The law firm that I had been with since this before weblog unveiled will be dissolving at the end of the month. Thereafter, I will be at Fisher & Winner, LLP just a block up the street.
Sunday, July 27, 2003
Monday, July 21, 2003
Spy v. Spy
In Robinson v. U.S., the United States Court of Appeals for the Federal Circuit allowed the employer a substantial deduction for the "bargain element" inherent in stock distributed to an employee, even though the employee had filed a Section 83(b) election that valued the bargain element at zero. The opinion has been praised by Janell Grenier at Benefitsblog (see here). Regardless of the merits of the decision as a matter of tax law, the facts are vaguely reminiscent of an installment of Spy v. Spy.
The Robinsons owned all of the stock of a related group of corporations known as Morgan Creek. In 1995, they granted the COO, Gary Barber, 10% of the stock in the enterprise. Barber paid $2 million for the stock and filed a Section 83(b) election stating that the bargain element in the transaction, that is the fair market value of the stock in excess of what he had paid for it, was zero. As required by the regulations under Section 83, he sent a copy of the election to the corporation, namely himself acting as the COO.
In 1998, the Robinsons and Barber had a falling out. To resolve the dispute, in June of 1998, Morgan Creek redeemed Barber's stock for $13.2 million. Morgan Creek (presumably after the closing on the purchase of Barber's stock) issued him a revised W-2 for 1995 reflecting additional compensation of $26,759,800 (i.e., a stock valuation of $28,759,800, less the $2 million paid for the stock by Barber) as a result of the bargain element inherent in the 10% of the company's stock he received in that year. And, of course, Morgan Creek claimed an ordinary deduction for compensation paid to Barber in 1995 of the $26,759,800 bargain element.
The Service argued that Morgan Creek was barred from taking the deduction since the corporation's deduction was limited to the amount included in Barber's income. Since Barber had included nothing in his income, the Service's position was that Morgan Creek was not entitled to any deduction. The Court of Appeals, reversing the Claims Court, disagreed, holding that the term "included" means not the amount actually shown on the employee's return, but also the amount that, as a matter of law, should have been included on the return.
I will leave the analysis of the legal questions involved in the decision to commentators like Grenier. Instead, I will focus on the human factors behind the case.
I don't know whether in 1995 the parties addressed the Section 83 issues inherent in the stock grant to Barber. I'm willing to bet that they did not and that Barber, finding a vacuum, seized upon it to structure the transaction to confer some tax benefits on himself. Later, however, in the course of what must have been acrimonious negotiations over Barber's departure from the company, the company (read: the Robinsons) realized that it could settle its dispute with Barber and, as soon as the ink was dry on the contract, amend the 1995 returns to obtain tax benefits that would substantially fund the settlement. Thus, Morgan Creek paid Barber $13.2 million, but its amendment of the 1995 income tax returns resulted in federal income tax benefits of over $8.85 million, plus interest from 1995. Of course, Morgan Creek will likely enjoy additional state income tax benefits as well. Assuming the state tax benefits to be about $2 million, the company virtually broke even on the deal, since Barber had paid $2 million for the stock. (The arithmetic: $8.85 million, plus $2 million, plus $2 million, plus interest, comes pretty damn close to $13.2 million.) Barber, on the other hand, could end up with additional tax on $26,759,800, plus substantial penalties and interest from 1995, and a long term capital loss in 1998, that he may or may not be able to use, of about $15 million. Not a pretty picture.
The case illustrates the virtue of having both sides (i) recognize that there are Section 83(b) issues inherent in any grant of an equity interest to an employee, and (ii) agree to a consistent (and reasonable) position with respect to the manner in which the "bargain element" is to be reported.
The Robinsons owned all of the stock of a related group of corporations known as Morgan Creek. In 1995, they granted the COO, Gary Barber, 10% of the stock in the enterprise. Barber paid $2 million for the stock and filed a Section 83(b) election stating that the bargain element in the transaction, that is the fair market value of the stock in excess of what he had paid for it, was zero. As required by the regulations under Section 83, he sent a copy of the election to the corporation, namely himself acting as the COO.
In 1998, the Robinsons and Barber had a falling out. To resolve the dispute, in June of 1998, Morgan Creek redeemed Barber's stock for $13.2 million. Morgan Creek (presumably after the closing on the purchase of Barber's stock) issued him a revised W-2 for 1995 reflecting additional compensation of $26,759,800 (i.e., a stock valuation of $28,759,800, less the $2 million paid for the stock by Barber) as a result of the bargain element inherent in the 10% of the company's stock he received in that year. And, of course, Morgan Creek claimed an ordinary deduction for compensation paid to Barber in 1995 of the $26,759,800 bargain element.
The Service argued that Morgan Creek was barred from taking the deduction since the corporation's deduction was limited to the amount included in Barber's income. Since Barber had included nothing in his income, the Service's position was that Morgan Creek was not entitled to any deduction. The Court of Appeals, reversing the Claims Court, disagreed, holding that the term "included" means not the amount actually shown on the employee's return, but also the amount that, as a matter of law, should have been included on the return.
I will leave the analysis of the legal questions involved in the decision to commentators like Grenier. Instead, I will focus on the human factors behind the case.
I don't know whether in 1995 the parties addressed the Section 83 issues inherent in the stock grant to Barber. I'm willing to bet that they did not and that Barber, finding a vacuum, seized upon it to structure the transaction to confer some tax benefits on himself. Later, however, in the course of what must have been acrimonious negotiations over Barber's departure from the company, the company (read: the Robinsons) realized that it could settle its dispute with Barber and, as soon as the ink was dry on the contract, amend the 1995 returns to obtain tax benefits that would substantially fund the settlement. Thus, Morgan Creek paid Barber $13.2 million, but its amendment of the 1995 income tax returns resulted in federal income tax benefits of over $8.85 million, plus interest from 1995. Of course, Morgan Creek will likely enjoy additional state income tax benefits as well. Assuming the state tax benefits to be about $2 million, the company virtually broke even on the deal, since Barber had paid $2 million for the stock. (The arithmetic: $8.85 million, plus $2 million, plus $2 million, plus interest, comes pretty damn close to $13.2 million.) Barber, on the other hand, could end up with additional tax on $26,759,800, plus substantial penalties and interest from 1995, and a long term capital loss in 1998, that he may or may not be able to use, of about $15 million. Not a pretty picture.
The case illustrates the virtue of having both sides (i) recognize that there are Section 83(b) issues inherent in any grant of an equity interest to an employee, and (ii) agree to a consistent (and reasonable) position with respect to the manner in which the "bargain element" is to be reported.
Accepting an Invitiation
The SW Virginia Law Blog on the 20th noted two articles in the Virginian-Pilot (here and here) that reported that "[i]nsurance companies licensed to do business in Virginia can only underwrite group policies to cover family members defined as spouses or dependent children," thus excluding gay or lesbian partners and children of such a partner that the non-biological partner nevertheless considers as his or her progeny.
SW Virginia Law Blog then suggests that the problem was not one of state law, but rather of federal law, more particularly federal tax law, and it put out a request to other blogs that focus on business and tax issues, including yours truly, to offer their view of the locus of the issue. Well, here goes.
There is obviously a federal tax slant to this issue. As the SWVa Law Blog correctly noted, medical insurance benefits paid by an employer that provides insurance to a non-family member of the employee (meaning non-married "significant others" and children of such individuals) is taxable to the employee, unless the significant other or his/her child is (are) dependents of the employee. However, the authority cited by SWVa Law Blog, CCA 200117038 makes it clear that a plan may provide benefits to such individuals, even though the benefits are taxable.
