alberts, the trustee for the Doctors Community Hospital Corporation Liquidating Trust, appeals from the final judgment of U.S. Bankruptcy Judge S. Martin Teel. In bankruptcy court, Alberts had initiated an adversary proceeding against, inter alia, appellees Hospital Corporation of America, Inc., and its wholly-owned subsidiaries Galen Hospital Illinois, Inc. and Western Plains Capital, Inc. In 1998, DCHC (through its wholly-owned subsidiary Reese Corporation) bought Michael Reese Hospital from HCA for approximately $66–68 million. In bankruptcy court, Alberts claimed that the sale of Reese Hospital was a “fraudulent transfer” because Reese Corp. did not receive reasonably equivalent value for the price it paid. Alberts sought to avoid and recover as a fraudulent transfer the allegedly excess purchase price.
After a series of dispositive motions and a five week bench trial, Judge Teel issued a 192-page statement of the bankruptcy court’s findings of law and conclusions of fact. Judge Teel calculated the fair market value of Reese Hospital as $68.6 million, concluded that Reese Corp. received reasonably equivalent value, and entered judgment for the appellees. Alberts presents two questions on appeal (as thus characterized by Alberts):
(1) Did the bankruptcy court err when, in the course of conducting a discounted cash flow analysis, the court treated the Hospital’s working capital as a surplus asset and then calculated the Hospital’s going concern value by adding the value of the working capital to the value of the income that the Hospital was projected to generate from its operations, assuming its operations were “fully capitalized”?
(2) Did the bankruptcy court err when, in the course of concluding that the Hospital’s net working capital could be treated as a surplus asset and added to the Hospital’s projected income from operations, the court employed an asset valuation method that was not supported by or consistent with any party’s expert or any learned treatise and was not subject to evaluation under the Federal Rules of Evidence?
After reviewing the record on appeal, the underlying decisions of the bankruptcy court, and the parties’ briefs, the court finds that Judge Teel correctly ascertained the controlling law and did not commit clear error in his factual findings. Furthermore, to the extent Judge Teel committed any reversible error regarding his treatment of the net working capital, such error is harmless. Therefore, this Court will affirm the judgment of the bankruptcy court.
A. Factual History
This case concerns the 1998 sale of Chicago-based Columbia Michael Reese Hospital and Medical Center (“the Hospital” or “Reese Hospital”). Hospital Corporation of America (“HCA”) is among the world’s largest private healthcare providers. In 1997, HCA began a divestiture program to reduce the number of hospitals it owned. As part of this program, HCA put Reese Hospital up for sale. In late 1997 and early 1998, HCA received multiple offers for Reese Hospital. Doctors Community Hospital Corporation (“DCHC”) was interested in purchasing the Hospital. As the bankruptcy court stated, “DCHC executives were sophisticated and experienced professionals in the healthcare industry…[who] had successfully turned around distressed hospitals and were confident they could do the same with Reese Hospital.” Am. Mem. Dec. Constituting the Ct.’s Findings of Fact & Conclusions of L. 187–88 (“Am. Mem. Dec.”), ADV 04-10366, May 19, 2008, ECF No. 596.
On February 18, 1998, DCHC entered into a letter of intent with HCA, indicating that DCHC would purchase Reese Hospital. DCHC subsequently conducted due diligence before completing its purchase of the Hospital. On July 8, 1998, Reese Corporation, a wholly-owned and specially-created subsidiary of DCHC, entered into an asset purchase agreement with Galen Hospital Illinois (“GHI”), a wholly-owned subsidiary of HCA, for the purchase of Reese Hospital. The transaction closed on November 12, 1998 (the “transfer date”). The bankruptcy court concluded as a factual matter that Reese Corp. paid $66, 048, 640 as consideration for Reese Hospital. See Am. Mem. Dec. 16.
