And it’s been about 8 months since public hearings wrapped up in another ICSID arbitration between Pacific Rim and the Republic of El Salvador.

Both proceedings were webcast online, and perhaps you tuned into one or both proceedings at some point during the hearings?

Or, more likely, you didn’t.

But, either way, you’ll enjoy the luxury of going back and watching an archived video of these proceedings on the ICSID website at some later date.

I think that’s worth reflecting upon.

Some of the first “public” hearings in ICSID arbitration required that curious parties show up at the Centre and watch the proceedings unfold in real-time.

When the parties to the Southern Blue Fin Tuna arbitration agreed to open the doors, only to have nobody show up, some skeptics muttered that the whole experiment showed that the need for transparency was overblown.

A few years later, the Methanex v. United States arbitration was opened to the public via a live-video feed that you had to watch in a special viewing room at the ICSID. I attended parts of these hearings, and while there were students, academics and practitioners in the audience, I’d also be the first to concede that elbow-room was never at a premium.

Prof. William W. Park, in a recent academic article, reminds us that when investor-state arbitration proceedings have been opened to the public, they “usually prove so utterly boring that the audience dwindles quickly.” Hence, he wonders if concerns about the conflict between public and private interests are “more theoretical, than real.”

I don’t think so.

Given the great inconvenience of having to travel to Washington, D.C. and devote one or more workweeks to a viewing experience, it’s remarkable that anyone showed up at the Methanex hearings in 2004. Even courthouse journalists, who get paid to cover legal proceedings, rarely have 8 hours a day to devote to the art of spectating. The same goes for academics, practitioners, and just about anyone else with a day job.

But, thanks to advances in internet technology – which allow for the webcasting of hearings and for them to be archived online in perpetuity – the true audience for a public hearing is now a much more elastic concept. As with a television program, the real audience consists not merely of those who troubled themselves to watch it in real-time, but also those who may watch it online – days, weeks, or even years later.

Let’s be clear: I believe that the case for transparency in investor-state arbitration ought to be rooted in concepts of good governance, economic efficiency and human rights law – not in any sort of crude head-count. (For a thoughtful exposition of the rationale for openness in investor-state arbitration, take a look at Marcos Orellana’s article in the Autumn 2011 ICSID Review.)

But, if we insist upon counting heads, let’s agree that the definition of the audience has changed dramatically over the last decade. Thanks to these dramatic technological changes, the opening-night box office numbers are not the only ones that matter.

For this expanded audience, one of transparency’s greatest gifts may be that it is spawning a growing online archive of arbitration proceedings that can be utilized by generations of future scholars, practitioners, and even critics of the present system.

Luke Eric Peterson
InvestmentArbitrationReporter.com

In my previous article, I noted that a business is only worth what someone is prepared to pay for it. Under the market-approach to valuation, Company A’s worth may be informed at least in part by recent transactions in Company A itself and/ or businesses sufficiently comparable to Company A. The ability to apply usefully the market-approach ultimately depends on the availability of relevant and timely transaction data.

Whilst the market-approach provides a useful insight as to what price was paid for any given asset or business, it may be of less help if one wishes to know how the purchase price of a business was determined. Understanding the underlying value of a business, and the drivers of that value, is often central to the quantification of damages in international arbitration.

Although the purchase price of an asset can be determined by many factors, the underlying value of an asset is based on the future economic benefits that accrue to its owner. This notion is at the heart of the income-based approach to valuation. Within the overall income-based approach, one needs to distinguish between earnings methods and cash flow methods.

Earnings are analogous to the accounting profits that are generated by a company, and attributable to the ordinary shareholders. Since a company’s earnings can be heavily influenced by the specific accounting policies it adopts and applies, comparisons of earnings across different companies can sometimes be difficult. For this reason, valuers often choose to focus on a business’s actual cash flows as this avoids the distorting impact of accounting. On the other hand, where one does not have sufficient detail about the accounting treatments used, it may be easier to focus on earnings. There are a number of different valuation methodologies focusing on either cash flows or earning methods, a few of which are described very briefly in the footnote to this article.

Introduction to DCF

DCF continues to generate much discussion within the arbitration community; certainly, it is being used ever more frequently in support of claims, if anecdotal and personal experience is any guide. In my experience, however, DCF is not always properly understood by non-valuation professional and/ or is on occasions applied incorrectly. I do wonder if this explains, at least in part, why certain arbitrators are sometimes wary of making awards in respect of claims that are based on DCF valuations.

Although the basic principles may appear simple, great care needs to be taken when constructing a DCF model to avoid nullifying its value to the arbitral process. The output of a DCF model is a single number, representing the net present value (NPV) of a project’s or business’s projected future cash flows, discounted to take into account the time value of money and the uncertainty – both upside as well as downside – over the projected future earnings. Crucially, DCF focuses on cash movements rather than accounting profits. When DCF is applied correctly, the calculated NPV can approximate to the fair market value (FMV) of a project or business since it reflects the present value of the future cash flows and hence determines a price at which a well-informed and willing vendor and purchaser could transact.

The quality and relevance of the output from a DCF model depends on the quality of the inputs e.g. the reasonableness of the growth assumptions and the discount rate. As we shall see below, far from being a purely ‘mechanical’ exercise, the derivation of a business’s value under DCF requires considerable skill and judgement.

Overview of a DCF model

In order to prepare a DCF valuation, one needs to determine inter alia the following:

• The relevant time-period – a cash flow model will comprise firstly an explicit forecast period, e.g. the first 5-10 years. An explicit forecast period may seek to capture the initial growth of a company until net cash flows stabilise. For example, the net cash flows of a start-up business might grow by 200% in the first year, 100% in the second year, 50% in the third, and decline each year until stabilising at say 3% per year after year 10. Where the duration of a project is fixed (e.g. a non-renewable 20 year concession over a mine), one would normally expect to see an explicit forecast period only. Where a project has an indefinite life, a terminal growth calculation is usually added to value the cash flows from the end of the explicit forecast period to perpetuity.
• The future cash flows themselves – central to producing a robust DCF model is the ability to produce reasonable forecasts of future cash flows. The model should include, in cash terms, all revenues, direct and indirect costs, capital expenditure, working capital movements etc. Since we are only interested in cash, it will not include non-cash (accounting) items like depreciation and amortisation.
• What is being valued – Defining what precisely is being valued is key; for example, valuers distinguish between the enterprise value of a business (being the value to both debt holders and shareholders) and the equity value (the value to equity holders only). The precise DCF approach used will depend on what is being valued.
• The discount rate – discussed below

Determining the discount rate

As noted above, the projected cash flows need to be adjusted to reflect both the time value of money (€100 today is worth more than the right to €100 for certain in a year’s time) and the uncertainty of the future cash flows; the greater the relevant uncertainty over the projected earnings, the greater the discount rate needed. Another way of looking at this is to say that the discount rate reflects the expected or required return from investors; the greater the risks to which the investor is exposed, the higher the return required.

