March 2009 Newsletter

Nano-Proprietary Inc. v. Canon Inc; Canon USA Inc
(No. 07-50640, Court of Appeals, 5th Circuit)

The case arises from the alleged breach of a technology patent license agreement. Two aspects of the damage claims addressed in the appeal may be helpful in preparing and/or defending other damage claims.

First, when calculating the value of the lost license from Nano's perspective, Nano's damages expert relied upon Canon's internal, confidential future sales projection known only to Canon. Such testimony was excluded because the Canon document was unknown to Nano, and Nano had no evidence the document would ever have been available to it. Referring to how fair market value requires both the buyer and the seller to have reasonable knowledge of relevant facts, the Court held that having "reasonable knowledge of relevant facts" does not require knowledge of all of the opposing party's secret documents. The expert was only allowed to use the document to testify as to the lost asset's value from Canon's perspective. Care should be taken when basing a damage claim upon another party's projections (see also Ramco v. Anglo-Dutch, Texas 14th Court of Appeals No. 14-04-00433-CV regarding a different prohibited use of a party's internal forecasts).

Second, the Court disallowed the use of capital contributed to a Canon joint venture as indicative of the license's value. Such capital amount was claimed to be equivalent to the value of the license held by the joint venture. The Court said no, the capitalization value was not a "recent sale price for the subject asset" and hence Nano had not produced sufficient evidence to support the value of the lost license. In other words, capitalization of an entity does not equate to the value of an asset held by the entity.

The Significance of the Valuation Date

We have recommended regularly the selection of one "neutral" [1] appraiser selected jointly by opposing parties to resolve valuation disputes. Each party should be advised by a valuation professional not only in the selection of the neutral appraiser but in the assignment to be given to the neutral appraiser. A key aspect of the assignment is the valuation date because information not known or knowable as of the valuation date cannot be factored into the appraisal. While intuitively this seems to ignore what ones knows now, it must be remembered that if a hypothetical buyer and seller could not have known something at the time of the valuation then their agreed price for the asset and hence its fair market value could not have been affected by the now-obvious information.

Specifically, the standards for a CPA performing an appraisal state:

The valuation date is the specific date at which the valuation analyst estimates the value of the subject interest and concludes on his or her estimation of value. Generally, the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date. An event that could affect the value may occur subsequent to the valuation date; such an occurrence is referred to as a subsequent event. Subsequent events are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions. Moreover, the valuation report would typically not include a discussion of those events or conditions because a valuation is performed as of a point in time-the valuation date-and the events described in this subparagraph, occurring subsequent to that date, are not relevant to the value determined as of that date. In situations in which a valuation is meaningful to the intended user beyond the valuation date, the events may be of such nature and significance as to warrant disclosure (at the option of the valuation analyst) in a separate section of the report in order to keep users informed (paragraphs 52(p), 71(r), and 74). Such disclosure should clearly indicate that information regarding the events is provided for informational purposes only and does not affect the determination of value as of the specified valuation date. (SSVS No. 1, para. 43)

One should know there exists a litigation exemption from these standards for lost profits calculations but not for lost value calculations. (Interpretation No. 1-01, "Scope of Applicable Services" of Statement on Standards for Valuation Services No.1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset issued by the AICPA, para 11). These standards are incorporated into the Rules of the Texas State Board of Public Accountancy and apply to all CPAs practicing in Texas.

[1] We use the term "neutral" to mean unaffiliated. All professional appraisers are required to be objective.

May One Testify in Court About What One Is Not Qualified to Do Outside of Court?

Texas and most other states require that a CPA or CPA firm issuing financial statements have a current peer review to assure the public that the firm has adequate technical knowledge and quality control. Specifically, the Texas statute says:

Participation in the program is required of each firm licensed or registered with the board that performs any attest service or any accounting and/or auditing engagements, including, audits, reviews, compilations, forecasts, projections, or special reports. A firm which issues only compilations where no report is required under the Statements on Standards for Accounting and Review Services is required to participate in the program. (Texas Administrative Code Title 22, Part 22, Section 527, Rule §527.4)

The website for the Texas State Board of Public Accountancy states:

A firm performing any of the following services is required to undergo a peer review:

  • Financial statements
  • Audits
  • Reviews
  • Compilations*
Special reports (such as bank directors' examinations, completed statements on forms, etc.)

*Compilations include financial statements prepared as a result of other services such as taxes, bookkeeping (either computer or handposted), personal financial planning, etc.

In other words, to issue financial statements as a CPA in Texas, the CPA or firm must have a current peer review. However, a litigation exemption from the performance and communication requirements applies to presenting financial statements solely in court. This leads to situations where a CPA may be presenting financial statements in court but absent a peer review would not be qualified to present them outside of court.

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