DCHC and Reese Corp. were heavily reliant on financing from National Century Financial Enterprises, Inc. for satisfy ongoing expenses. In November 2002, National Century filed for bankruptcy, causing accounts from which DCHC and Reese Corp. drew operational funds to be frozen. Three days after National Century’s bankruptcy filing—and a little over four years after completing the purchase of Reese Hospital—DCHC filed for Chapter 11 bankruptcy relief. See, e.g., Appellant’s Brief 8, Civil No. 12-564, June 4, 2012, ECF No. 9; Trial Tr. 447:5–448:11, Jan. 23, 2007, Ex. 691 to Record on Appeal (testimony of M. Redman) (Ex. I to Appellant’s Brief); Trial Tr. 129:21–130:2, Jan. 19, 2007, Ex. 689 to Record on Appeal (testimony of P. Tuft) (Ex. K to Appellant’s Brief).
B. Procedural History
1.Proceedings Prior to Bankruptcy Bench Trial
DCHC’s initial bankruptcy proceedings were protracted, lasting almost 18 months. On April 5, 2004, the debtors achieved confirmation of their second amended plan of reorganization. Section 6.6 of this reorganization plan created the DCHC Liquidating Trust (“Trust”) to liquidate certain assets of the debtors and distribute those funds to certain classes of creditors. Among the assets conveyed to the Trust were fraudulent conveyance and other actions authorized under Chapter 5 of the Bankruptcy Code. Sam J. Alberts was appointed trustee of the DCHC Trust. See Am. Mem. Dec. 4.
On November 18, 2004, in his capacity as trustee, Alberts instituted an adversary proceeding against HCA (and its affiliated companies and subsidiaries) in the U.S. Bankruptcy Court for the District of Columbia. This adversary proceeding is the subject of the instant appeal. Alberts instituted this action to recover, as a fraudulent conveyance under the Illinois Uniform Fraudulent Conveyance Act, the allegedly-excess purchase price Reese Corp. paid for Reese Hospital. Under the Illinois Act, a bankruptcy trustee can unwind a past transaction if the trustee proves: (1) the debtor transferred goods and received less than reasonably equivalent value in exchange for the transfer; and (2) the debtor was insolvent as of the date of the transaction. 740 Ill. Comp. Stat. § 160/5(a).
This adversary proceeding was also protracted. Over the course of several memorandum decisions, Judge Teel pared down the issues. See Alberts v. HCA Inc. (In re Greater Se. Cmty. Hosp. Corp. I), 365 B.R. 293 (Bankr. D.D.C. 2006) (“HCA I”); Alberts v. HCA Inc. (In re Greater Se. Cmty. Hosp. Corp. I), ADV 04-10366, 2007 WL 80812 (Bankr. D.D.C. Jan. 3, 2007) (“HCA II”); Alberts v. HCA Inc. (In re Greater Se. Cmty. Hosp. Corp. I), ADV 04-10366 (Bankr. D.D.C. Jan. 3, 2007) (“HCA III”); Alberts v. HCA Inc. (In re Greater Se. Cmty. Hosp. Corp. I), 365 B.R. 322 (Bankr. D.D.C. 2007) (“HCA IV”).
2.Bankruptcy Bench Trial and Ensuing Opinion of Judge Teel
On January 19, 2007, Judge Teel commenced a five week bench trial to determine whether the sale of Reese Hospital was a fraudulent conveyance. During this trial, according to appellees, Judge Teel heard testimony from 23 witnesses and received 772 exhibits into evidence. See Appellees’ Brief 2, Civil No. 12-564, July 23, 2012, ECF No. 11. The primary purpose of this trial was to introduce evidence and advance legal arguments regarding the fair market value of the Reese Hospital, whether DCHC and Reese Corp. received “reasonably equivalent value” for its purchase price, and whether DCHC and Reese Corp. were insolvent at the time of the transfer. See Am. Mem. Dec 3–8.
Judge Teel afterwards issued a 192-page decision outlining the bankruptcy court’s findings of fact and conclusions of law. In order to determine whether DCHC and Reese Corp. received “reasonably equivalent value, ” Judge Teel needed to determine the fair market value of what Reese Corp. received (the Hospital), and compare it to what Reese Corp. transferred to HCA (the $66 million). See Barber v. Golden Seed Co., Inc., 129 F.3d 382, 378 (7th Cir. 1997). Judge Teel dedicated the bulk of his opinion to this exercise. See Am. Mem. Dec. 23–180. At the outset, Judge Teel noted that there was no dispute that the sale of the Hospital was the result of arm’s-length negotiations between the parties. Id. at 22. There are three primary methods for determining “fair market value”: (1) the “market” approach; (2) the “net asset” or “cost” approach; and (3) the “income” approach. Jay E. Fishman, et al., PPC’s Guide to Business Valuations ¶ 203.2 (15th ed. 2005); Shannon P. Pratt, et al., Valuing a Business: The Analysis and Appraisal of Closely Held Companies 45 (4th ed. 2000).