The calculation of the discount rate will depend on what is being valued; for example, if we are interested in the enterprise value of a business, the discount rate will typically be based on the weighted average of the returns required by debt holders (cost of debt) (after taking into account the tax benefits of debt finance) and equity holders (cost of equity); this is referred to as the after-tax weighted average cost of capital.

The usual starting point in calculating both the cost of debt and the cost of equity is the use of a so-called risk-free rate of return, being the yield on a ‘risk-free’ asset such as a long-term US government bond. [NB: In some contexts it is important to consider the risks in fact associated with an investment in US government debt]

Dealing firstly with the cost of debt, in general, since they are paid ahead of shareholders, and hence are exposed to less risk, debt holders require lower returns than equity holders. In addition to the risk-free rate, a premium will typically be added to take into account the additional risk of lending to a company rather than a government; this premium will be determined by factors such as existing indebtedness, the size of the business, ability to cover interest payments from profits etc.

Whereas the calculation of the cost of debt is relatively straightforward, the calculation of the cost of equity can include many risk premia. A common method of calculating the cost of equity is known as the capital asset pricing model (CAPM). In very general terms, one builds up the cost of equity by taking account of several risk premia including:

• the equity risk premium (the additional return required by holders of stocks over bonds) multiplied by beta (a measure of the sensitivity of a given stock to the overall market);
• a country risk premium (CRP) – The assessment of a suitable discount rate for an investment in a developing market or emerging economy (e.g. countries in the former soviet union) requires the investor to consider risks in addition to those related to investments in more mature, developed economies (such as the United States or Germany). The exercise is one of assessing a risk premium over the return required on investments in more mature, stable economies; and
• a small company risk or ‘size’ premium – whilst this is debatable, some valuers add an additional premium for small companies to reflect the perceived additional risks when compared with larger, more established companies

This is a complicated area, and a detailed treatment is beyond the scope of this article, but it suffices to say that selecting an appropriate discount rate is an art rather than a science. A major part of the quantum expert’s role is to demonstrate to the arbitral tribunal, in as clear and transparent a fashion as possible, that he has considered all relevant issues and has been reasonable in the calculation of the discount rate.

Strengths and weaknesses of the DCF approach

A major attraction of the DCF approach is its inherent flexibility in that it can be applied in many different contexts; it is a commonly accepted basis for assessing the present value of a project, company or asset and can also be used to appraise investment decisions. Importantly, DCF is company or project-specific. Finally, DCF expresses future cash flows in present day terms.

On the other hand, like all valuation methods, a DCF model is only ever as good as the data used and the underlying assumptions. On occasions, it may simply not be possible to make a reasonable estimate of projected future cash flows e.g. because there is insufficient contemporary and/ or historic data; were one to plough on regardless, the output from the DCF model is unlikely to be anything other than pure speculation. In such circumstances, it may be more appropriate to use different valuation methodologies. In any event, the DCF methodology is not the only approach and, as explained in part 1 of this series, best practice requires that a valuation produced under one approach is cross-checked against valuation(s) produced under (a) different approach(es). I discussed approaches to dealing with uncertainty in an earlier article which can be accessed here.

Common mistakes made with DCF

As noted above, it is this writer’s experience that DCF is sometimes applied incorrectly, rendering the results of a model useless at best and, at worst, dangerously misleading. Whilst the below is not intended to be an exhaustive list, here are some of the more common errors to watch out for:

• Overlooking capital expenditure – a DCF valuation which assumes steady growth in annual cash flows should also take into account the capital expenditure required to generate that growth. The re-investment of cash in the business is something which can easily be overlooked, resulting in unrealistically high valuations where capital expenditure is ignored. Where a DCF model includes a terminal period, it is critical that the final year of the explicit period reflects the likely annual capital expenditure going forward
• Overly-aggressive terminal growth assumptions – for the purposes of determining the terminal value component of the DCF valuation, the assumed long-term rate of growth should not exceed the sum of inflation and real GDP growth at the most.
• Double-counting of risk – the uncertainty of future cash flows can be taken into account either by directly adjusting the cash flows in the model or through the discount rate. Normally, one should not make adjustments to both as this would constitute double-counting of the risk
• Explicit period too long – uncertainty increases over time. For this reason, the explicit period should not be excessive.
• Scenarios / sensitivity analysis – best practice requires that the use of sensitivity analysis and/ or considering various scenarios (best case, worst case, base case) showing how the valuation changes as adjustments are made to the various inputs. It is not uncommon for small changes (e.g. to the assumed growth rate) to have a major impact on the valuation. Alas, best practice is not always followed, with the result that some valuations are not accompanied by sensitivity analysis.
• Mathematical errors – as a general rule, the risk that a DCF model will contain formulaic errors, errors in referencing data etc increases in direct proportion to the complexity of the model and the number of assumptions.

Impact of the financial crisis on the application of the DCF approach

Having provided above a very high-level overview of the DCF approach, I will consider briefly what implications the financial crisis has for the use of DCF valuations in international arbitration.
In some ways, the financial crisis has arguably changed nothing at all; as a mere methodology for quantifying damages, DCF remains as applicable as it was prior to autumn 2008. The financial crisis has, however, made the application of DCF, including the calculation of an appropriate discount rate, a far more challenging exercise than it was previously, for reasons I touch upon below.

Dealing firstly with factors impacting on the estimation of future cash flows, it cannot be forgotten that the current global economic climate is characterized by tremendous volatility and uncertainty. In constructing a DCF model, the valuer needs to undertake rigorous analysis to ensure that projections of revenue growth and profitability can be justified. The now common sight of major financial institutions and other businesses with household names going insolvent demonstrates clearly we are living in a time of unprecedented change. The valuer must try to make sense of this volatility and make sensible predictions of future cash flows. This is not the same as saying, however, that such projections need always be excessively conservative. Just as the word ‘crisis’ in Chinese is translated by two symbols representing respectively ‘danger’ and ‘opportunity’, so might the DCF model take into account the reality that some businesses (particularly those well-financed and with excess cash) stand to gain from others’ demise due to reduced competition, availability of key assets at fire-sell price etc.

The financial crisis has a number of potential impacts on the calculation of the discount rate. Firstly, the sovereign debt crisis and the well-publicized downgrading of US debt has called into question whether there exists a truly risk-free rate. Until recent events, bonds issued by the United States and other stable countries were widely considered the best proxy for the risk-free rate – a key component of the cost of capital – and, in many experts’ eyes, still are. With the threat of outright default in some countries and/ or destruction of the currency through monetary inflation in others, the idea of a risk-free rate can seem quaint! If the risk-free rate is not to be derived from US bond yields, however, what possible alternatives are there?

Two further factors to be considered in the calculation of the discount rate include the market-risk premium and the beta (explained above). Given high volatility, the observed premium of required equity returns over government bond yields can fluctuate significantly over short amounts of time. In a similar way, the beta of a given company in a given industry can also vary a great deal; it may be the case for example, that Company A had a beta of 1.5 on 1 January 2011 but that this subsequently increased to say 2.0 by the summer of 2012. It goes without saying that such changes are by their nature difficult to predict and yet this is precisely what the valuer is required to do.

