Summary

This article deals with the formulation of a central tool as a necessary condition in evaluating the validity and applicability of the "professional solution" provided via an expert opinion by an expert, and no less important by decision makers and those affected by them in court cases.

Applicable and valid solutions to business issues and disputes are a necessary condition for continuity, stability and growth, and therefore their validity and appraisal are derived from their ability to provide and preserve business continuity under market conditions for a reasonable period. Such a grand goal should not be "science fiction", but rather an evaluation tool focusing on the sustainability of the solution as a result of the price of its implementation or violation.

There is a natural and understandable tendency among professionals to act based on professional, well known and valid models that serve as "incubators" and give a sense of security and professional validity to the opinions of experts. It is often the case that this sweeping reliance on the familiar is appropriate, and releases the professional from the need to "reinventing the wheel" again and again, and this is good. On the other hand, the dynamic business reality of our lives, that is not always balanced, and reflected in the decision making conditions that are not optimal, is expressed in a limited level of database validity and integrity, and a legal-business structure that is ambiguous. Therefore, in quite a few cases based completely and automatically on familiar models, the models serve as "professional crutches" that often do not pass the test of reality, and therefore constitute a two-edged sword for those adopting them.

The reader of this article may conclude that professional tools and the logic on which they are founded should be abandoned - this is not the case! Yet I must stress that it is necessary to examine the suitability of the professional tools in many cases, based on a critical approach founded on the logical thinking and life experience of those connected to the issue, be they decision makers, the parties affected by these decisions or professionals that have formulated the proposed solution.

Such a critical approach may produce an applied solution, whose validity and applicability is not tried in local courts or boards, without undervaluing the importance of these forums, but stands the test of reality over time.

Business and legal decision makers are managers by nature and training, and as such tend to base their decisions on professionals they rely on, sometimes automatically accepting the attitude of the professional, especially when dealing with fields of expertise that are perceived as complex and technical such as: accounting and financing, and engineering and medical fields. This tendency to rely on a professional "thinking straight" is reinforced when the solution's "bottom line" suits the decision maker's approach. This type of conduct usually stems from the part of the expert's report that is technical, professional and distinctive, whether it is necessary or because it is easier for the professional to remain within the confines of his field expertise.

This type of conduct produces, on the one hand a sense of discomfort and lack of confidence in the decision maker, who is acting so to speak "outside his personal zone of comfort", and is therefore totally dependent on the professional. This dependence prevents the decision maker, in these types of cases, from combining independent and critical thinking with reliance on the expert opinion in reaching educated decisions. On the other hand, this sense of discomfort does not enable in-depth examination of the solution that was formulated, and sometimes creates a sense of alienation from the solution in the decision maker – even if he feels that all in all the solution is acceptable, and especially so if the solution is not an easy one, and the decision maker does not understand the process of development of the solution and its component.

In order to correct this state of affairs, it is possible to adopt an essential validation test for solutions in the economic and financial field. This rule is derived from the very nature of the field, that requires the solution to meet market conditions, i.e. to be accepted as an applied and valid solution by a "reasonable man / woman".

Therefore, it is possible to formulate a necessary but not sufficient condition for the solutions validity:

The solution formed based on the opinion, including the solution components and its development (not as a bottom line), must pass the common-sense test of a "reasonable man / woman", as opposed to an expert, that will from this point on be referred to as the "reasonable man / woman test".

The professional expert operating based on this approach acts with personal and professional integrity so as to advance the solution.

The decision maker who will adopt this critical approach by implementing the "common sense" test of the "reasonable man/woman" may attain a better understanding of the proposed solution, and thus can better rely on the professional expert. If the solution does not pass the decision maker's common sense test – he must not ignore this. Examination of the solution's components and its formulation process may provide surprising answers, which may explain the decision maker's gut feelings.

In summary, passing the common sense test can be defined as a necessary but not sufficient condition for validation of the applied solution proposed in the expert opinion. Failure to pass this test means that the solution is not valid and applicable, yet passing it does not necessarily guarantee a high quality solution, supported by additional elements that the professional must consider. In other words, the decision maker cannot and should not replace the professional expert in formulating the expert opinion, but certainly should ensure that the proposed solution meets a necessary and basic condition: the common sense tests of a reasonable man/woman.