The bankruptcy court first found that “there are no truly comparable transactions or public companies from which the court can derive an accurate and reliable fair market value for Reese Hospital using the market approach.” Am. Mem. Dec. 25. Alberts does not challenge this determination. Judge Teel then calculated the Hospital’s value using the cost approach, which values a business based on the net aggregate value of its underlying assets, focusing on the underlying value of the company’s assets in a hypothetical sale rather than on a company’s earnings potential. Id. at 32. After making a series of factual findings, the bankruptcy court calculated the value of Reese Hospital under the cost approach as $57, 985, 984.00. Id. at 80.
Judge Teel then endeavored to determine the value of Reese Hospital under the income approach. “Under the income approach, the [valuation consultant] estimates the future ownership benefits and discounts those benefits to present value using a rate suitable for the risks associated with realizing those benefits.” Fishman, PCC’s Guide ¶ 203.3. Judge Teel used the “discounted cash flow” method for making such an estimate. Am. Mem. Dec. 81. “Many authorities recognize that the most reliable method for determining the value of a business is the discounted cash flow method.” Lippe v. Bairnco Corp., 288 B.R. 678, 689 (S.D.N.Y. 2003).
In order to derive a value for Reese Hospital under the income approach, the bankruptcy court took several steps to determine the value of the business enterprise under the discounted cash flow analysis. First, the bankruptcy court determined the projected earnings—projecting the earnings before interest and taxes (“EBIT”) of the business in question. Am. Mem. Dec. 83– 142. In making this assessment, Judge Teel reviewed five sets of projections as to the reasonably projected earnings of Reese Corp. See id. at 81–82. After reviewing these projections, the bankruptcy court concluded “as a factual matter that none of these projections offer a totally realistic picture of the reasonable anticipated future earnings of Reese Corp.” Id. at 83.
Judge Teel felt this situation left him with two options. First, he could have concluded that there were “no credible projections from which [he] could derive a business enterprise value, and that the court’s conclusion with respect to the fair market value of Reese Hospital on November 12, 1998, under the income approach should be that no such value can be ascertained.” Id. at 134. The second, “more arduous choice would be to credit” one set of projections “in part then modify the projections consistent with the evidence presented at trial— to attempt, as best the court can, to correct the Reese Management Team’s mistakes.” Id. at 134.
Judge Teel chose the second option, and made a number of modifications to the Reese Management Team Strategic Assumptions in order to correct deficiencies and errors in the Reese Management Projections and align them with the court’s factual findings. Id. at 135–39. Based on these modified projections, the court made factual findings as to the projected revenue, expenses, and EBIT for the Hospital from the transfer date through 2002. Id. at 139–42.
Second, the bankruptcy court ascertained the net cash flow of Reese Hospital for each of the years in which the projections were made. Id. at 142. To arrive at this figure, the “factfinder must add projected depreciation and amortization to and subtract projected income taxes, net working capital expenditures, and capital expenditures from the projected EBIT.” Id. at 142 (citing Fishman, PCC’s Guide ¶¶ 505.25, 505.39–505.43). In this section, Judge Teel did not factor the $20, 678, 221.00 capital transfer into the net working capital projections, and calculated these amounts assuming that the $20.6 million was not transferred. See Id . at 175 & n.110. After making specific factual findings as to these inputs, Judge Teel made final net cash flow projections—ranging from a negative cash flow of $17, 762, 247.53 in 1999 to a positive cash flow of $14, 979, 180.61 in 2001. Id. at 149–50.