I am not admitted to practice in Virginia, but I suspect that the concept that is at the core of the problem the news articles focus on is that of "an insurable interest." This is a well-known concept in insurance law. In essence, one can only be the owner of a policy of insurance that insures against some hazard occuring to some other individual if the owner has an "insurable interest" in the person insured. Thus, I cannot obtain a policy of insurance on the authors of the SWVa Law Blog because, even though I like reading their publication, I do not have an insurable interest in their lives. Going one step further, insurance companies have been found to be liable for damages for the tort of "insuring" when they enter into contracts of insurance with an individual with no insurable interest in the named insured party. (The damages are usually derived from the premature death of the named insured due to the active intervention of the policy owner. In simple English, someone buys a life insurance policy on someone else's life and then knocks them off to obtain the proceeds. I am willing to bet, however, that for every lawsuit for the tort of insuring, there have been fifty murder mysteries based on the practice.)
The question originally posed by the SWVa Law Blog was whether this was an instance of state law creating a due process or equal protection issue. To the extent that my hypothesis as to the derivation of the rule discussed in the newspaper articles is correct, I believe that the application of the state law does create a Constitutional issue. There would seem to be no question but that an individual has a strong interest in seeing to it that the medical needs of the others in his/her household are met. A state law that attempt to stretch the concept of "insurable interest" to bar the issuance of such coverage is nothing more than an attempt to limit the free association of individuals based upon their marital status or sexual orientation by making it difficult or more expensive for them to obtain medical insurance for everyone in their household.
SW Virginia Law Blog then suggests that the problem was not one of state law, but rather of federal law, more particularly federal tax law, and it put out a request to other blogs that focus on business and tax issues, including yours truly, to offer their view of the locus of the issue. Well, here goes.
There is obviously a federal tax slant to this issue. As the SWVa Law Blog correctly noted, medical insurance benefits paid by an employer that provides insurance to a non-family member of the employee (meaning non-married "significant others" and children of such individuals) is taxable to the employee, unless the significant other or his/her child is (are) dependents of the employee. However, the authority cited by SWVa Law Blog, CCA 200117038 makes it clear that a plan may provide benefits to such individuals, even though the benefits are taxable.
I am not admitted to practice in Virginia, but I suspect that the concept that is at the core of the problem the news articles focus on is that of "an insurable interest." This is a well-known concept in insurance law. In essence, one can only be the owner of a policy of insurance that insures against some hazard occuring to some other individual if the owner has an "insurable interest" in the person insured. Thus, I cannot obtain a policy of insurance on the authors of the SWVa Law Blog because, even though I like reading their publication, I do not have an insurable interest in their lives. Going one step further, insurance companies have been found to be liable for damages for the tort of "insuring" when they enter into contracts of insurance with an individual with no insurable interest in the named insured party. (The damages are usually derived from the premature death of the named insured due to the active intervention of the policy owner. In simple English, someone buys a life insurance policy on someone else's life and then knocks them off to obtain the proceeds. I am willing to bet, however, that for every lawsuit for the tort of insuring, there have been fifty murder mysteries based on the practice.)
The question originally posed by the SWVa Law Blog was whether this was an instance of state law creating a due process or equal protection issue. To the extent that my hypothesis as to the derivation of the rule discussed in the newspaper articles is correct, I believe that the application of the state law does create a Constitutional issue. There would seem to be no question but that an individual has a strong interest in seeing to it that the medical needs of the others in his/her household are met. A state law that attempt to stretch the concept of "insurable interest" to bar the issuance of such coverage is nothing more than an attempt to limit the free association of individuals based upon their marital status or sexual orientation by making it difficult or more expensive for them to obtain medical insurance for everyone in their household.
Friday, July 18, 2003
Manic's Better Than Depressed
I previously commented on the case of Keeley v. Commissioner, a Tax Court summary decision that denied relief from the 10% penalty imposed on a premature withdrawal from a qualified plan. The relief had been sought because the taxpayer suffered from clinical depression and contended that he was entitled to relief because he was disabled. The Court denied relief because the taxpayer's condition did not require that he be institutionalized or have constant supervision.
I criticized the opinion, noting that it relied on a regulation that was more restrictive than the Code required and that was inconsistent with current treatment modalities.
Tuesday, in the case of Mary L. Coleman-Stephens v. Commissioner, the Tax Court reached an entirely different conclusion based on essentially identical facts. Because Keely was a summary disposition and could not be relied upon as precedent, the Court in Coleman-Stephens did not seek to harmonize its conclusion with that of the prior opinion.
Since Coleman-Stephens, like Keely, is a summary disposition, taxpayers cannot rely upon it for authority. Given the relative small amounts involved in these cases (Coleman-Stephens involved only $510 in taxes), they are unlikely to get appealed to the circuit court level. The Tax Court ought to step in and issue a formal opinion, even if it's only a memorandum decision, addressing the issue. Better yet, the Service might issue a ruling stating that it now concludes that the regulation is overly broad and, to the extent that it requires institutionalization or some other type of custodial care before the penalty can be avoided, it will be disregarded.
I criticized the opinion, noting that it relied on a regulation that was more restrictive than the Code required and that was inconsistent with current treatment modalities.
Tuesday, in the case of Mary L. Coleman-Stephens v. Commissioner, the Tax Court reached an entirely different conclusion based on essentially identical facts. Because Keely was a summary disposition and could not be relied upon as precedent, the Court in Coleman-Stephens did not seek to harmonize its conclusion with that of the prior opinion.
Since Coleman-Stephens, like Keely, is a summary disposition, taxpayers cannot rely upon it for authority. Given the relative small amounts involved in these cases (Coleman-Stephens involved only $510 in taxes), they are unlikely to get appealed to the circuit court level. The Tax Court ought to step in and issue a formal opinion, even if it's only a memorandum decision, addressing the issue. Better yet, the Service might issue a ruling stating that it now concludes that the regulation is overly broad and, to the extent that it requires institutionalization or some other type of custodial care before the penalty can be avoided, it will be disregarded.
Monday, July 14, 2003
One Tough Veil
With the possible exception of claims for intentional infliction of emotional distress, I doubt that there is no action that is bruited around more often and results in fewer successful prosecutions than attempts to pierce the corporate veil. The recent opinion in the case of Iceland Telecom, Ltd. v. Information Systems & Network Corp. illustrates the rather restrictive limits placed on this doctrine, particularly in Maryland.
Iceland Telecom brought the action against Information Systems & Networks Corp. ("ISN"), ISN Global Communications, Inc. ("Global"), and an individual, Arvin Malkani ("Malkani") for breach of contract and unjust enrichment. Neither ISN nor Malkani were parties to the disputed contract. Iceland Telecom sought to hold them liable for the obligations of Global via the application of the piercing the corporate veil doctrine, seeking to apply either the "instrumentality" theory or the "alter ego" theory, or because Global allegedly acted as the agent for ISN and Malkani.
To say the least, Global was operated on a fairly informal basis. It never held stockholder or director meetings. Two of the three individuals who the extant corporate documents indicated were directors (Malkani's mother and sister) apparently did not know that they were directors. ISN picked up most of Global's expenses and Malkani, Global's president, had his salary paid directly by Global. Global shared ISN's office space, with the rent being paid by ISN without any contribution from Global. Indeed, Global used ISN's phone numers, office furniture, and some of its office staff.
Significantly, in the negotiations leading up to the execution of the contract, it often appeared that Iceland Telecom was dealing with ISN. For instance, Malkani, negotiating on behalf of Global frequently referred to that company as ISN. In fact, the court specficially stated that Iceland Telecom "thought it was dealing with ISN." However, the written contract executed by Iceland Telecom identified Global as the other contracting party.
