Misinterpretation and Misapplication of Kumho Tire to Business Valuation Chartwell Litigation Trust v. Addus Healthcare, Inc. (In re Med Diversified) Authored By: ROBERT JAMES CIMASI, MHA, ASA, CBA, AVA, CM&AA President HEALTH CAPITAL CONSULTANTS 1143 Olivette Executive Parkway St. Louis, MO 63132-3205 3205 (800) FYI-VALU www.healthcapital.com This presentation addresses information and developments in the admittedly broad and rapidly changing regulatory environment as it relates to healthcare assets. Neither the presenters nor the sponsor intend this presentation to render any legal or accounting advice, but rather to provide general information and sources. Neither the presenter, nor the sponsor, assume any liability with respect to the use of information contained in this presentation. For legal or accounting advice, individuals and their firms are urged to consult their attorney or CPA. 1
HISTORY AND DEVELOPMENT OF KUMHO TIRE STANDARD FOR EXPERT WITNESS TESTIMONY Daubert v. Merrell Dow Pharmaceuticals, Inc. (1993) Daubert superseded the Frye standard in federal courts and listed four factors to be applied in determining the reliability of scientific expert testimony: some specific factors that may possibly bear on the reliability determination-- whether the theory or technique: (1) can be and has been tested, (2) has been subjected to peer review or publication, (3) has (a) a high known or potential rate of error, and (b) standards controlling the technique's operation, and (4) enjoys general acceptance within a relevant scientific community. 2
HISTORY AND DEVELOPMENT OF KUMHO TIRE STANDARD FOR EXPERT WITNESS TESTIMONY Kumho Tire v. Carmichael (1999) Kumho Tire, the admissibility standard used by courts for non-scientific expert testimony, is increasingly being applied in the courts when business valuators serve as expert witnesses. The unusual nature (and perhaps, importance) of the Med Diversified case is based, in part, on: (1) the trial judge s unusual application of judicial notice in a case where both experts were disqualified; and, (2) the trial judge s advancement of his undertaking in this case as adopting the role of the aspiring progenitor of Kumho Tire s precepts in the bankruptcy courts, as illustrated by the judge s Order: Since this particular issue has not been discussed by any other bankruptcy court, this Court has taken the pains to present a comprehensive analysis of the gatekeeper function in the hope that it may be useful to other bankruptcy judges, the business bankruptcy bar, and, tangentially, the bankruptcy law professoriate. 3
CHRONOLOGY OF THE MED DIVERSIFIED CASE: KEY EVENTS November 14, 2005: Disqualifies Defendant s Expert except as limited to rebutting Plaintiff s Expert on issues of methodology. November 23, 2005: During Defendant s Expert s final day of rebuttal testimony, the Med Diversified trial judge rules that he will not exclude Plaintiff s Expert s testimony and report. June 30, 2006: Med Diversified trial judge issues a preliminary order urging settlement between the parties and threatening to strike Plaintiff s Expert s report and testimony if settlement is not reached. Summer 2006: Med Diversified trial judge has article entitled, The Empowerment of Bankruptcy Courts in Addressing Financial Expert Testimony, published in the America Bankruptcy Law Journal. July 15, 2006: Both Plaintiff and Defendant notify the court that they have reached a preliminary settlement agreement. August 2, 2006: Med Diversified trial judge issues to Plaintiff s counsel and Defendant s counsel a Memorandum of Decision and Order, excluding Plaintiff s Expert s previously admitted report and testimony. August 4, 2006: Both Plaintiff and Defendant request as part of their settlement agreement that the trial judge not release his opinion, i.e. Memorandum of Decision and Order, which was denied and published. July 31, 2007: Med Diversified trial judge retires from the US Bankruptcy Court in the Eastern District of New York and begins position as full-time faculty professor at Atlanta John Marshall School of Law, a provisionally approved school by the American Bar Association (ABA), 2008: Med Diversified trial judge publishes, Squaring Bankruptcy Valuation Practice with Daubert Demands, together with Susan H. Seabury, & Jack F. Williams, American Bankruptcy Institute Law Review, Vol. 16: 161. 4
CHRONOLOGY OF THE MED DIVERSIFIED CASE: APPRAISER QUALIFICATIONS On November 23, 2005, three months after Plaintiff s Expert had completed his testimony, and during Defendant Expert s rebuttal testimony, the trial judge denied the Defendant s motion, finding Plaintiff s Expert to be qualified to provide expert witness testimony while stating: I don t see a failure on the grounds of relevancy, reliability and personal qualifications to grant the motion in limine to strike or to preclude [Plaintiff s Expert] from testimony or having once testified in connection with his voir dire and going further, that I should now strike his entire testimony. I think he does have the qualifications as an expert in this industry. I think he testified to that very extensively. I think he does have all kinds of peer-granted recognitions, although I do think it s a rather small, select self-validating society, but he did seem to apply it as evidence of his expertise I think the rest of [his testimony] goes to his weight So I m going to deny the motion [ emphasis added] 11/14/05, Memorandum of Decision and Order Granting in Part and Denying in Part Plaintiff s Motion in Limine to Exclude the Report and Testimony of Defendant s Expert Witness, p.3. 5