Third, the bankruptcy court determined the weighted average cost of capital (“WACC”)—i.e., “the appropriate discount rate to apply to the projected net cash flow set forth [earlier].” Id. at 150. After considering evidence and expert testimony about the risk-free rate of return, the equity risk premium, the industry-specific risk premium, the risk premium for the size of the business, the specific company risk premium, the after-tax cost of debt, and the appropriate debt-to-equity ratio, the court made a final factual determination as to the weighted average cost of capital. Id. at 151–64. The court applied a 19.36% WACC to the projected net cash flows from November 13, 1998, through the end of 2001, and applied a 18.14% WACC to the projected cash flows for 2002. Id. at 164.
Fourth, the bankruptcy court determined the terminal value of Reese Hospital—i.e., the “value of the company as of ‘the first full year after the company reaches a stabilized level of growth and sustainable profit margins.’” Id. at 165 (quoting Fishman, PCC’s Guide ¶ 505.45). The court determined as a factual matter that the “Gordon Model, ” was the proper method to determine the Hospital’s terminal value. Id. at 167–68. The “Gordon Model derives the terminal value of a company by dividing the terminal net cash flow (the first net cash flow resulting from a stabilized level of growth) by the discount rate less long-term growth.” Id. at 165. The court found as a matter of fact that the terminal value of the Hospital was $100, 390, 116.02. Id. at 169.
Fifth, the bankruptcy court, in the penultimate step to determining value under the income approach, determined the present value of the projected net cash flows and projected terminal value of the business. “The present value is determined by dividing the full value (i.e., the discounted projected net cash flows and capitalized terminal value) by 100% of that net cash flow or terminal value plus the applicable discount or capitalization rate raised to a predetermined discount period exponentially.” Id. at 169 (citing Fishman, PCC’s Guide ¶ 505.51). The court then determined, as a factual matter, the appropriate discount rates to apply to determine the present value of the projected net cash flow and terminal value. Id at 171–72.
Sixth, the bankruptcy court, in the final step of determining a business enterprise value under the income approach, added the non-operating and excess assets purchased by Reese Corp. as a part of the transaction. Id. at 172. The court determined that the Hospital’s excess real estate had no asset value, as it would require an expensive and uncertain re-zoning process to make the land valuable to an outside buyer. Id. at 173–74. However, the bankruptcy court determined that the expert witnesses erred when they incorporated the $20, 678, 221 in net working capital acquired by Reese Corp. into their net cash flow calculations. Id. at 174. Finding that the record did not permit including the $20.6 million into the income stream for the projections used by the court, the court instead calculated projected net working capital without factoring in the $20.6 million, and then considered the $20.6 million as an non-operating asset. Id. at 174–75 & n.110. As a result, the court added $20, 678.221 in non-operating and excess assets to the $51, 507, 704.65 Value As If Normally Capitalized (derived from steps one through five, detailed supra) to arrive at a final total business enterprise value of $72, 185, 925.65. Id. at 175–76. This $72 million figure represents the total value of Reese Hospital as determined by the income approach.
Finally, the bankruptcy court reconciled the findings of the court that Reese Hospital was worth $58 million under the cost approach and $72 million under the income approach. Id. at 178–80. Based on the testimony of expert witness Kevin Moss and the treatise guidelines for reconciliations, the bankruptcy court found “as a factual matter that it is appropriate to explicitly weigh its determinations of value for Reese Hospital heavily in favor of the income approach.” Id. at 180. Thus, the court weighed the value under the cost approach at 25%, and the value under the income approach at 75%, deriving a final fair market value for Reese Hospital of $68, 635, 940.24. Id.
The bankruptcy court then determined that the transaction was the result of arm’s-length negotiations, and the parties acted in good faith. Id. at 180–91. Finally, since “the court’s findings of fact with respect to the fair market value of Reese Hospital as of the Transfer Date suggest that Reese Corp. received more than reasonably equivalent value from the Reese Transfers [the $66–68 million], not less, ” id. at 191 (emphasis in original), the court concluded as a matter of law that “Alberts has not demonstrated by a preponderance of the evidence that Reese Corp. did not receive reasonably equivalent value, ” id. at 192. Therefore, the bankruptcy court awarded final judgment and costs in favor of the appellees. Id.