Conclusion

In my experience, there are few circumstances in which a DCF method, properly applied, cannot be usefully adopted. On occasion, however, applying a DCF method properly can be both costly and difficult. Where such difficulties arise, if the same degree of relevance and reliability is required from the result, the issues giving rise to the difficulty and cost do not ‘go away’ simply by selecting a different method; on occasions where there is not an observable market price, all valuation methods (properly applied) – in one way or another – require one nonetheless to form a view about possible future outcomes and the uncertainty surrounding those outcomes.

Notes
Cash flow methods include Discounted Cash Flows or “DCF” (the focus on this article), and Capitalised Cash Flows, which derive a value for a company based on the company’s historical cash flows.

Earnings methods include Capitalised Earnings and Discounted future earnings. Whilst a detailed discussion of these methods is outside the scope of this article, under the capitalised earnings method, a company’s valuation is derived by dividing the expected annual maintainable earnings of the company (often based on an average of historical earnings) by the required earnings yield. This method is typically used where future earnings growth is expected to be minimal. If future earnings growth is expected to be high, the discounted future earnings method may be more appropriate. This method aims to calculate the present value of the expected future earnings of a business by using an appropriate discount rate.

A further methodology in the income-approach is the Discounted Dividends Model (DDM). Under the DDM, the value of an investor’s shares is based on the present value of the likely current and future dividends earned from those shares. DDM is typically used in the case of minority shareholdings and/ or where the relevant shareholder exercises little control.

©FTI Consulting, Inc., 2012. All rights reserved.
The views expressed in the article are held by the author and are not necessarily representative of FTI Consulting, Inc, or its other professionals. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual, entity or transaction. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation

Under the new Article S14 which came into effect on 1 January 2012, the ICAS is free to call upon personalities with full legal training, recognized competence with regard to sports law and/or international arbitration, a good knowledge of sport in general, and a good command of at least one CAS working language, whose names and qualifications are brought to the attention of the ICAS, including by the IOC, the IFs and the NOCs. This is the major amendment of the January 2012 revision and is to be welcomed as it further enhances the already existing independence of CAS arbitrators.

Other significant modifications relate to the Consultation Proceedings and to consolidation. The special provisions applicable to Consultation Proceedings (Articles 60 – 62 of the Procedural Rules of the CAS), pursuant to which the above-named organizations and associations could request advisory opinions from the CAS, were indeed abandoned. Moreover a new subsection of Article 39 of the Procedural Rules now provides for the possibility to consolidate two arbitration proceedings.

As reported in this blog, in May 2011 the Supreme Court of India (SCI) moderated the controversial principle it established in 2002 that allowed the Indian courts to intervene in arbitrations held outside of India unless that possibility was expressly excluded by the parties (see Videocon Industries Ltd. Vs. Union Of India & Anr. (2011) 6 SCC 161). In a decision which should be welcomed by the international legal and commercial communities, on 1 September 2011 the SCI further restricted the scope for the Indian Courts to interfere in international arbitrations seated outside the country in its decision in Yograj Infrastructure Ltd. Vs. Ssang Yong Engineering and Construction Co. Ltd.

Legal background

In Bhatia International Vs. Bulk Trading SA (2002) (4) SCC 105 it was held that the provisions of Part I of the Indian Arbitration and Conciliation Act 1996 (the Act) (which allow the Indian Courts to grant interim measures (Section 9), to make arbitral appointments in the absence of agreement by the parties (Section 11) and to set aside arbitration awards (Section 34) among other measures) would apply to international arbitrations held outside of India unless the parties agreed to exclude their application.

Since the Bhatia case, the requirement of “express exclusion” appears to have been relaxed through judgments given by the Gudjarat High Court in Hardy Oil & Gas Vs. Hindustan Oil Exploration (2006) 1 GLR 658 and the SCI in Videocon Industries Ltd. Vs. Union Of India & Anr. (2011) 6 SCC 161. However, the courts’ reasoning in those decisions was not without fault.

In Hardy Oil the Gudjarat High Court confirmed that Part I of the Act could be impliedly excluded, in that case by express agreement by the parties to a contract providing that “[t]he place of arbitration shall be London and the … law governing the arbitration shall be English law”. Hardy Oil suggests that the reference to a law governing the arbitration, in other words, the law of the seat of the arbitration, should have been determinative.

In Videocon, the SCI followed that line of reasoning but appeared to misjudge the distinction between the law of the arbitration agreement and the curial law, relying instead on the law governing the arbitration agreement as determinative. The SCI held that, since the parties had agreed to an arbitration clause governed by English law, even though the main contract was governed by Indian law, they too had implied an exclusion to Part I of the Act. Had the SCI correctly applied Hardy Oil the result may have been no different, as the curial law in Videocon was not Indian law either and therefore Part I of the Act should have been excluded in any event. However, it is concerning that this fundamental distinction was mishandled at all.

In Yograj Infrastructure the SCI gets the distinction right.

Facts

In April 2006 a Korean incorporated Company, SSang Yong Engineering and Construction Co. Ltd. (SSY) entered into a sub-contract (the Agreement) with Indian-incorporated Yograj Infrastructure Limited (YAL) for a highways infrastructure project in the province of Madhya Pradesh which had been granted to SSY by the National Highways Authority of India, New Delhi. In September 2009, SSY terminated the agreement with YAL on the grounds that YAL had delayed in performing the construction work.

SSY (who was the Respondent in the present proceedings) and YAL (who was the Applicant) each applied for interim relief before the Indian courts. The court referred the parties to arbitration in Singapore in accordance with Clause 27 of the Agreement which specified that “All disputes, differences arising out of or in connection with the Agreement shall be referred to arbitration. The arbitration proceedings shall be conducted in English in Singapore in accordance with the Singapore International Arbitration Centre (SIAC) Rules as in force at the time of signing of this Agreement … [t]he arbitration shall take place in Singapore…”.

Once the arbitral tribunal was composed, the Respondent applied for, and was granted, certain relief against the Applicant in an interim order. The Applicant appealed the tribunal’s interim order to the Indian District Court which rejected the appeal. Following another appeal to the Madhya Pradesh High Court (also rejected) the Appellant brought an appeal to the SCI.

The SCI’s decision

The SCI examined the arbitration clause in the Agreement noting that there was “no ambiguity” surrounding the fact that the governing law (or “proper” law) of the Agreement was the law of India (provided for at Clause 28 of the Agreement). However, quite correctly, the SCI differentiated the proper law from the “curial” law governing the arbitration itself, which the parties were free to nominate.

As is normal, the parties had not expressly provided for a curial law governing the arbitration, rather they had simply referred to Singapore as the seat of the arbitration. While this should not normally lead to any ambiguity regarding the correct curial law, as the Videocon decision demonstrates the Indian courts have not always appreciated the distinctions between the various laws at play in the international arbitration context. However, that Singaporean law was the applicable curial law in this case was beyond issue by application of the Singapore International Arbitration Centre (“SIAC”) Rules 2007.