Nevertheless, the court concluded that neither the piercing the veil doctrine nor the agency doctrine applied to this case. The court emphasized that the Maryland courts had set the bar high with respect to the ability to pierce the corporate veil (quoting Dixon v. Process Corp., 38 Md.App. 644, 645 (1978) to the effect that it is a "herculean task" for a creditor to attempt to "rip away the corporate facade.") The court rejected the approach outlined in the well-known 4th Circuit case of DeWitt Truck Brokers v. W. Ray Fleming Fruit Co., 540 F.2d 681 (1976) where the court, applying South Carolina law, allowed the corporate veil to be pierced because of such factors as the lack of corporate formalities, gross undercapitalization, and the non-functioning of officers or directors other than the sole shareholder. Instead, the court concluded that, under Maryland law, nothing short of actual fraud would suffice to sustain a veil piercing effort.
Iceland Telecom's attempts to rely on an agency or an agency by estoppel theory to impose liability were similarly unavailing. Iceland Telecom had, after all, entered into a written contract that had clearly identified the other party as being Global. There was no evidence that it believed that Global was acting as ISN's agent nor that it entered into the contract upon reliance upon a belief that Global was acting as ISN's agent. Thus, neither of these two "agency" theories could apply.
Even though I've used it as authority, I've always thought that DeWitt Truck Brokers was problematic. After all, most, if not all, closely-held corporations have significant gaps in their adherence to corporate formalities. The rationale behind veil piercing should be anchored in the rational expectancies of the various actors. A plaintiff should not be able to look beyond the limited liability shield of a limited liability entity if it entered into a contract with full knowledge that there were limited liability walls in place. Only if the plaintiff suffers loss that is unexpected (e.g., being told that the entity was solvent, when, in fact, the owners were draining it of assets) should it be able to avoid the limitations in collectability that it tacitly acknowledged when it entered into the deal.
Iceland Telecom brought the action against Information Systems & Networks Corp. ("ISN"), ISN Global Communications, Inc. ("Global"), and an individual, Arvin Malkani ("Malkani") for breach of contract and unjust enrichment. Neither ISN nor Malkani were parties to the disputed contract. Iceland Telecom sought to hold them liable for the obligations of Global via the application of the piercing the corporate veil doctrine, seeking to apply either the "instrumentality" theory or the "alter ego" theory, or because Global allegedly acted as the agent for ISN and Malkani.
To say the least, Global was operated on a fairly informal basis. It never held stockholder or director meetings. Two of the three individuals who the extant corporate documents indicated were directors (Malkani's mother and sister) apparently did not know that they were directors. ISN picked up most of Global's expenses and Malkani, Global's president, had his salary paid directly by Global. Global shared ISN's office space, with the rent being paid by ISN without any contribution from Global. Indeed, Global used ISN's phone numers, office furniture, and some of its office staff.
Significantly, in the negotiations leading up to the execution of the contract, it often appeared that Iceland Telecom was dealing with ISN. For instance, Malkani, negotiating on behalf of Global frequently referred to that company as ISN. In fact, the court specficially stated that Iceland Telecom "thought it was dealing with ISN." However, the written contract executed by Iceland Telecom identified Global as the other contracting party.
Nevertheless, the court concluded that neither the piercing the veil doctrine nor the agency doctrine applied to this case. The court emphasized that the Maryland courts had set the bar high with respect to the ability to pierce the corporate veil (quoting Dixon v. Process Corp., 38 Md.App. 644, 645 (1978) to the effect that it is a "herculean task" for a creditor to attempt to "rip away the corporate facade.") The court rejected the approach outlined in the well-known 4th Circuit case of DeWitt Truck Brokers v. W. Ray Fleming Fruit Co., 540 F.2d 681 (1976) where the court, applying South Carolina law, allowed the corporate veil to be pierced because of such factors as the lack of corporate formalities, gross undercapitalization, and the non-functioning of officers or directors other than the sole shareholder. Instead, the court concluded that, under Maryland law, nothing short of actual fraud would suffice to sustain a veil piercing effort.
Iceland Telecom's attempts to rely on an agency or an agency by estoppel theory to impose liability were similarly unavailing. Iceland Telecom had, after all, entered into a written contract that had clearly identified the other party as being Global. There was no evidence that it believed that Global was acting as ISN's agent nor that it entered into the contract upon reliance upon a belief that Global was acting as ISN's agent. Thus, neither of these two "agency" theories could apply.
Even though I've used it as authority, I've always thought that DeWitt Truck Brokers was problematic. After all, most, if not all, closely-held corporations have significant gaps in their adherence to corporate formalities. The rationale behind veil piercing should be anchored in the rational expectancies of the various actors. A plaintiff should not be able to look beyond the limited liability shield of a limited liability entity if it entered into a contract with full knowledge that there were limited liability walls in place. Only if the plaintiff suffers loss that is unexpected (e.g., being told that the entity was solvent, when, in fact, the owners were draining it of assets) should it be able to avoid the limitations in collectability that it tacitly acknowledged when it entered into the deal.
Sunday, July 06, 2003
Seeing Double?
Subscribers may have noticed that they have been getting two copies of each posting. The reason is that for several months I have attempted to use a subscription service called Bloglet. While subscription requests found their way to Bloglet (via the subscription box on the right), for some reason the postings were never circulated. In response, I created a mailing list and copied all of the addresses in Bloglet to that list. Each posting was directed to circulate to the list.
This weekend, Bloglet suddenly began working again. Of course, subscribers began getting each posting twice, once from Bloglet and once from my mailing list. I will cure the problem tomorrow and subscribers will be back to getting only one copy of each posting. One other housekeeping note.
I have finally figured out how to syndicate this weblog via RSS coding. By the end of the week there should be a way to click and get the RSS syndication information.
This weekend, Bloglet suddenly began working again. Of course, subscribers began getting each posting twice, once from Bloglet and once from my mailing list. I will cure the problem tomorrow and subscribers will be back to getting only one copy of each posting. One other housekeeping note.
I have finally figured out how to syndicate this weblog via RSS coding. By the end of the week there should be a way to click and get the RSS syndication information.
Saturday, July 05, 2003
More on Verne
David Giacalone at ethicalEsq has offered some comments on my posting Putting Strains on My Friends about the Verne opinion. Although I agree with most of what he has to say (he does a good job, for instance in detailing most of the salient facts that were not presented in the opinion), I have one area of disagreement.
Specifically, Dave states that "[i]f Verne never held himself out as being an attorney and he reminded his clients that they might want to consider getting legal advice or having additional documents drafted for their business, he may have been giving them just what they wanted and needed -- and chose -- given their situation and their willingness to risk future problems." (Emphasis is Dave's.) I'm not at all certain that this clears Verne under the circumstances.
One of the lessons I learned in law school is that it is less important to know the answer to a question than it is to know the correct questions to ask. Theoretically at least, lawyers are by training supposed to be able to ask the right questions. Accountants, as to the majority of issues that go into operating agreements, for instance, simply do not have this training.
I think that Dave is on the right track when he suggests various elements of cost benefit analysis that should go into the decision as to whether Verne should be penalized for his actions or omissions. However, in many cases, even highly skilled and experienced counsel do not have the knowledge to make the appropriate cost benefit analysis. By way of example, assume that most small businesses, such as Verne's clients, typically rely on a form LLC operating agreement that does little more than restate the default provisions in the state's LLC act. Is the lawyer who prepares such a document (i) underlawyering, (ii) overlawyering, or (iii) getting it just right. As I suggested in my first post, I really don't know the answer to this question.
