There’s No Crying In Property Valuation Baseball Arbitration
October 25, 2024 – Law360 Expert AnalysisPublished in Law360 Expert Analysis.
The World Series is not the only reason to be talking baseball. Forbes recently reported that "New York City is nearing a 'changing of the guard' and a tsunami of transactions and activity," generated by "mortgage maturities forcing sales, real estate prices falling and fresh capital entering the market."[1] So, now is the perfect time to be discussing baseball arbitration.
What Is Baseball Arbitration?
Baseball arbitration — a moniker earned by this arbitration form's roots in settling salary disputes between MLB players and teams — is often an ideal means to resolving property valuation disputes and usually worth including in your transaction documents.
In baseball arbitrations, each side offers competing valuations to an arbitrator, who must select one as final and binding. The key to baseball arbitration is its prohibition against the arbitrator selecting any value aside from one of the party submissions. The arbitrator may not make any value adjustments or impose an independent valuation.
The arbitrator must select whichever value submission the arbitrator deems the most reasonable. This incentivizes each side to be reasonable and discourages valuations out of left field (i.e., high-ball or low-ball offers), because such extreme valuations increase the likelihood that the other side's value will be adopted.
Parties are thus encouraged to make offers an arbitrator would perceive as reasonable based on the market. This moderating influence encourages compromise, often leading to prearbitration settlements.[2]
Below are some suggestions on how best to increase your odds of achieving an amicable resolution via baseball arbitration by (1) identifying key valuation criteria at the outset, and (2) building baseball arbitration provisions into your governing contracts.
Avoid Foul Territory: Identify Key Criteria at the Outset
Valuation is not an exact science. It relies on expert appraisers' experience, knowledge and professional judgment. Variances between two expert appraisers' valuations should be expected, but all things being equal, that gap should rarely exceed about 10%. A wider gap is often attributable to (1) an appraiser's use of an unrecognized or inconsistent valuation methodology, or (2) a failure by the parties to agree ahead of time about what precisely is being valued and as of what date.
While it's difficult to account for appraiser error, steps can be taken to minimize the risk of a disconnect as to what is being valued. Therefore, before the appraisal work begins, the parties should seek to agree on the valuation parameters. In appraisal literature, this is called the "definition of the problem."
What precisely is being valued? Is it the real property itself or an interest in the ownership entity? What is the valuation date? If it's a partial interest valuation, are discounts applicable? Discount applicability is often hotly contested and may require arbitrator resolution. If so, should the use of discounts be decided separately by the arbitrator or as part of the valuation itself?
Here are some helpful criteria for the parties to consider agreeing upon in advance of their valuation submissions:
1. The Type and Definition of the Property's Value
In litigation settings, real estate appraisers are often engaged to provide an as-is market value, meaning valuing the property in its current condition, subject to existing zoning laws, and accounting for its current or potential use in its current state.
Including the as-is requirement does not preclude an appraiser from considering the property's highest and best use — in fact, an appraiser is required to determine its highest and best use. But requiring an as-is valuation precludes utilizing a hypothetical condition without adjusting to account for its current state, which would likely result in divergent values.
2. The Effective Date of Valuation Opinion
The valuation date is critical. It affects the data used, thereby affecting values. An appraiser can opine to a retrospective value (date in the past), current value and prospective value (date in the future).
In litigation settings, the effective date of value is often triggered by an action of one of the parties or a particular contract provision. Dates commonly used include: an auction date, the date of lease termination, a loan expiration date or contract breach date.
3. The Property's Relevant Characteristics
Agreeing in advance upon the property's relevant characteristics can also help minimize the risk of foul balls. Is this vacant land or an abandoned commercial property? Is the land in a flood zone or restricted by easements? What topography factors should be considered? For example, is the land subject to stormwater runoff?
4. The Assignment Conditions
These fall under two categories: extraordinary assumptions and hypothetical conditions.
Extraordinary assumptions are uncertain assumptions about the property's characteristics or conditions that the appraiser assumes to be true through observation. For example, water stains on a ceiling may or may not indicate a faulty roof, and an unused oil tank on the property may or may not be leaking. And how the appraisers treat these uncertain conditions will likely affect their value conclusions.
Hypothetical conditions overlook as-is conditions and, rather, derive a hypothetical value based on as-if conditions that do not align with what exists. They are contrary to fact. Examples of hypothetical conditions are when an appraiser bases the value of an empty property as if it were fully leased or on an obviously distressed property that at one time may have been in excellent condition.
Agreeing in advance as to whether, and how, any extraordinary assumptions or hypothetical conditions apply helps minimize the risk of divergent valuations.
Building Baseball Arbitration Into Agreements
Generally, baseball arbitration rules will only apply by consent of the parties, so it's important that they are built into the governing contracts long before any dispute arises.
Once a disagreement exists, some parties may be inclined to swing for the fences with their value submissions, hoping to achieve a windfall or pressure the other side into a less favorable resolution, so they may be unwilling to agree to baseball arbitration.
Parties, of course, can agree to baseball arbitration, even without being contractually obligated to do so, and many do. But if the contract already contains a baseball arbitration provision, parties are incentivized from the outset to take more reasonable positions.
At minimum, agreements should contain language stating that any dispute concerning property valuation must be resolved exclusively through binding baseball arbitration, specifying that the arbitrator or arbitrators must select one of the party's valuation submissions without making any adjustments.
Other factors to consider include: the arbitration forum (e.g., the American Arbitration Association or JAMS); the number of arbitrators; selection criteria or mandatory qualifications for the arbitrators, including experience and appraiser certifications; and how the arbitrators should be selected.
If the parties agree upon three arbitrators, each side could select an arbitrator, with the third arbitrator being agreed upon by (1) the two appointed arbitrators, or (2) the arbitration forum's rules if the two arbitrators were unable to agree upon the third arbitrator. The AAA and JAMS each have default rules respecting arbitrator appointments, which generally work well and may be modified by agreement. Ultimately, the parties' contract trumps arbitration forum rules.
Often, baseball arbitration provisions obligate the parties to exchange valuations before appointing an arbitrator and require the parties to settle their dispute by splitting the difference if the valuations are within a certain percentage or dollar amount of each other.
It's generally also a good idea to consider including a "loser pays" provision, requiring the arbitrator to award the prevailing party its fees and costs, including attorney and expert fees and costs. This is yet another mechanism to encourage the parties to act reasonably and resolve their differences amicably.
Sean E. O'Donnell is a partner and co-chair of the Restructuring & Finance Litigation Department at Herrick, Feinstein LLP.
Mark Dunec is a senior managing director at FTI Consulting, Inc.
Associate Rodger T. Quigley contributed to this article.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Shimon Shkury, New York City Transaction Volume Poised to Rise: Here's The Opportunity, Forbes (Sept. 13, 2024), https://www.forbes.com/sites/shimonshkury/2024/09/13/new-york-city-transaction-volume-poised-to-rise-heres-the-opportunity.
[2] Jason Micah Ross, "Baseball Litigation": A New Calculus for Awarding Damages in Tort Trials, 78 Tex. L. Rev. 439, 448 (1999) (citation omitted) (quoting Carl Stevens, the economist who devised baseball arbitration). Studies support that baseball arbitration is highly effective in promoting settlement generally. E.g., id.
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