Article 32 of the SIAC Rules 2007 (which has since been replaced by Article 27 of the 2010 SIAC Rules which allows the tribunal greater discretion in this regard) provides that “Where the seat of arbitration is Singapore, the law of the arbitration under these Rules shall be the [Singaporean] International Arbitration Act … or its modification or reenactment thereof”.

Accordingly, as the parties had by implication of the SIAC Rules 2007 agreed Singaporean law as the curial law, the SCI concluded that they had impliedly excluded the application of Part I of the Act.

Commentary

It is encouraging that the SCI has correctly distinguished between the general law of the arbitration clause (Indian law in this case) and the law governing the procedure and conduct of the arbitration (Singaporean law). While the decision as a whole is welcome insofar as it further reduces the scope for the Indian courts to interfere in arbitral proceedings seated outside of India. The SCI is to be applauded for further restricting the application of the controversial principle established in the Bhatia case.

However, it is hoped that the SCI may yet go further. At the time of writing, the SCI had just begun hearing a number of consolidated appeals that could lead to full reversal of the Bhatia line of authority. The SCI has invited amici curiae briefs and those submitting briefs include the LCIA India and the SIAC. Commentators are therefore quietly hopeful that this may spell the end for Bhatia.

But if one particular approach can be shown to be superior for certain types of disputes, is employing a different or compromise approach actually sub-optimal?

I confess that I am as guilty as the next person when it comes to promoting the value of harmonization and flexibility when discussing international arbitration. But I am ready to admit to being wrong. Practices that do not lead to an overall better procedure may be more vice than a virtue.

So in today’s post I wish to challenge conventional wisdom by positing that for international commercial arbitration, the civil law approach to fact evidence is generally better than the common law’s. This rests on two underlying assumptions: (a) greater decisional weight placed on documentary evidence than witness testimony in civil law practice, and (b) parties in civil law proceedings are expected to meet their burdens by relying on documents within their control, not what they can obtain from the other side.

To be clear, my hypothesis is narrowly drawn. I would not extend it, for example, to the treatment of expert evidence, especially the practice in many (but not all) civil law jurisdictions in which a tribunal will appoint its own expert to report on contested technical issues. It would be a stretch to claim this is usually better than directly vetting the parties’ experts, as typically occurs in the common law.

With respect to fact evidence, however, the civil law practice can bring greater predictability of outcome in commercial disputes, and less time and expense of the resolution process. Here are some of the reasons why this is so:

1. Documents are how parties themselves record their commercial dealings. Few sophisticated parties today would rely solely on the memory of employees to recall past commercial events. If parties are doing their jobs right, they will create and retain contemporaneous records that accurately reflect how and when key events unfolded. Good record keeping should render the need for witness testimony largely superfluous, at best. Since documents are how parties themselves wish to record events, why shouldn’t they be considered the best possible evidence of what transpired between them?

2. Fact witness availability can be unpredictable. The ability to secure the testimony of key employees in an international commercial dispute is too often an unrequited hope. There is often no way to secure the testimony of a key employee/witness who retires or goes to work for a competitor after a dispute arises, and as a result does not wish to cooperate. The unavailability of a witness will often have nothing to do with the issues in dispute, yet it can have considerable impact on a party’s ability to present its side of events where fact witness testimony is considered important. This risk is largely avoided where documentary evidence is afforded greater value than fact witnesses.

3. The unreliability of fact witness testimony. There has been an impressive quantity and quality of research in recent years about how the brain processes information. Filters in perception, called cognitive biases, alter our ability to recall past events accurately, which is a scientific way of explaining why you can never win an argument with your mother over something you did or didn’t do in childhood. One very effective cognitive bias, and this is just one example, is self-deception. A witness can present an inaccurate history of events with incredible sincerity if they have deceived themselves into believing that what they say is true. The eminent evolutionary biologist Robert Trivers developed a theory of why we would deceive ourselves in a seminal essay published in the 1970s, Self-Deception in the Service of Deceit. As the title implies, the theory is that we self-deceive in order to better deceive others. He recently expanded his theory into a book which I commend to anyone who believes that witnesses are better at recalling past events than documents, The Folly of Fools: The Logic of Deceit and Self-Deception in Human Life (Basic Books 2011). And even when a witness is capable of presenting an unfiltered representation of past events, that does not mean that arbitrators will recognize it as such. Just like everyone else, they perceive the world through their own cognitive biases. A self-deceived witness will appear truthful, even as they are lying to themselves and the tribunal.

4. The time and cost of fact testimony can be disproportionate to the value added. There are evidentiary hearings that take place because at least one of the parties insists on the right for its witnesses to be heard. While tribunals may feel they necessarily have to grant hearing time in order to avoid a later due process challenge, that does not mean the time and cost of a hearing will be justified, especially if the hearing time is spent on witness testimony that may be of marginal value at best. Even where witnesses will testify, however, the economy of the civil law is usually more attractive than the common law. My informal rule of thumb for estimating hearing time in domestic arbitrations is that one day of testimony in a civil law arbitration translates into five days in purely common law proceedings. In other words, if two days are required to get through each side’s witnesses in a domestic arbitration in Germany or Italy, it will take at least two weeks to complete the testimony of the same witnesses in a domestic arbitration in the United States.

5. The vagaries of document retention practices across cultures. International business disputes present a special problem with the broad and expensive requests for documents that may occur in common law practice (often permitted under the IBA Rules of Evidence). Parties from different legal cultures will have different legal or ethical obligations for retaining documents, and different duties whether to make them available when requested by an adverse party. Parties with robust document retention programs, usually found in common law legal cultures, are likely to have the ability (and ethical obligation) to locate and produce potentially adverse documents. This is not always the case for parties that hail from legal cultures, often the civil law, where documents are not routinely produced. This disparity can lead to an unfair balance in access to evidence, and does not exactly lend itself to greater predictability of outcome. The civil law approach, in which each side produces the documents they intend to rely upon, is less expensive, less burdensome, and is more likely to lead to a result that a business can predict at the inception of a dispute (point 1 above).

The value of harmonizing practices from diverse legal systems is that it keeps the door open to parties and practitioners from different countries, making the practice of international arbitration accessible and non-threatening. That is certainly good. But as international arbitration continues to grow and mature, there will also be value (and virture) in adopting practices that are just, well, better.

First, Hong Kong’s new Arbitration Ordinance (cap. 609) came into effect on 1 June 2011 (blogged here). Drawing heavily on the internationally-recognised and accepted framework of the UNCITRAL Model Law, the new Ordinance was designed to provide maximum party autonomy and minimal court intervention. With a host of features including expanded provisions on interim measures and a new codified obligation of confidentiality, the new Ordinance sets a high standard in modern arbitration legislation and has been enthusiastically welcomed by the arbitration community.