Specifically, Dave states that "[i]f Verne never held himself out as being an attorney and he reminded his clients that they might want to consider getting legal advice or having additional documents drafted for their business, he may have been giving them just what they wanted and needed -- and chose -- given their situation and their willingness to risk future problems." (Emphasis is Dave's.) I'm not at all certain that this clears Verne under the circumstances.
One of the lessons I learned in law school is that it is less important to know the answer to a question than it is to know the correct questions to ask. Theoretically at least, lawyers are by training supposed to be able to ask the right questions. Accountants, as to the majority of issues that go into operating agreements, for instance, simply do not have this training.
I think that Dave is on the right track when he suggests various elements of cost benefit analysis that should go into the decision as to whether Verne should be penalized for his actions or omissions. However, in many cases, even highly skilled and experienced counsel do not have the knowledge to make the appropriate cost benefit analysis. By way of example, assume that most small businesses, such as Verne's clients, typically rely on a form LLC operating agreement that does little more than restate the default provisions in the state's LLC act. Is the lawyer who prepares such a document (i) underlawyering, (ii) overlawyering, or (iii) getting it just right. As I suggested in my first post, I really don't know the answer to this question.
Friday, July 04, 2003
Government Undercover Uncovered
I don't ordinarily use my postings to announce links to specific websites, but I'll make an exception today.
MIT just opened its Open Government Information Awareness site. The site offers a remarkable amount of information about all three branches of the federal government. The amount of information now at your fingertips is simply daunting. By way of example (and certainly not in limitation), the site gives a list of contributors to the campaigns of members of Congress, a detailed listing of the expenditures of those members, and their financial disclosure filings.
Well designed sites such as this raise any number of questions. For instance, given the proliferation of bloggers of all stripes (both in topic choice and political viewpoint) and the ready accessibility of information, the market for commercial alternatives, newspapers for instance, would seem to be seriously eroding. The implications are huge.
In Baltimore, I grew up with three daily newspapers, The Sun (often known to residents as The Morning Sun), The Evening Sun, and The News American. We're now down to just The Sun. Since you can get The Washington Post, The New York Times, and The Wall Street Journal delivered to your home or office, The Sun becomes a secondary (or, given the web, a tertiary) source of national and international news. It is thus limited to being a primary source only of local news. And, even here, is challenged by The Washinton Post with respect to statewide coverage. Give The Sun the competition of a few good local bloggers and it's out of business. I suspect that the knowledge of its tenuous position by its reporters was one of the reasons they made significant concessions in their most recent contract negotiations with the paper.
MIT just opened its Open Government Information Awareness site. The site offers a remarkable amount of information about all three branches of the federal government. The amount of information now at your fingertips is simply daunting. By way of example (and certainly not in limitation), the site gives a list of contributors to the campaigns of members of Congress, a detailed listing of the expenditures of those members, and their financial disclosure filings.
Well designed sites such as this raise any number of questions. For instance, given the proliferation of bloggers of all stripes (both in topic choice and political viewpoint) and the ready accessibility of information, the market for commercial alternatives, newspapers for instance, would seem to be seriously eroding. The implications are huge.
In Baltimore, I grew up with three daily newspapers, The Sun (often known to residents as The Morning Sun), The Evening Sun, and The News American. We're now down to just The Sun. Since you can get The Washington Post, The New York Times, and The Wall Street Journal delivered to your home or office, The Sun becomes a secondary (or, given the web, a tertiary) source of national and international news. It is thus limited to being a primary source only of local news. And, even here, is challenged by The Washinton Post with respect to statewide coverage. Give The Sun the competition of a few good local bloggers and it's out of business. I suspect that the knowledge of its tenuous position by its reporters was one of the reasons they made significant concessions in their most recent contract negotiations with the paper.
2003 State Tax Update
The Spring issue of Tax Talk, the newsletter of the Section of Taxation of the Maryland State Bar Association has two summaries of tax legislation passed in the recent session of the Maryland General Assembly. One is by Evelyn Pasquier, the other by the Comptroller's Office.
H.B. 438 is worthy of note because it imposes upon various officers and owners of corporations and LLCs personal liability for unpaid vessel excise that the business entity is required to collect and pay over. The language is identical to a similar provision with respect to sales tax that I argued, to no avail, constituted a violation of due process. It’s significant because previously the sales tax provision stood alone in its sweeping imposition of personal liability. (OK, I'm a sore loser.)
Now that this broad imposition of liability has been extended with respect to another tax, there is a possibility that it might be further extended. For instance, the failure to collect and pay over withholding taxes might create personal liability by virtue of an individual's status rather than, as is currently the case, the individual's dereliction of duty.
H.B. 438 is worthy of note because it imposes upon various officers and owners of corporations and LLCs personal liability for unpaid vessel excise that the business entity is required to collect and pay over. The language is identical to a similar provision with respect to sales tax that I argued, to no avail, constituted a violation of due process. It’s significant because previously the sales tax provision stood alone in its sweeping imposition of personal liability. (OK, I'm a sore loser.)
Now that this broad imposition of liability has been extended with respect to another tax, there is a possibility that it might be further extended. For instance, the failure to collect and pay over withholding taxes might create personal liability by virtue of an individual's status rather than, as is currently the case, the individual's dereliction of duty.
Thursday, July 03, 2003
Putting Strains On My Friends
While some of my best friends are accountants, I may be straining our friendship with this posting.
The Ohio Supreme Court, in the case of Columbus Bar Assn. v. Verne, recently enjoined an accountant from "preparing legal documents that constitute the unauthorized practice of law." Verne, the accountant in question, had formed an LLC on behalf of two of his clients by drafting and filing articles of organization with the Secretary of State. The articles used, as a baseline, forms that were available in the secretary of state's office.
In the real world, the practice of law by accountants, insurance agents, stock brokerage houses, and banks is rampant. A few good lawsuits resulting in liability might encourage a reduction in the unlicensed practice of law.
The opinion correctly focuses on the types of advice that clients need that are particularly within the province of attorneys, namely those issues that ought to be reflected in an operating agreement. However, in its conclusion, the Court focuses on the one area in which Verne’s transgression was relatively benign: the drafting of the articles of organization. Thus, the order merely enjoins him from "preparing legal documents."
In fact, as the opinion reveals, Verne's sins that caused his clients serious harm were not found in the simple document that he drafted, but in the complex document that he didn't even think about. Verne failed as a lawyer because he apparently did not even attempt to explain to his clients the importance of addressing and memorializing the various elements of their deal. The order does not focus on this problem. And, perhaps, it cannot. After all, it would come dangerously close to an infringement on free speech rights to block Verne from opining, to clients or prospective clients, as to the relative merits of different types of entities and the issues that should be addressed in organizing a business.
Going one step further, however, a more difficult issue underlies this case. What should it cost to form a relatively simple business deal? In this sense, law faces the same economic problem that medicine faces. In medicine, doctors often order or perform too many tests in order to reduce their exposure to malpractice claims. In forming a business, lawyers face the problem of how detailed an operating agreement (or shareholders' agreement or partnership agreement or lease or etc.) needs to be in order to meet the needs of the client and, to cover all of their bases, there is a tendency to "overlawyer" a deal.
Of course, "overlawyering" is in the eyes of the beholder.
Although no facts as to this are set forth in the opinion, I'm willing to bet that Verne's clients' business involved little initial capital and they were operating on a shoestring. How much upfront capital should they be willing to spend to draft the "appropriate" documents addressing all of the "pertinent" issues? Appropriateness and pertinency are, after all, fluid concepts. Maybe the default provisions in the Ohio LLC statute were sufficient for their purposes. Of course, Verne probably lacked the training (and certainly lacked the appropriate license) to give his clients the requisite information that would have allowed them to make a knowing choice with respect to these matters. Thus, his real crime was not the document he drafted, but the document he didn't draft.