MED DIVERSIFIED: IMPROPER JUDICIAL NOTICE Med Diversified directly contradicts the mandate of FRE 201. FRE 201 limits Judicial Notice to facts that are either: (a) generally known within the territorial jurisdiction of the trial court or (b) capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned. Facts which are never ripe for judicial notice are those facts based on a judge s own personal and subjective belief. - In re Western Co. of North America (1991, ND Tex) [emphasis added]. In the Med Diversified case, the trial judge eventually excluded both experts, thereby serving as his own expert and relying upon his own subjective beliefs and personal experience 6
MED DIVERSIFIED: IMPROPER JUDICIAL NOTICE The underlying objective of having a gatekeeper is to keep testimony couched on unproven methods from the ears of a susceptible jury, out of concern that that a jury may be unduly persuaded by junk science where a witness is classified as an expert. Any concern for such a risk is, of course, obviated in a bench trial where there is no jury which serves as the trier-of-fact - only a judge, as was the circumstance in the Med Diversified case. There is growing concern that the aggressive wielding of gatekeeping authority in bench trials does not serve the practical purpose envisioned by Daubert and Kumho Tire and may be used to disguise the trial judge s inappropriate use of judicial notice under the banner of purported reliability concerns. 7
MED DIVERSIFIED: IMPROPER JUDICIAL NOTICE Examples from Med Diversified I ve been reading more of Shannon Pratt than I really wanted to know. I'm the only judge in this courthouse who orders books for the library on law and economics, finance, and things of that sort And I make them available to the lawyers and the Bar because I don't think my job is curtailed or limited to reading the statute in light of legislative history. I need other working expertise. By this admitted conduct, the Med Diversified trial judge took judicial notice of facts that were not present in the record, thereby bringing his own subjective research into the court. 8
MED DIVERSIFIED: AN ATTACK ON BV? The trial judge s statements related to the BV profession:...i have a discreet understanding of my limitations, but I also have an understanding of what my experience tells me in having listened for the past thirty years to appraisers, and while they may not bear all the credentials and all the publications [Plaintiff s Expert], I have yet to find an appraiser of value of non-real estate that ever says anything that s cogent and persuasive. Go ahead. I m always willing to be persuaded. [emphasis added] I d love to finally found [sic] an appraiser who convinces me that through a rigorous application of a methodology, that person can effectively value a company. Several have tried. [emphasis added]. None have succeeded, no one as sophisticated as you, but in the universe of companies rather than real estate projects or cash flows, the science isn t there yet, at least as you re presenting it to me because I m testing it at every single conceivable angle simply because I have a tremendous degree of skepticism... I don't really care about your certifications, although I do appreciate that this is somehow made up by persons who have some professional standing in connection with some effort by the government to improve the quality and integrity of appraisals. I would much rather hear about your experience as an author and the number of cases in which you've testified in a similar capacity. I want to see what kind of forensic experience you've had. So you don't need to go through all of these. I'm sure they're all noble, but I really want to know what cases you appeared in what books you've written or major articles. 9
MED DIVERSIFIED: AN ATTACK ON BV? The trial judge appears to doubt the reliability of the data regularly relied upon by BV. the only primary sources you look to are the fellow publications of your fellow members of the Appraisal Institute I don t know what empirical data you re using to tell me it s widely accepted in the profession. I don t know how many what s the concept of widely accepted, other than citations in each and other s footnotes, and I don t know what the size of the profession, and I don t know what independent scrutiny has been given to these by persons who aren t members of the profession... and I m just telling you that s what I understand the gatekeeper function to be because all I get are people who are self-certifying and selfvalidating, and it s the same pack that travels around the country and testifies in the cases or serves as consultants. You re assuming that I should rely upon this body of data published by Integra and published by Risk Management Associates, that you didn't look behind that data. You simply accepted their statistical analysis of this data, and started that -- started with that as givens? That's just accepted -- that's just internal to your profession. You seem to misunderstand me. I'm trying to get out of your closed universe. I'm trying to get out of the situation in which everything is self-fulfilling. Okay. Just -- I'm just telling you I'm stumbling on the lack of databases on privately-held companies. I just find when I've had valuation experts come in here, that's where they fall down because there's no ability for them to replicate the data. There's no way for me to test it. 10
CONCLUDING REMARKS Kumho Tire is increasingly being applied (although not uniformly) in the bankruptcy courts, as well as other courts in which business valuators serve as expert witnesses. Experts should discuss Daubert and Kumho Tire requirements, venue precedent, and coping strategies with counsel prior to acceptance of and throughout the engagement. The business valuation profession needs to be consistently aware of these developments and organize structures that will allow the profession to effectively address occurrences of inappropriate judicial intrusion on expert business valuation testimony. 11