Second, the Court of Final Appeal in Democratic Republic of the Congo v. FG Hemisphere Associates FACV Nos 5, 6 & 7 clarified the law in relation to sovereign immunity in Hong Kong. Whilst immunity will apply to the enforcement of court judgments and arbitral awards (wherever rendered) in Hong Kong, it is clear that it will not apply to arbitral proceedings (blogged here). Parties can therefore include Hong Kong arbitration clauses in their contracts with states, safe in the knowledge that sovereign immunity cannot be pleaded as a bar to the jurisdiction of the arbitral tribunal. But could sovereign immunity prevent the courts of Hong Kong from exercising supervisory jurisdiction over an arbitration seated here? That question remains unanswered for now, but there are compelling reasons (including obiter dicta of the Court of Appeal in the Congo case) to suggest that it would not, and that the courts of Hong Kong could exercise supervisory jurisdiction notwithstanding a claim of sovereign immunity. It’s also unlikely that state owned entities would be entitled to immunity before the Hong Kong courts (blogged here), restricting the cases in which sovereign immunity would be a live issue to the small number specifically involving sovereign states.

Third, Hong Kong’s pro-enforcement credentials were on clear display in a number of cases upholding the enforcement of arbitral awards in Hong Kong. In two of the most prominent, Shandong Hongri Acron Chemical Joint Stock Company Limited v. PetroChina International (Hong Kong) Corporation Limited CACV 31/2011 and Gao Haiyan and another v. Keeneye Holdings Limited and another CACV 79/2011 (reported here), the Court of Appeal enforced arbitral awards rendered in mainland China and emphasised that the enforcing court should take a mechanistic approach to enforcement and must not review the merits of the award. The court’s readiness in the PetroChina case to enforce against a mainland state owned entity also illustrates the judicial independence which makes Hong Kong such an attractive venue, particularly in China-related cases.

Fourth, an international arbitral award rendered in Hong Kong was set aside by the Court of First Instance under Article 34(2) of the UNCITRAL Model Law in Pacific China Holdings Ltd v. Grand Pacific Holdings Ltd HCCT 15/2010. This is a rare example of the power to set aside being exercised by the Hong Kong courts, in this case on the basis of procedural irregularities. The case is notable for its discussion of the circumstances in which the court’s residual discretion not to set aside an award (Article 34(2) of the Model Law states that an award “may” be set aside) should be exercised. The court considered that the applicant in a set-aside case had to establish that “it cannot be said that if the violation had not occurred the result could not have been different“. The judgment raised concerns for arbitrators and counsel given the frequency with which thorny procedural issues arise in practice, and the result of the appeal which is currently pending is therefore likely to be followed with interest.

Fifth, the importance of procedural issues at the enforcement stage, a consideration too often forgotten in the heat of the arbitration proceedings themselves, was highlighted in the Keeneye and PetroChina cases. Keeneye demonstrated why it is imperative that a party which objects to the procedure adopted in an arbitration should object formally at the time, since a failure to do so risks being deemed later (for example, in proceedings to set aside an award or refuse enforcement) to be a waiver of the right to object. Conversely, the PetroChina judgment is a reminder that where the parties seek a supplementary award from the arbitral tribunal, the procedures required by law or the relevant institutional rules must be followed if the supplementary document is to be recognised as an award at the enforcement stage.

Sixth, so-called “arb-med” procedures, where arbitrators act as mediators during the course of the arbitration, hit the headlines. Hong Kong’s new Arbitration Ordinance specifically provides for both “arb-med” and “med-arb” (where a mediator is appointed before arbitration is commenced) (reported here), but there were concerns following the judgment of the Court of First Instance in the Keeneye case that the use of arb-med procedure could increase the risk of challenge to the award or its enforcement. Whilst that concern was arguably over-stated given the very specific facts of the case, the recent judgment of the Court of Appeal reversing the first instance decision (reported here) offers some measure of reassurance and indicates that in assessing the propriety of an arb-med procedure in the context of proceedings to enforce the award, the Hong Kong courts will take account of what is considered to be acceptable practice at the seat of arbitration. It remains to be seen, however, whether arb-med will be widely adopted in Hong Kong itself, given the obligation on arbitrator-mediators under the new Arbitration Ordinance to disclose confidential information obtained in any mediation to the parties – a requirement which seems likely to encourage parties to pursue evaluative as opposed to facilitative mediation, or mediation outside the context of the arbitration, rather than to embrace med-arb.

Seventh, Hong Kong’s close ties with the mainland continue to be the source of both opportunities and challenges. Long recognised as a unique interface between the PRC and other trading nations, Hong Kong offers arbitration users access to a legal profession which has the expertise and experience to deal with PRC-related disputes and the convenience of geographical proximity to the the mainland. At the same time, this very proximity makes the courts and the legal profession all the more keenly aware of the need to uphold, and be seen to uphold, the judicial independence which is a cornerstone of confidence in Hong Kong’s legal system.

The importance of local knowledge was highlighted in the Court of First Instance case of Klöckner Pentaplast GmbH v. Advance Technology (HK) Company Limited HCA 1526/2010, which provided a useful reminder of the need, when drafting arbitration clauses providing for arbitration seated in the PRC, to expressly designate an administering institution. Whilst not addressed by the court, it is also notable that the relevant arbitration clause provided for ICC arbitration in Shanghai. Whether or not such a clause is valid under PRC law remains uncertain, and it is recommended that ad hoc arbitration or arbitration under the auspices of a non-Chinese arbitration institution should not be adopted where arbitration is to take place in mainland China (discussed here).

It’s encouraging that the developments above illustrate the quality and continuing development of Hong Kong as an arbitral centre: modern legislation designed to minimise court intervention in the arbitral process; pro-arbitration courts which respect the autonomy of the parties; and particular expertise in dealing with mainland China-related arbitration issues.

With other jurisdictions in the region striving to develop their own arbitration offerings, the challenge for Hong Kong is to continue to innovate and adapt. Looking ahead, the expansion and refurbishment of the Hong Kong International Arbitration Centre which is already underway, the ICC’s continued support of its Asia-based secretariat in Hong Kong, and the upcoming revision of the HKIAC Administered Arbitration Rules, will all help to keep Hong Kong’s arbitration facilities and legal infrastructure competitive. Along with the continued support of the courts for arbitration, such measures should ensure that arbitration in Hong Kong continues to thrive.

Justin D’Agostino and Martin Wallace, Herbert Smith

Bederman was a prince of a guy, and a great international law scholar who loved the life of the law. I’ve known him for over twenty years and always appreciated his thoughtful analysis and kind words.

When I asked him several years ago what sustained him as he was battling cancer, he said that, in addition to his family, he loved to wake up every morning and think about his latest writing project. He wrote until his dying days, finishing his last great book, Custom as a Source of Law, just last year. Among his passions was international arbitration, especially the history of international adjudication.