Two other points about the opinion.
First, I had not previously been to the Ohio Supreme Court's website. The opinions give not only the "book" official citation (that is, a citation to the hard bound volumes of published opinions) but an official "cyber" citation as well. All courts should emulate this practice.
Second, the Court's opinion cited as authority Henning & McQuown, Ohio Limited Liability Company: Forms and Practice Manual (December 2001). A disclaimer: I have a slight (very slight) financial interest in that publication, but (and?) I was happy to see it relied upon as authority.
The Ohio Supreme Court, in the case of Columbus Bar Assn. v. Verne, recently enjoined an accountant from "preparing legal documents that constitute the unauthorized practice of law." Verne, the accountant in question, had formed an LLC on behalf of two of his clients by drafting and filing articles of organization with the Secretary of State. The articles used, as a baseline, forms that were available in the secretary of state's office.
In the real world, the practice of law by accountants, insurance agents, stock brokerage houses, and banks is rampant. A few good lawsuits resulting in liability might encourage a reduction in the unlicensed practice of law.
The opinion correctly focuses on the types of advice that clients need that are particularly within the province of attorneys, namely those issues that ought to be reflected in an operating agreement. However, in its conclusion, the Court focuses on the one area in which Verne’s transgression was relatively benign: the drafting of the articles of organization. Thus, the order merely enjoins him from "preparing legal documents."
In fact, as the opinion reveals, Verne's sins that caused his clients serious harm were not found in the simple document that he drafted, but in the complex document that he didn't even think about. Verne failed as a lawyer because he apparently did not even attempt to explain to his clients the importance of addressing and memorializing the various elements of their deal. The order does not focus on this problem. And, perhaps, it cannot. After all, it would come dangerously close to an infringement on free speech rights to block Verne from opining, to clients or prospective clients, as to the relative merits of different types of entities and the issues that should be addressed in organizing a business.
Going one step further, however, a more difficult issue underlies this case. What should it cost to form a relatively simple business deal? In this sense, law faces the same economic problem that medicine faces. In medicine, doctors often order or perform too many tests in order to reduce their exposure to malpractice claims. In forming a business, lawyers face the problem of how detailed an operating agreement (or shareholders' agreement or partnership agreement or lease or etc.) needs to be in order to meet the needs of the client and, to cover all of their bases, there is a tendency to "overlawyer" a deal.
Of course, "overlawyering" is in the eyes of the beholder.
Although no facts as to this are set forth in the opinion, I'm willing to bet that Verne's clients' business involved little initial capital and they were operating on a shoestring. How much upfront capital should they be willing to spend to draft the "appropriate" documents addressing all of the "pertinent" issues? Appropriateness and pertinency are, after all, fluid concepts. Maybe the default provisions in the Ohio LLC statute were sufficient for their purposes. Of course, Verne probably lacked the training (and certainly lacked the appropriate license) to give his clients the requisite information that would have allowed them to make a knowing choice with respect to these matters. Thus, his real crime was not the document he drafted, but the document he didn't draft.
Two other points about the opinion.
First, I had not previously been to the Ohio Supreme Court's website. The opinions give not only the "book" official citation (that is, a citation to the hard bound volumes of published opinions) but an official "cyber" citation as well. All courts should emulate this practice.
Second, the Court's opinion cited as authority Henning & McQuown, Ohio Limited Liability Company: Forms and Practice Manual (December 2001). A disclaimer: I have a slight (very slight) financial interest in that publication, but (and?) I was happy to see it relied upon as authority.
Wednesday, June 11, 2003
An Act of Faith
One of the best things about participating in Bar activities is that you get exposed to a group of people who have a high degree of pride in their profession. That is, for them, being a lawyer is not merely a job, but a calling as well.
Now most of those who populate these meetings are what I call "average smart guys." That is, they're people who are well-educated and very bright, but not necessarily on the intellectual level of a Brandeis or Holmes. (By the way, on my best days, I rate myself at the lower rungs of the "average smart guy" scale.) Occasionally, however, you get the opportunity to meet people who go to the top of the scale and then beyond.
Once of the people who I've had the opportunity to meet and who is beyond the category of "average smart guy" is Susan Pace Hamill. (Ok, she's not a guy, but you get the idea.)
Susan was with the I.R.S. when LLCs were in their infancy and, I suspect, did a great deal to advance their acceptance within the Service. Subsequently, she became a professor at the University of Alabama School of Law. More recently, she has caused a bit of stir by publishing an article in the University of Alabama Law Review entitled An Argument for Tax Reform Based on Judeo-Christian Ethics. (Susan also has a Masters in Theology from the Beeson Divinity School.)
The article focuses on Alabama's tax system, labeling it unfair to the poor. It is easy to see, however, that a similar analysis would apply to most state and local tax regimes in this country, since, to a great degree, they all rely on regressive taxes. And the President's welfare bill for the wealthy? Although not a theologian, I think that to ask the question is to answer it.
In an editorial piece in the New York Times on Tuesday, Adam Cohen outlined the impact that Susan's article has had on tax policy in Alabama, moving even an arch-conservative governor to back tax reform. But don't hold your breath waiting for the alleged conservatives in the White House to get religion.
Now most of those who populate these meetings are what I call "average smart guys." That is, they're people who are well-educated and very bright, but not necessarily on the intellectual level of a Brandeis or Holmes. (By the way, on my best days, I rate myself at the lower rungs of the "average smart guy" scale.) Occasionally, however, you get the opportunity to meet people who go to the top of the scale and then beyond.
Once of the people who I've had the opportunity to meet and who is beyond the category of "average smart guy" is Susan Pace Hamill. (Ok, she's not a guy, but you get the idea.)
Susan was with the I.R.S. when LLCs were in their infancy and, I suspect, did a great deal to advance their acceptance within the Service. Subsequently, she became a professor at the University of Alabama School of Law. More recently, she has caused a bit of stir by publishing an article in the University of Alabama Law Review entitled An Argument for Tax Reform Based on Judeo-Christian Ethics. (Susan also has a Masters in Theology from the Beeson Divinity School.)
The article focuses on Alabama's tax system, labeling it unfair to the poor. It is easy to see, however, that a similar analysis would apply to most state and local tax regimes in this country, since, to a great degree, they all rely on regressive taxes. And the President's welfare bill for the wealthy? Although not a theologian, I think that to ask the question is to answer it.
In an editorial piece in the New York Times on Tuesday, Adam Cohen outlined the impact that Susan's article has had on tax policy in Alabama, moving even an arch-conservative governor to back tax reform. But don't hold your breath waiting for the alleged conservatives in the White House to get religion.
Sunday, June 08, 2003
A Hatchett Job
The Sixth Circuit just issued an opinion applying U.S. v. Craft. It is certain to send shivers down the spines of title insurance companies.
The case, Hatchett v. U.S., arose out of an assessment that grew from the tax fraud of Mr. Hatchett, formerly a prominent Detroit trial attorney. While the Craft case was wending its way to the Supreme Court, the Hatchetts had been contesting the government's attempt to enforce its lien against Mr. Hatchett by attaching their tenancy by the entirety property.
The Sixth Circuit admitted that the Supreme Court in Craft had enunciated "a new rule of federal law" since, prior to that decision, "several federal and state courts, including [the Sixth Circuit], as well as the IRS, had assumed that entireties property was excluded from the definition of 'all property and rights to property' as defined by the tax code." However, the Court applied the rule found in Reynoldsville Casket Co. v. Hyde, 514 U.S. 749, 752 (1995), that: "[W]hen (1) the Court decides a case and applies the (new) legal rule of that case to the parties before it, then (2) it and other courts must treat that same (new) legal rule as 'retroactive,' applying it, for example, to all pending cases, whether or not those cases involve predecision events."