To illustrate how the reasonable man/woman test is applied, following is an example:

A couple who separated in 2004 filed for divorce in the Family Court on the 30th of June 2004. The case reached the "resource leveling" stage on June 30th 2009. Since the husband was the owner of a cleaning services company, the court appointed an expert behalf to assess the value of the company for the purpose of division of the joint property. At the hearing held to appoint the expert, held on June 30th 2009, the court stated that the expert must:

  1. Prepare an assessment of the company's value upon opening of the divorce action on the 30th of June 2004.
  1. Examine whether from the file opening date and until June 30th 2009 the husband, or anyone on his behalf, acted so as to smuggle assets out of the company, "dry it up" or cause damage to its profits and activities.
  1. Prepare an evaluation of the company's value as of the hearing date - June 30th 2009.

In his report, the appointed expert referred to all of the above and stated:

  1. The value of the company according to the DCF model (discounted cash Flow) model as of June 30th 2004, totaled 4,000,000 NIS.
  2. A comprehensive examination revealed that no actions were taken with the goal of smuggling assets, drying up the company or damaging its profitability and / or activities.
  3. The value of the company according to the DCF model (discounted cash Flow) model as of June 30th 2009, totaled 400,000 NIS. The drastic decline in the value of the company stems from structural changes in the market, regulations and entry of competition, which in a loss of large institutional clients.

The expert presented the court with the two valuations and recommended that the court adopt the updated valuation as of June 30th 2009. With this recommendation, the appointed expert passed on to the court a complex professional dilemma:

On the one hand, according to the phrasing of the law that was valid during the said period, "resource leveling" refers to the date of opening of the file. On the other hand, by submitting this question to the Reasonable Man/ woman test, it is clear that it is not possible to divide a value that does not actually exist. In this case, the court chose to adhere to the word of the law and ruled that for the purpose of "resource leveling", the value of the company will be set based on its value on June 30th 2004, i.e. 4,000,000.

Following the court's decision – the husband, adopting the court's ruling, offered his wife his part of the company for a sum of 2,000,000 NIS (50%). The legal grappling between them continued to escalate, resulting after a few months in the total collapse of the company, insolvency and receivership. The company, that had been operating for 20 years, owed money to its creditors, many of its employees were fired, and clearly – both husband and wife suffered a significant loss of their investment. Why did this happen?

Reasonable Man / Woman Test

As we saw, the expert's opinion seemingly produced a contradiction between the Reasonable Man/Woman solution, according to which it was clear that there was no way to divide a value that does not exist, and therefore the value selected should have been the updated value as of June 30th 2009, as opposed to the higher value as of June 30th 2004, the day the file was opened (according to which resource leveling is usually supposed to be conducted). This contradiction was not supposed to happen. So what did happen?

The expert estimated the value of the company as of two dates based on a valuation of a future cash flow, with this valuation being conducted on June 30th 2009. If the valuation would have been conducted around June 30th 2004, it would have been possible to estimate a cash flow supporting a valuation of 4,000,000 NIS, but it should be noted that the valuations for June 30th 2004 was conducted on June 30th 2009, with the cash flow from 2004 to 2009 being known, as well as the estimates with regard to the future based on the processes the company and market underwent. Therefore, ignoring the known cash flow data and basing the calculation on a projection, that is known in advance to be irrelevant – leads to a result that does not meet the Reasonable Man/Woman test, a result that was arrived at by technically implementing a model without examining its essence, while ignoring real, valid and known data.

The husband's attorney attempted to convince the court that the updated valuation should be used – but failed. On the other hand, had the attorney chosen to take a different approach and had shown the court, by cleverly questioning the expert and showing that his expert opinion was based on an internal contradiction, as described above, it is highly likely that the high price that the people involved in this case paid, as well as the market, would have been avoided. Naturally, in order to present this contradiction to the court, the attorney must understand the principles of the valuation model.

Finally, I would like to remind us of the foremost goal of the economic solution: continuity of market activities and growth.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.