Just to give you a taste of his work, here’s a choice excerpt from a book chapter he wrote:

What made international claims tribunals the preferred method of claims settlement until the end of the Second World War? One factor not to be underrated is the psychology of international arbitration. It makes for a superb face-saving device in the conduct of international relations. Contentious disputes are submitted to what appear to be a neutral authority which adjudicates them on the basis of a respect for law. The highly-charged political circumstances which gave rise to the claims—whether wars or political upheavals—are neutralized with (usually) years of dispassionate legal analysis and adjustment. If nothing else, international claims settlement is a superb political soporific.

David Bederman gave a “Final Lecture” in September 2011, but it was not a self-reflective journey on the meaning of life. Rather it was the Inaugural David J. Bederman Lecture.

Interim Dean Robert Schapiro introduced David by stating “Please join me in welcoming … our friend and colleague, and a hero of mine, Professor David J. Bederman.” After a standing ovation, David said, “I’m glad to be here, in so many respects. I look out in the audience and see so many friends and I’m going to try and spend a few minutes with each of you after the lecture. I am deeply touched that you would spend your afternoon with me. It means a lot to me.” Then he spent the next hour discussing his latest work on the role of custom in law.

That was David Bederman. Always thinking, always excited about the life of the law, always looking to his next great project. A scholar and friend to the very end.

Interference by Indian courts in arbitral proceedings has especially been striking in the grant of interim measures of protection and interim relief. This is normally in exercise of the power under Section 9 of the [Indian] Arbitration and Conciliation Act, 1996 (the “1996 Act”). Section 9 forms part of Part I of the 1996 Act that largely incorporates the provisions of the Model Law on the conduct of arbitrations. Part II of the 1996 Act codifies the New York and Geneva Conventions and provides for the recognition and enforcement of foreign awards in India.

In the beginning was Bhatia

In the specific area of grant of interim measures of protection, of foremost importance, is the Bhatia (2002) decision of the Supreme Court taking the view that Part I of the 1996 Act applies equally to international commercial arbitrations that are seated outside India. The decision came about in the context of a request for interim relief made by a party to an ICC arbitration seated in Paris. The request was made to, and rejected by a District Judge. The appeal to the High Court was also rejected. The Supreme Court, however, took the view that unless expressly or impliedly excluded, the provisions of Part I would also apply to arbitrations seated outside India. The argument that succeeded, amongst others, was that Section 2 (2) of the 1996 Act which provided that Part I would apply where the place of arbitration was in India, did not use the word ‘only’, implying that the legislature had not provided that Part I is not to apply to arbitrations which take place outside India.

The post Bhatia conundrum

Given that a court could pass interim orders before the commencement of arbitral proceedings, the Bhatia decision led to scores of ‘Section 9 applications’ for interim relief being filed in courts across the country in relation to arbitrations, whether seated in India or outside. The decision remains a topic of debate.

However, the only carve out that the Court provided for was the parties’ express or implied exclusion of Part I. There was no guidance on what constituted an implied exclusion of Part I. This only served to complicate matters further since Part I also included important provisions for appointment of arbitrators and setting aside of awards, amongst others. Unclear with whether Part I had been impliedly excluded or not in specific instances, Indian courts began to appoint arbitrators in arbitrations seated outside India, for instance in National Agricultural (2007) and Indtel (2008) and permit setting aside of foreign awards, for instance in Venture Global (2008).

Recent trends

In this context, a brief look at some of the recent cases in India on the issue is interesting. The following table seeks to demonstrate the factors that have weighed with Indian courts in determining the question of whether parties had impliedly agreed to exclude the applicability of Part I of the 1996 Act.

It is interesting to see that courts are increasingly willing to exercise restraint where parties have chosen to apply laws of other jurisdictions to govern the arbitration agreement. Similarly, foreign seats of arbitration appear to be an important factor. The choice of specific institutional rules for the conduct of arbitration is also of considerable influence in making the determination that parties had impliedly excluded the application of Part I.

Of some interest to Indian parties is the Videocon decision where the Supreme Court, albeit seized with other issues concerning the distinction between the seat and venue of arbitration, was willing to respect the choice of English law as the governing law of arbitration while the substantive contract continued to be governed by Indian law. This is a clear positive option for Indian entities negotiating dispute resolution clauses with foreign entities.

Equally of interest is the mention of Rule 26 of the SIAC Rules, being the SIAC Emergency Arbitrator provisions in Unknown by the Madras High Court as an alternate remedy for interim relief. Since their introduction in the 2010 Rules, the SIAC Emergency Arbitrator provisions have most often been used by Indian parties to seek and obtain emergency interim relief, in one case within three days and in another within ten days of the application. In these cases, as luck would have it, the disputes were consensually and amicably resolved by parties subsequent to the grant of such emergency interim relief.

Also of some interest is news that the Supreme Court of India has now constituted a five judge Bench to hear a batch of cases which will consider whether Indian courts can entertain a challenge to a foreign award under Section 34 and in effect reconsider Bhatia (2002) and Venture Global (2008).

The views in these cases should serve as an important guideline for drafting dispute resolution clauses effectively with a view to ensuring that the correct jurisdiction can be approached to seek reliefs to aid arbitral proceedings. Needless to say, it is also perhaps reason for some measured optimism on the hitherto held view that Indian courts are interventionist and mindless of jurisdictional limitations.

Ankit Goyal is Head (South Asia) & Counsel and Vivekananda N. is Deputy Head (South Asia) at the Singapore International Arbitration Centre (SIAC).

My suspicion is that expert witnesses could do much more to assist the arbitration community in their dealings with the important issue of quantum. Without wishing to make sweeping generalisations, I do wonder whether some arbitrators’ relative lack of familiarity with different approaches to measuring damages might be at least a partial explanation for the following:

• The existence of relatively few awards which explain in any real detail arbitrators’ reasoning for preferring one valuation approach over another and hence their eventual award for damages.
• The perception that arbitrators ‘split the baby’ i.e. issuing an award for damages that is somewhere in the middle of two experts’ valuations, despite said valuations having been produced using entirely different methodologies and/ or assumptions.

In a similar vein, whilst many lawyers I have met say they understand (for example) discounted cash flows (DCF), it is not always clear to me that their knowledge of this methodology extends beyond the pure mechanics of the calculation. What is also needed when analysing a DCF calculation is a proper awareness of the importance and role of assumptions and the various sensitivities in a DCF calculation.

Given the above, I thought it might be helpful to produce a short series of blog postings covering the rudiments of the most common valuation methodologies. Each post will explain the basic mechanics of the valuation approach, its applicability to different situations and its strengths and weaknesses. Finally, I will explain how the ongoing financial and economic crisis may impact a valuation performed under the particular valuation approach being considered.