The problem with Sixth Circuit's application of the rule is that it assumes that the litigation contesting the lien is the applicable "case" for purposes of the Reynoldsville Casket rule. The problem this raises is not obvious, but is extremely troublesome.
Assume that a tax lien was filed prior to the date the Craft decision was handed down. The parties subsequently (either before or after Craft, I don't think that it matters) sold tenancy by the entirety property to a third party bona fide purchaser for value. The third party's title insurer issued title insurance because, after all, the IRS's administrative practice in the state in which the property was located was not to attempt to levy against tenancy by the entirety property to enforce a lien against one spouse and the title insurer, correctly it seems to me, assumed that the lien did not attach to the property.
Now, the IRS attempts to assert its lien against the property. After all, Craft holds that the lien was good when it was initially filed and when the third party purchased the property. Presumably, the third party (or its title insurer) will attempt to judicially challenge the lien. However, by applying the Reynoldsville Casket rule to the "case," that is, the filing of the challenge to the lien, the third party loses because the case was instituted subsequent to Craft.
If the foregoing analysis holds, there are numerous tax liens that title insurers thought were dead, at least as to tenancy by the entirety property that had been conveyed, but which can presumably spring back to life. Thus, if the hypothetical third party in my illustration attempts to subsequently convey the property, should (or will) a title insurer issue a policy without a specific exception? And, if an exception is noted, will a lender participate in the purchase?
The Sixth Circuit's website is down this evening. When it comes back up, I will post a link to the Hatchett opinion.
The case, Hatchett v. U.S., arose out of an assessment that grew from the tax fraud of Mr. Hatchett, formerly a prominent Detroit trial attorney. While the Craft case was wending its way to the Supreme Court, the Hatchetts had been contesting the government's attempt to enforce its lien against Mr. Hatchett by attaching their tenancy by the entirety property.
The Sixth Circuit admitted that the Supreme Court in Craft had enunciated "a new rule of federal law" since, prior to that decision, "several federal and state courts, including [the Sixth Circuit], as well as the IRS, had assumed that entireties property was excluded from the definition of 'all property and rights to property' as defined by the tax code." However, the Court applied the rule found in Reynoldsville Casket Co. v. Hyde, 514 U.S. 749, 752 (1995), that: "[W]hen (1) the Court decides a case and applies the (new) legal rule of that case to the parties before it, then (2) it and other courts must treat that same (new) legal rule as 'retroactive,' applying it, for example, to all pending cases, whether or not those cases involve predecision events."
The problem with Sixth Circuit's application of the rule is that it assumes that the litigation contesting the lien is the applicable "case" for purposes of the Reynoldsville Casket rule. The problem this raises is not obvious, but is extremely troublesome.
Assume that a tax lien was filed prior to the date the Craft decision was handed down. The parties subsequently (either before or after Craft, I don't think that it matters) sold tenancy by the entirety property to a third party bona fide purchaser for value. The third party's title insurer issued title insurance because, after all, the IRS's administrative practice in the state in which the property was located was not to attempt to levy against tenancy by the entirety property to enforce a lien against one spouse and the title insurer, correctly it seems to me, assumed that the lien did not attach to the property.
Now, the IRS attempts to assert its lien against the property. After all, Craft holds that the lien was good when it was initially filed and when the third party purchased the property. Presumably, the third party (or its title insurer) will attempt to judicially challenge the lien. However, by applying the Reynoldsville Casket rule to the "case," that is, the filing of the challenge to the lien, the third party loses because the case was instituted subsequent to Craft.
If the foregoing analysis holds, there are numerous tax liens that title insurers thought were dead, at least as to tenancy by the entirety property that had been conveyed, but which can presumably spring back to life. Thus, if the hypothetical third party in my illustration attempts to subsequently convey the property, should (or will) a title insurer issue a policy without a specific exception? And, if an exception is noted, will a lender participate in the purchase?
The Sixth Circuit's website is down this evening. When it comes back up, I will post a link to the Hatchett opinion.
Saturday, May 31, 2003
On-Line EIN/TIN--It's Baaaaaack!
Thanks to Andy Sandler who brought to my attention that the IRS EIN/TIN website was back in operation.
One aspect of the site that appears to be different is its treatment of LLCs. When applying for an EIN/TIN for an LLC, for question 8.a., one needs to check the box for the tax classification of the LLC (sole proprietorshp, partnership, or corporation) and then, on the spot in the question 8.a. area marked "Other," state whether the LLC is a single member or multi-member LLC. However, you should not check the box marked "Other."
Got that? Now go there.
One aspect of the site that appears to be different is its treatment of LLCs. When applying for an EIN/TIN for an LLC, for question 8.a., one needs to check the box for the tax classification of the LLC (sole proprietorshp, partnership, or corporation) and then, on the spot in the question 8.a. area marked "Other," state whether the LLC is a single member or multi-member LLC. However, you should not check the box marked "Other."
Got that? Now go there.
Wednesday, May 21, 2003
A Depressing Opinion
I think that the general public believes that the answers to questions of law, in general, and tax law, in particular, are found by investigating arcane points of case law and statutory construction. Of course, that is often the case. However, just as often, answers turn on facts and knowledge that is outside of the hermetic world of cases and statutes. Oliver Wendell Holmes was right: "the path of law is experience, not logic." This basic precept was ignored by the U.S. Tax Court in the case of Keeley v. Commissioner.
In 1996, Mr. Keeley left a well-paying job because in each of the previous 3 to 4 years at the job his compensation had been cut. He attempted to become a commissioned life insurance agent without success. As a consequence, in 1997 he had a mental breakdown. He suffered from and was treated for moderate to severe depression. His income from employment suffered as a result.
In 1997 and 1998, as a result of this diminution in income, he and his wife had to make premature withdrawals from their qualified retirement plans. In order to avoid the imposition of the 10% penalty on these premature withdrawals, they attempted to invoke the provisions of I.R.C. Section 72(t)(2)(A)(iii). That section provides that a premature withdrawal of funds from a qualified plan is not subject to the penalty if the taxpayer is disabled within the meaning of Code Section 72(m)(7) which provides that "an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require."
Section 1.72-17A(f)((2)(vi) of the Treasury Regulations gives, as an example of a disability, "Mental diseases (e.g., psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual." The Regulations also provide that an impairment that is remediable does not constitute a disability. Specifically, Treas. Reg. Section 1.72-17A(f)(4) provides that: "An individual will not be deemed disabled if, with reasonable effort and safety to himself, the impairment can be diminished to the extent that the individual will not be prevented by the impairment from engaging in his customary or any comparable substantial gainful activity."
The Court concluded that Keeley did not suffer from a mental disease because he did not require continued institutionalization or constant supervision. Additionally, the Court concluded, without any real discussion, that Keeley's condition was not irremediable.
The first part of the Court's conclusion is based on precedent (i.e., logic) not real world experience. Anyone who has walked through the District of Columbia or any other major city should be aware of the mentally impaired homeless who populate the streets. They're there because we have medications available that allow us to dump them there and we thus avoid the expense of "continued institutionalization or constant supervision" of these individuals. Nevertheless, no one would argue that they suffer from mental illness. To pretend otherwise is simply to ignore reality. And, in this case, it was clear from the evidence presented that Keeley actually suffered from mental illness. However, the court applied the restrictive definition of the concept found in the regulations (but absent from the statute).
The court may have reached the conclusion that Keeley's condition was not irremediable based on the fact that, by 1998, he had been able to obtain gainful employment. However, the test of whether the disability is reasonably expected to be of long-continued and indefinite duration should be made based upon the condition of the taxpayer when the withdrawal from the qualified plan is made. In this case, at least in 1997, it seemed clear that Keeley's depression met this standard and there was no evidence to the contrary.
