Arbitration is regarded as a procedure in which a dispute is submitted before an
Arbitration Tribunal, by agreement of the parties guided by the arbitration
contract or a clause in the contract. By this, the parties opt for private
dispute resolution procedure instead of going to court. It is outside court
settlement thereby saving time and resources at the same time.
parties themselves appoint an arbitrator, or by an application to the court or
in case of institutional arbitration appointed according to the rules and
regulations. Asset valuation is the process by which we can determine the
current value of company's assets, such as buildings, stocks, equipment's,
goodwill, equipment etc. we can calculate the net worth of the by adding up the
current value of its assets deducted by its liabilities. In this article we
shall discuss how arbitration can play an active role in determining asset
valuation and distribution cases.
Arbitration and Asset Valuation
There has been an increasing trend where the parties/clients are in need of
someone with a good background in asset valuation and distribution, they often
look for a professional arbitrator who has a sound background and unique skill
set to deal with the same. The process of arbitration is similar to a litigation
where the evidences and testimony are presented and there is an arbitrator who
decides the case on merits.
While it is not a civil court but if functions like
a civil court and governed by the Arbitration and Conciliation Act, 1996. The
Arbitrators are governed by the Act who act as the Judge with qualifications
mentioned under the Act. The parties are in ore control of the process in a
sense that, whether the award given in Arbitration will be absolutely binding or
there is any limitation to it. Moreover, the process of Arbitration can also be
decided whether ad-hoc or institutional.
There are various factors which an arbitrator looks and considers before valuing
the assets and dividing them. One of the factors is how long both the parties
are connected to each other i.e., the term of their relationship. Longer the
time duration, there are more chances of providing a more equalized decision.
Another factor which plays a crucial role in determining is income and separate
property of each party. It varies from case to case and relationship to
relationship. It is the responsibility of the arbitrator to act fairly.
For example, there is a case where the assets are valued between husband and
wife, if one of the parties has better source of income due to better education,
age, health and other factors, the arbitrator may provide more property to the
spouse who is at disadvantage for any reason. In the same way assets can be
valued between any individuals, HUF, or any organization. The arbitrator can
also take into consideration the non-economic factors along with the monetary
ones. The arbitrator can also consider the effects on the award on any other
In determining any award, the arbitrator uses his expert of knowledge of law and
uses his experience to arrive to a conclusion. The arbitrator like civil courts
can also take various evidences into the consideration pertaining to the case.
Approaches for Asset Valuation
Sometimes it may happen that the sum of company's net assets and liabilities
shown in the financial statements are not reliable or fair to indicate the
company's true market value or its capacity to generate profits. Therefore,
arbitrators may find it a little difficult to determine the valuation of the
company as it becomes difficult to forecast the future cash flows. In such
situation, it may be appropriate to consider the asset-based approach.
It is regarded as a correct method of valuation when we are dealing with an
issue of controlling interest over a business. If there is any minority
shareholder who has no control over the assets of the organization, the
valuation shall generally revolve around the value of the future dividends
which the minority shareholder is expected to receive. There is an exception
to the effect that sale of a minority shareholding in order to give another
shareholder overall control of the business.
It is the duty of the valuer to see whether the asset-based approach will solve
the purpose and whether it is the appropriate method of valuation where the
company to be valued is going concern and generates positive cash flows. For
this purpose, the arbitrators shall have a good understanding of the assets and
liabilities of the company.
To further understand this approach, suppose the value of the organization is
company said to be the net amount of its assets and liabilities. So, the company
shows the assets side as Rs. 100 in total, and the amounts owned to its banks
and other creditors is Rs. 80, the company has net assets of Rs. 20 in that
case. However, it shall be noted that not all the assets are recognized and
measured for the purpose of financial reporting.
Investment Spend ApproachThe valuer simply aggregates all expenditure/ sunk-costs incurred in developing
a given project or business and the total amount is used as a proxy for the
value of said project. The cost of investment may cover not only the expenditure
incurred to acquire or develop fixed assets but also all other costs involved in
developing the project including the cost of financing, market research,
salaries, administration etc. at certain times, the given the passage of time,
the current value of an investment may be very different form the costs that
were incurred to acquire it.
In short, an award made on the basis of actual investment spend can lead to
either over or under-compensation. In the case of the latter, tribunals have
sometimes sought to avoid treating claimants unfairly by adding an amount to the
sum invested to represent the likely future return on the investment absent the
given breach/ action.
Impact of the financial crisis on the application of the asset-based approach
A deep analysis of the relationship between business's accounting net worth and
financial crisis is not within the scope of this article. Financial crisis has a
very major impact on the company's balance sheet (usually Negative). Let's
have a look at some of the examples of the financial crisis.
- There are chances of increased counterparty risks, credit risks that may
not generally be reflected in the measurement of financial crisis.
- If there is a requirement where relevant accounting standards are to be
stated on the balance sheet at their €˜fair value' asset values have often been
written-down to reflect their recoverable amount. It is also considered relevant
where the accounting conventions require non-current assets such as plant, long
term investments, machinery, property etc. needs to be recognized at the
historical cost & recoverable amount.
- It is also stated that billions of dollars of goodwill have been
written-off companies' balance sheets in accordance with the Financial Accounting Standards
for calculation and accounting for goodwill. Purchased goodwill arises when an
organization is acquired, it may be defined as the excess of the purchasing
price of the business over the the fair market value of the net assets which
have been acquired.
- Due to the financial crisis, under certain accounting conventions, many
businesses have discovered that their existing provisions for defined and
other benefit plans are now insufficient to cover their likely eventual
exposure. Whilst some businesses have made additional provision on their
balance sheet to cover these deficits, due to a certain degree of
flexibility allowed under accounting conventions, much of this deficit is
off-balance sheet. It was recently reported in the UK Daily Telegraph, for
example, that the deficit at all UK private sector pension schemes rose to
While the asset-based approach is considered to be one of the most generalized
form and may appear to be conceptually simple, it is often misunderstood.
Although, this approach seems to be a better option but it requires proper
application of this approach inter alia dealing with complex concepts such as
recognition and measurement of the assets for the purpose of asset valuation and
distribution. It also counts for competitiveness, inflation and dynamics of the
markets, the role placed by the replacement costs, the true economic costs of
replicating assets. When the asset-based approach is applied, one should be
careful about the relative weight provided by its results.
- Kluwer Arbitration Blog, April 10, 2012 available at http://arbitrationblog.kluwerarbitration.com/2012/04/10/asset-based-methods-part-3-valuation-and-the-financial-crisis/ (Last
Visited 22 May 2021)
- Arbitration Forum, 21 July 2021, available at https://www.arbitration.com/blog/tag/asset-distribution/#:~:text=An%20arbitrator%20can%20help%20resolve,facts%20that%20clarify%20ownership%20rights.&text=Another%20situation%20which%20may%20call,particular%20asset%20is%20in%20question.
(Last Visited 21 May 2021)
- Grant Thornton, Dispute Insights, available at https://www.grantthornton.in/globalassets/1.-member-firms/india/assets/pdfs/dispute_insights-perspectives_on_arbitration_and_disputes.pdf (Last
Visited 22 May 2021)