Introduction

Forensic accountants and other valuation professionals are frequently involved in the arbitral process to assist disputing parties and tribunals quantify economic loss as a result of a given breach or act. In order to determine the amount of economic loss (e.g. suffered by a business), an expert will often need to perform two different valuations: a counterfactual (or ‘but for’) valuation and an ‘actual’ valuation’ where the difference between the two represents the loss. There are many different methodologies for valuing a business, with the following being the most common approaches:

• Market-based approach (e.g. comparable transactions)
• Income-based approach (e.g. DCF)
• Asset-based approaches (e.g. adjusted net book value)

This article will focus on the market approach; subsequent articles will discuss the DCF and asset-based approaches.

Overview of the market approach

Underpinning the market-based approach is the basic principle that a business is only worth what somebody is prepared to pay for it. For this reason, when attempting to value a given business (let’s call it Company A) in the context of a dispute, an expert may firstly look at the value of any past transactions in Company A itself. Recent past transactions in Company A may be the best available evidence of the value of Company A, although the details of such transactions would need to be studied carefully before arriving at such a conclusion. It is not uncommon, however, that the expert will find few, if any, recent transactions in Company A; any transactions that he does find may not have been made at arm’s length (hence failing one of the tests in the definition of fair market value – see below) or else made in the distant past (and hence not reflecting current information).

In lieu of (or in addition to) using own-company transaction data, the expert will research recent transactions in businesses he deems to be similar to Company A. The premise supporting this approach is that if Company A is similar to Company B, and Company B has a value of X (assuming that we know the value of Company B), it is reasonable to assume that Company A’s value can be determined by reference to X. In this example, X might refer to any of Company B’s share price, the transaction price for the sale of the entire business, total enterprise value (value of both shareholders’ equity and debt) or equity value (the value attributable to shareholders) among other values.

The first step then for the expert who wishes to value Company A using comparable transactions is to identify businesses which are similar to Company A in that they have share common characteristics. Characteristics that are commonly taken into account include:

• Industry/ business sector
• Size of organisation (number of employees, turnover, geographical spread)
• Product mix
• Financial structure (e.g. mix of debt/ equity)
• Geography
• Maturity of the business i.e. does Company A have stable/ predictable revenues or is it a young fast-growth company?
• Profit margins

It will be appreciated that, in reality, no two businesses are exactly alike in all respects. Whilst an expert may successfully identify a business (Company B) which provides a close match to Company A, there will often be important differences between the businesses. The expert will need to take these differences into account when performing his valuation.

Putting aside for the time being the above practical considerations, assuming that the expert does find a reasonably close match, he will then seek to use the (known) valuation of Company B to inform his valuation of Company A. Today, the expert benefits from being able to access a wealth of publically available information from a variety of sources. By accessing a suitable database (e.g. Bloomberg), the expert can obtain and use details of Company B’s key financial metrics. He may discover, for example, that the enterprise value of Company B is a multiple of 10 times EBITDA (Earnings Before Interest Tax Depreciation and Amortisation). To conclude this simplistic example, the expert may decide that Companies A and B are so similar that the former should also be valued on a multiple of 10 times EBITDA. Alternatively, he might observe that Company B was recently sold for a price X and conclude that this price should inform the value of Company A.

In some industries, key drivers of value are used as relative valuation multiples, for example:

• value per customer or subscriber (telecoms, financial services, internet businesses)
• value per square foot (retail)
• revenue per available room (RevPar) (hotel industry)
• value per unit of proven reserves (mining companies, oil companies)
• value per unit of sales (value per bottle in the champagne industry in France, daily milk bottle sales in dairy industry)

As variants on the above, the study of comparable businesses may also be relevant in the following circumstances:

• selection of an appropriate discount rate for the purposes of the income (DCF) approach – discussed in the next posting. If Companies A and B are similar (e.g. large mobile phone companies operating in a given country), the discount rate for Company A at a certain date may be a sensible proxy for that of Company B on a slightly different date, although again care needs to be taken to ensure one is truly comparing like with like; and

• understanding how a business might have performed (but for a breach) by reference to the trading performance of a similar business in the same time period.

That then is the (over) simplified overview of the market/ comparables approach. I set out below some of the key strengths and weaknesses of this methodology.

Strengths and weaknesses of the comparables approach.

By way of an opening comment, it should be recognized that the market/ comparable businesses approach is generally accepted within the professional valuation community and is widely used. If properly prepared, an independent valuation which is supported by reference to real-life transactions in comparable companies demands to be taken seriously and may be difficult to criticize.

A further strength of this methodology is that the expert can access a huge amount of data in his search for a comparable company. By way of illustration, when searching recently for a particular type of manufacturing company in Eastern Europe, a database returned over 30 possible results, showing all the financial and accounting data I could possibly need and more besides.

One obvious reason why the market approach is often used in arbitration for the purposes of calculating damages is that, on the face of it, the approach itself seems entirely straight-forward and reasonable. From personal experience, it is often easier to explain to lawyers than DCF!

On a cynical view, however, in preparing its claim, a party might rely on this approach precisely because it knows it is conceptually simple and can usually be understood more easily by the lay person than a claim which is based on a complicated DCF model. As we shall see in the next article, however, the DCF approach is widely used and generally accepted in the professional valuation community. Becoming even more cynical, it can be observed that M&A transactions often reflect a heavy ‘control premium’ that might not arise in valuations produced under other methodologies. Put simply, the market approach can sometimes give higher values (and thus work in the claimant’s favour) than either the income or asset based approaches, although this does also depend on prevailing market sentiment.

What then are the flaws of using what seems to be an approach grounded in common sense and straight-forward logic?

Firstly, there exist relatively few truly comparable companies. Even assuming one is able to find a similar company in terms of size, product, geography, capital structure etc, any differences in other factors (e.g. the actual profit margins earned and/ or the profit growth rates) can mortally wound the comparison or else require complicated adjustments to be made to the valuation to create an artificial comparability.

A second difficulty is that historical transaction values may not reflect current values and, as we know, market sentiment can change quickly. The M&A market in spring 2007 (i.e. prior to the onset of the financial crisis) was completely different to that in the fall of 2008 i.e. post Lehman collapse.
The following is a non-exhaustive list of other potential weaknesses/ drawbacks:

• Given the (sometimes) large population of notionally comparable businesses, it may be tempting for a party to ‘cherry-pick’ the businesses that support a pre-determined valuation; an experienced expert charged with rebutting a claim should be able to identify the existence of such bias by getting to the same overall population
• A deep understanding of the relevant industry/ sector may be required in order to decide which businesses truly are comparable
• Particular care needs to be taken when dealing with businesses with little history and/ or high growth
• The assumptions underpinning valuations based on comparable companies can be far less transparent than is generally the case in say a DCF valuation.
• The approach may not be possible in the case of start-up ventures
• Important intangible differences between otherwise comparable companies tend to be glossed over, such as brands, management styles, culture etc.