The case is also troubling because the court ties the overly restrictive test for disability set forth in the regulations to the statutory provision in Section 72 that requires the taxpayer to provide "proof of the existence [of a disabling mental illness] in such form and manner as the Secretary may require." Here, the court mistakes the grant of authority to set forth the manner in which the disability must be reported with a grant of authority to the Treasury define what constitutes a long-term disability for purposes of the statute.
The best part of the decision is that it is a summary disposition and cannot be treated as precedent for any other case. Thus, the Court is not bound by the opinion and free to ignore the holding in the future.
In 1996, Mr. Keeley left a well-paying job because in each of the previous 3 to 4 years at the job his compensation had been cut. He attempted to become a commissioned life insurance agent without success. As a consequence, in 1997 he had a mental breakdown. He suffered from and was treated for moderate to severe depression. His income from employment suffered as a result.
In 1997 and 1998, as a result of this diminution in income, he and his wife had to make premature withdrawals from their qualified retirement plans. In order to avoid the imposition of the 10% penalty on these premature withdrawals, they attempted to invoke the provisions of I.R.C. Section 72(t)(2)(A)(iii). That section provides that a premature withdrawal of funds from a qualified plan is not subject to the penalty if the taxpayer is disabled within the meaning of Code Section 72(m)(7) which provides that "an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require."
Section 1.72-17A(f)((2)(vi) of the Treasury Regulations gives, as an example of a disability, "Mental diseases (e.g., psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual." The Regulations also provide that an impairment that is remediable does not constitute a disability. Specifically, Treas. Reg. Section 1.72-17A(f)(4) provides that: "An individual will not be deemed disabled if, with reasonable effort and safety to himself, the impairment can be diminished to the extent that the individual will not be prevented by the impairment from engaging in his customary or any comparable substantial gainful activity."
The Court concluded that Keeley did not suffer from a mental disease because he did not require continued institutionalization or constant supervision. Additionally, the Court concluded, without any real discussion, that Keeley's condition was not irremediable.
The first part of the Court's conclusion is based on precedent (i.e., logic) not real world experience. Anyone who has walked through the District of Columbia or any other major city should be aware of the mentally impaired homeless who populate the streets. They're there because we have medications available that allow us to dump them there and we thus avoid the expense of "continued institutionalization or constant supervision" of these individuals. Nevertheless, no one would argue that they suffer from mental illness. To pretend otherwise is simply to ignore reality. And, in this case, it was clear from the evidence presented that Keeley actually suffered from mental illness. However, the court applied the restrictive definition of the concept found in the regulations (but absent from the statute).
The court may have reached the conclusion that Keeley's condition was not irremediable based on the fact that, by 1998, he had been able to obtain gainful employment. However, the test of whether the disability is reasonably expected to be of long-continued and indefinite duration should be made based upon the condition of the taxpayer when the withdrawal from the qualified plan is made. In this case, at least in 1997, it seemed clear that Keeley's depression met this standard and there was no evidence to the contrary.
The case is also troubling because the court ties the overly restrictive test for disability set forth in the regulations to the statutory provision in Section 72 that requires the taxpayer to provide "proof of the existence [of a disabling mental illness] in such form and manner as the Secretary may require." Here, the court mistakes the grant of authority to set forth the manner in which the disability must be reported with a grant of authority to the Treasury define what constitutes a long-term disability for purposes of the statute.
The best part of the decision is that it is a summary disposition and cannot be treated as precedent for any other case. Thus, the Court is not bound by the opinion and free to ignore the holding in the future.
Monday, May 19, 2003
Update on IRS Web EIN/TIN Applications
Sunday, May 18, 2003
Humpty Dumpty On a Roll
Humpty Dumpty articulated a principle that remains the lodestone of contract interpretation: "When I use a word . . .it means just what I choose it to mean-neither more nor less." The problem that gives rise to most contract litigation is HD’s admonition that: "The question is . . . which is to be master-that's all." (For the complete quote, go here.) A recent LLC case out of Connecticut, brought to my attention by Professor Gary Rosin, illustrates the hazards of not exercising the power of the master.
In Radding v. Freedom Choice Mortgage, LLC, Radding was an at-will employee of Freedom Choice, a mortgage broker. In late 1995, Freedom Mortgage instituted an incentive profit sharing plan for certain of its employees wherein the employees became members of the LLC. The LLC's operating agreement had a provision that no member of the company would be eligible to receive income from the production bonus or profit sharing programs until he or she had been a member for one full calendar year.
The admission of Radding and several other employees as members to the company was memorialized in an amendment to Freedom Choice's operating agreement that was dated December 12, 1995. That amendment stated that Radding and the other employees had become members of the LLC as of that date.
While Radding did not sign the operating agreement until December 28, 1995, he did execute a waiver of workers' compensation benefits on December 22, 1995, asserting that the company did not have to provide workers' compensation insurance coverage on him because he was a member of the LLC.
Radding and the principal owner of the company got into a dispute in late 1996. As a result, Radding was discharged as an employee on December 13,1996.
As a threshold matter, the company argued that Radding was not entitled to any benefits for the 1996 year since he had not been a member of the LLC for a full year. However, the court reviewed the terms of the operating agreement which provided that the date a person becomes a member "shall be stated on Schedule A [to the operating agreement]." The minutes to the meeting of the owners of the LLC, held on December 12, 1995, adopting the revised Schedule, stated that Schedule A was "hereby" amended to include Radding and the others as members. The court's conclusion was fortified by the fact that Radding was holding himself out as a member of the LLC at least by December 22, prior to the December 28, 1995, date that he executed the operating agreement.
What no doubt came as even a greater surprise to the principal owners of the company was the conclusion that Radding was still a member of the company even after he was discharged as an employee. The reason was that while the majority owners of the LLC could remove an individual as a member, they hadn’t bothered to formally do so. Thus, the court concluded that Radding remained a member of the LLC through at least 1998.
The lesson of Humpty Dumpty is not merely that one who drafts a contract can be the master of its terms. Humpty Dumpty also teaches that, because one is the master of the terms of a written document, one is bound by the common sense meaning of the words unless a "special meaning" (that is, a meaning defined by the master) is intended.
In Radding v. Freedom Choice Mortgage, LLC, Radding was an at-will employee of Freedom Choice, a mortgage broker. In late 1995, Freedom Mortgage instituted an incentive profit sharing plan for certain of its employees wherein the employees became members of the LLC. The LLC's operating agreement had a provision that no member of the company would be eligible to receive income from the production bonus or profit sharing programs until he or she had been a member for one full calendar year.
The admission of Radding and several other employees as members to the company was memorialized in an amendment to Freedom Choice's operating agreement that was dated December 12, 1995. That amendment stated that Radding and the other employees had become members of the LLC as of that date.
While Radding did not sign the operating agreement until December 28, 1995, he did execute a waiver of workers' compensation benefits on December 22, 1995, asserting that the company did not have to provide workers' compensation insurance coverage on him because he was a member of the LLC.
Radding and the principal owner of the company got into a dispute in late 1996. As a result, Radding was discharged as an employee on December 13,1996.
As a threshold matter, the company argued that Radding was not entitled to any benefits for the 1996 year since he had not been a member of the LLC for a full year. However, the court reviewed the terms of the operating agreement which provided that the date a person becomes a member "shall be stated on Schedule A [to the operating agreement]." The minutes to the meeting of the owners of the LLC, held on December 12, 1995, adopting the revised Schedule, stated that Schedule A was "hereby" amended to include Radding and the others as members. The court's conclusion was fortified by the fact that Radding was holding himself out as a member of the LLC at least by December 22, prior to the December 28, 1995, date that he executed the operating agreement.