3.Post-Trial Briefings and Appeal
After the bankruptcy court issued its Amended Memorandum Decision, the appellant moved for reconsideration. This motion challenged the court’s findings as to reasonably equivalent value and fair market value, and includes many of the arguments appellant raises in his instant appeal. On February 21, 2012, Judge Teel issued a Memorandum Decision denying appellant’s motion for reconsideration. Mem. Dec. re: Mot. of Pl. for Reconsideration & Am. of Am. Mem. Dec. (“Recons. Mem. Dec.”), ADV 04-10366, February 21, 2012, ECF No. 621. Thereafter, appellant filed an appeal in United States District Court on April 11, 2012. See Notice of Appeal from Bankruptcy Court, Civil No. 12-564, ECF No. 1. With the filing of Appellant’s Opening Brief, Civil No. 12-564, June 4, 2012, ECF No. 9, the Appellees’ Brief, Civil No. 12-564, July 23, 2012, ECF No. 11, and the Appellant’s Reply Brief, Civil No. 12-564, Aug. 23, 2012, ECF No. 13, this matter is ripe for consideration. Upon consideration of the parties’ briefs, the record, and the applicable law, this Court will affirm the final judgment of the bankruptcy court for the reasons stated below.
II. STANDARD OF REVIEW
United States District Courts have jurisdiction over appeals of bankruptcy court decisions. 28 U.S.C. § 158(a). On appeal, the district court “may affirm, modify, or reverse a bankruptcy judge’s judgment, order, or decree, or remand with instructions for further proceedings.” Fed.R.Bankr.P. 8013; see also Advantage Healthplan, Inc. v. Potter, 391 B.R. 521, 537 (D.D.C. 2008). The district court reviews conclusions of law de novo and findings of fact for clear error. See, e.g., Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405 (1990); McGuirl v. White, 86 F.3d 1232, 1234 (D.C. Cir. 1996); Duvall v. Bumbray, 423 B.R. 383, 388 (D.D.C. 2010). “The burden of proof is on the party that seeks to reverse the [b]ankruptcy [c]ourt’s holding. That party must show that the court’s holding was clearly erroneous as to the assessment of the facts or erroneous in its interpretation of the law and not simply that another conclusion could have been reached.” In re Johnson, 236 B.R. 510, 518 (D.D.C. 1999) (citing Anderson v. City of Bessmer, N.C. , 470 U.S. 564, 573–74 (1985)).
“Findings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses.” Fed.R.Bankr.P. 8013. “‘A finding is clearly erroneous when, although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.’” In re Johnson, 236 B.R. at 518 (quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948)). A reviewing court applying the “clearly erroneous” standard may not “reverse the finding of the trier of fact simply because it is convinced that it would have decided the case differently. The reviewing court oversteps the bounds of its duty…if it undertakes to duplicate the role of the lower court.” Anderson, 470 U.S. at 573.
The Court reviews the legal conclusions of Judge Teel de novo, and does not in any way “defer” to his conclusions of law. On appeal, the reviewing court should determine the applicable law on its own and then determine whether the lower court applied the correct legal standard. The Court will defer to the factual findings made by Judge Teel, unless those factual conclusions manifest clear error. While there is no direct correlation between the length of an opinion and its soundness, see Dred Scott v. Sandford, 60 U.S. 393, 399–454 (1856) (majority opinion of Taney, C.J., over 25, 000 words long), and this Court must review Judge Teel’s legal conclusions de novo, this Court will note that Judge Teel oversaw a five week bench trial and wrote 192 pages explaining his legal and factual conclusions. See Am. Mem. Dec.. After Alberts requested reconsideration of a narrower set of issues, Judge Teel wrote a 55-page opinion explaining his earlier decision. See In re Greater Se. Cmty. Hosp. Corp., ADV 04-10366, 2012 WL 589269 (Bankr. D.D.C. Feb. 22, 2012).
This Court has closely examined the record, applicable law, and parties’ briefs. This Court concludes that Judge Teel correctly determined the law for ascertaining value under the income approach, did not make any clear errors in his factual conclusions, and properly applied the law to the facts. Even if Judge Teel committed the errors alleged by Alberts, such errors would be harmless and not change the outcome of the case below.
A. Appellant’s First Issue on Appeal: Did the Bankruptcy Court Err in Treating a $20.6 Million Capital Transfer as ...