Impact of the financial crisis on the application of the market-based approach

Whilst the market-based approach continues to be as relevant today as it ever was, in this writer’s view, additional caution is warranted now when researching past transactions to ensure one is truly comparing like with like. The global financial and economic crisis does not look like it will dissipate in a hurry and hence its impact of valuation needs to be taken seriously. A sensible starting point for this discussion is the International Glossary of Business Valuation Terms’ definition of Fair Market Value, which is:

“the price, expressed in terms of cash equivalents, at which the property would change hands between a hypothetical willing and able buyer and hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market when neither is under the compulsion to buy or sell and when both have reasonable knowledge of the relevant facts” [emphasis added]

In conducting a review of market transactions for the purposes of identifying comparable business valuations, the absence of one or more of the above highlighted factors in a given transaction may render the transaction data useless, for the reasons explained below.

Hypothetical willing and able buyer – As is well-known, in the immediate aftermath of the Lehman’s collapse in 2008 and ensuing credit crunch, the M&A market collapsed. Whilst there has been a slight pick-up in the volume of deals since 2008, the global M&A market remains well below levels seen in spring 2007, the high watermark. An obvious implication of the depressed market is that there remains a continued lack of buyer appetite (and greater aversion to risk?) and hence numbers of buyers. Current restrictions on credit do not help. Of relevance here is the importance of geography; to pose a rhetorical question, are lending conditions in Spain – one of the countries most badly affected by the crisis – the same as in say France? If lending conditions are different, this may limit the comparability of French and Spanish businesses in a way that may not have been the case pre-crisis; both countries are, after all, members of the euro zone.

Open and unrestricted market – to what extent can pricing data, obtained from market transactions, be trusted to reflect underlying supply & demand factors, given that governments now regularly intervene in that market? By its very nature, government intervention generally makes markets less transparent and open. To use an extreme example, is the fair market value of a (toxic) derivative instrument truly its face-value simply because a government agency intervenes and purchases it for this price?

Neither is under the Compulsion to buy or sell – In reality, many transaction values since the beginning of the financial crisis may represent “fire sales”, where a vendor may have been under the compulsion to sell an asset or business and may have done so for less than it would have been able to sell it for under different circumstances. In a similar vein, due to heightened volatility, the market may not reflect “long term” view / “value-in-use”

Conclusion

It should be recalled that the market approach is only one of several possible valuation methodologies. Best practice requires that, where practicable, a valuer should seek to apply more than one valuation method, if only to cross-check the results of the different calculations in reaching a final view on value. Thus, the market approach might be used to support a valuation produced using DCF or vice-versa.
In the next article, I will discuss the DCF methodology.

©FTI Consulting, Inc., 2011. All rights reserved.
The views expressed in the article are held by the author and are not necessarily representative of FTI Consulting, Inc. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual, entity or transaction. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation

1. A control premium is the excess price a buyer is willing to pay over the current market value of publicly traded shares.

The writer would like to acknowledge the respective contributions of Andrew Flower and Greig Taylor of FTI Consulting (New York) in the writing of this article.

On the political front, some parts of North Africa, including Egypt, Tunisia, and Libya, are undergoing revolutionary transformations. The last time there had been a revolution in Libya, numerous disputes led to the three Libyan Oil arbitration cases – Colonel Gaddafi’s least recognized gift to the development of the jurisprudence of international arbitration. Although the nature of the revolutionary transformation in Africa this time around seems different, disputes cannot be less likely. Ironically, prior to the revolutions in Egypt, Tunisia, and even Libya, significant economic growth was recorded in each country. Foreign investment was at an all-time high. The economic transformation has been steady and appears sustainable. Moreover, the political transformation has been relatively less violent than before for the most part. When these factors are coupled with the developed world’s enthusiastic support for the changes, it is not difficult to see that the pacific settlement of disputes of any nature, including commercial and investment disputes, would be the most likely outcome. It is this combination of economic progress and political transformation that I call the perfect storm for international arbitration.

A remarkable new player on the field is also adding to the further perfection of the storm – that player is none other than China. Chinese trade and investment in Africa has been growing at unprecedented and extraordinary levels. To mention just a few examples, between 2000 and 2008, mineral export from Africa to China increased by 5000% while total trade grew by 700%, exceeding the $100 billion margin.¹ It has been more than six years now since Chinese investment in Africa has surpassed that of the World Bank.² Given the proliferation in economic relations in the last ten years, a remarkable increase in disputes coming to the fore is fairly predictable as disputes are natural consequences of economic interaction of this scale. According to the latest China-Africa Ministerial Action Plan, arbitration is the preferred means of dispute settlement. It reads in relevant part: “The two sides agreed to properly handle trade differences and frictions through friendly consultation under the principle of mutual understanding and mutual accommodation. The two sides agreed to encourage the usage of national and regional arbitration organs in resolving contractual conflicts between Chinese and African enterprises.”

Dean Philip McConnaughay of Penn State Law School, who spent almost ten years in Tokyo and Honk Kong as a resident partner of Morrison & Forester, recalls being challenged by his co-panelists at an American Bar Association forum in the early 1990s when he said that Asia was becoming as attractive a place to arbitrate as the leading Western centers. The challenge was grounded on the argument that the Asian legal infrastructure was inadequate to support a vibrant arbitration regime and that paving the way would take many years. As it happens, international arbitration found an alternative and largely independent way of flourishing in some parts of Asia. As Dean McConnaughay and Professor Tom Ginsburg observed in their book International Commercial Arbitration in Asia: “[P]aradoxically…it sometimes seems as if the relationship [] between legal infrastructure development and a suitable environment for international commercial arbitration has been inverse, with Japan (until recently, Korea and Taiwan) continuing to neglect arbitration-specific deficiencies in its otherwise highly developed judicial and legal infrastructure, while China (and to a lesser extent Malaysia, Indonesia, Thailand, and Vietnam) continues to promote arbitration-related improvements despite the relative under-development of its judicial and legal infrastructure. The lesson provided by these latter nations is an important one for developing economies, for it suggests that a nation can provide a means of commercial dispute resolution meeting international standards, and thereby promote both domestic and international investment and exchange, long before it will be able to afford and provide the permanent legal institutions characteristic of highly developed economies.” A case in point is the ascent of the China International Economic and Trade Arbitration Commission (CIETAC) to prominence in the last decade.

Dr. Mohamed Abdel Raouf, who took over the Directorship of the Cairo Regional Center for International Commercial Arbitration (CRCICA) after Dr. Nabil Elaraby left to become the Secretary General of the Arab League, has recently noted that “[t]he year 2010 was an exceptional year as far as CRCICA’s caseload is concerned (66 new cases). In spite of the recent events in the region, the first half of 2011 has witnessed the filing of 30 new cases. It is expected that the recent disruption caused to the performance of some contracts may well give rise to force majeure and insurance related claims.”³ Indeed, two investment claims (here and here) have already been filed against Egypt after the fall of former President Hosni Mubarak. Similar claims are likely to be filed against Libya in the near future.

It appears, therefore, that what Dean McConnaughay said a couple of decades back about Asia could be said about Africa today. Arbitral institutions such as CRCICA are already seeing a dramatic increase in the need for their services. It is time that stakeholders in international arbitration pay closer attention to these developments in Africa.