What no doubt came as even a greater surprise to the principal owners of the company was the conclusion that Radding was still a member of the company even after he was discharged as an employee. The reason was that while the majority owners of the LLC could remove an individual as a member, they hadn’t bothered to formally do so. Thus, the court concluded that Radding remained a member of the LLC through at least 1998.
The lesson of Humpty Dumpty is not merely that one who drafts a contract can be the master of its terms. Humpty Dumpty also teaches that, because one is the master of the terms of a written document, one is bound by the common sense meaning of the words unless a "special meaning" (that is, a meaning defined by the master) is intended.
Thursday, May 08, 2003
Look Before You Leap
A short opinion recently handed down by Judge Nickerson of the United States District Court for the District of Maryland illustrates the potential dangers inherent in entering into a settlement agreement without complete assurance that the terms of the agreement can be fully consummated.
Under the facts of the case, Columbia Gas Transmission Corp. had brought an action in federal court based upon a federal, as opposed to state, claims. The parties had entered into a settlement agreement that called for the action to be dismissed without prejudice, subject to the right of either party to move to reopen the case within thirty days. If neither party moved to reopen within the thirty day time period, the dismissal became a dismissal with prejudice.
After the thirty day period had expired, Columbia Gas moved to enforce the settlement agreement. The Court rejected the request holding that the settlement agreement was a state law contract that replaced the original claims. Since the settlement agreement was a state law contract and there were no longer any federal claims upon which the court's jurisdiction could be invoked, Columbia Gas's motion was dismissed.
As a consequence, Columbia Gas, which has now lost its previous (presumably greater) claims, must bring a totally new action in Maryland state court to enforce or obtain damages under the settlement agreement. While the state court action will likely be limited (i.e., what were the terms of the agreement, have they been breached, and, if so, what are the damages), Columbia Gas is still exposed to greater costs and will lack the advantage of having the matter heard by the judge who was presumably familiar with the settlement agreement and the underlying dispute. As a practical matter, Columbia Gas might have to make further concessions to the defendant since its upside is likely limited. Not a happy result.
Under the facts of the case, Columbia Gas Transmission Corp. had brought an action in federal court based upon a federal, as opposed to state, claims. The parties had entered into a settlement agreement that called for the action to be dismissed without prejudice, subject to the right of either party to move to reopen the case within thirty days. If neither party moved to reopen within the thirty day time period, the dismissal became a dismissal with prejudice.
After the thirty day period had expired, Columbia Gas moved to enforce the settlement agreement. The Court rejected the request holding that the settlement agreement was a state law contract that replaced the original claims. Since the settlement agreement was a state law contract and there were no longer any federal claims upon which the court's jurisdiction could be invoked, Columbia Gas's motion was dismissed.
As a consequence, Columbia Gas, which has now lost its previous (presumably greater) claims, must bring a totally new action in Maryland state court to enforce or obtain damages under the settlement agreement. While the state court action will likely be limited (i.e., what were the terms of the agreement, have they been breached, and, if so, what are the damages), Columbia Gas is still exposed to greater costs and will lack the advantage of having the matter heard by the judge who was presumably familiar with the settlement agreement and the underlying dispute. As a practical matter, Columbia Gas might have to make further concessions to the defendant since its upside is likely limited. Not a happy result.
Tuesday, May 06, 2003
Update on LLCs & EINs
The IRS website setting forth the directions for obtaining EINs over the web now has been modified to provide additional instructions for LLCs. These instructions make it clear that LLCs can apply for EINs over the web and direct how to do so. The revised web page can be reached by clicking here.
Saturday, May 03, 2003
God Bless The Child Who's Got His Own
Delauter v. Shafer, decided by the Court of Appeals on May 2, is a little outside of my normal haunts, but the facts are somewhat interesting. Going beyond the specific holding of the case, it gives an insight into the dynamics of dispute resolution through the courts.
In 1944, Shafer married one of the daughters of Mr. and Mrs. Deibert. Shafer and his wife lived with his parents until 1968 when then moved to the Deibert family farm. Mr. and Mrs. Deibert had previously moved their personal residence to a parcel across the road that they had purchased, but, even after the Shafers moved in, they were on the farm virtually every working day.
The Shafers paid virtually nothing to the Deiberts over the years. In fact, they had borrowed money from the Deiberts from time to time. The Deiberts paid all of the property taxes on the farm, and, except for certain improvements that the Shafers had made, the Deiberts paid all of the insurance premiums on the farm and its improvements.
Mr. Shafer declared bankruptcy in 1996. He did not list the farm as an asset in his bankruptcy estate.
Mr. Diebert died in 1990 and Mrs. Diebert died in November, 1998. In May of 1998, Mrs. Shafer died. In Mrs. Diebert's will she made a provision with regard to the farm, declaring it to be an "advancement" on the bequest to Mrs. Shafer under the will, with the amount of the advancement being $125.00 times the number of months that the Shafers had lived on the farm from March 1, 1969. Subject to the advancement and some other advancements noted in the will, Mrs. Diebert bequeathed her estate in equal shares to her children.
Trouble had begun brewing even before Mrs. Diebert's death. Shortly before she died, Mrs. Diebert's two other daughters, acting under a power of attorney from their mother, entered into a contract to sell the farm for a little less than $600,000.00 and attempted to get Mr. Shafer to vacate the farm. Mr. Shafer refused to vacate the premises. After Mrs. Diebert's death, these same two daughters, acting as the personal representatives of her estate, brought an ejectment action against Mr. Shafer.
Shafer responded with a counterclaim that a lease had existed for over 20 years, but that no rent had been paid or demanded. Thus, under the provisions of Section 8-107 of the Real Property Article of the Maryland Annotated Code, he argued that the estate could not seek rent or any right of reversion with respect to the property.
The matter was tried before a jury. The jury returned a special verdict in favor of Shafer, finding that a lease existed and that no rent had been paid or demanded for more than twenty years. Consequently, the trial court entered a judgment declaring that Shafer had title to the property.
The Court of Appeals rejected Shafer's position, resting its conclusion on two principles.
First, one of the pivotal issues was whether Shafer's possession of the farm was pursuant to a license from his in-laws or pursuant to a lease. The Court concluded that, because there was no dispute as to the underlying facts, the question of whether the arrangement was a lease or a license was a question of law for the court to determine and should not have been submitted to the jury.
Second, the Court outlined the distinction between a license and a lease. In particular, two elements that would argue that Shafer had leased the farm, the right to exclusive possession and the obligation to pay rent, were not present. Shafer lacked the right of exclusive possession to the farm, since the Dieberts had both been present at the farm virtually every working day, ceasing that activity only when physical infirmity overtook them. Additionally, it was clear that there was never a request or demand that either of the Shafers pay rent. Thus, the Court concluded that the arrangement was a license, not a lease. Consequently, the Court held that the provisions of Section 8-107 were not applicable and it reversed the circuit court.
What are the lessons with respect to dispute resolution?
First, it is likely that, as a practical matter, the case could not be settled since Shafer lacked the financial resources to make a reasonable settlement. After all, for the first 24 years of his marriage he lived at home with his parents. Thereafter, he lived rent free on his in-laws' property. Even then, he had to declare bankruptcy.
Second, the circuit court had abdicated its role when it allowed a jury to make the legal conclusion that the property was held by Shafer pursuant to a lease. To the extent that trial judges allow basic legal questions (as opposed to factual questions) to be resolved by a jury, litigation becomes a crap shoot. Litigants such as Shafer, who feel that they have nothing to lose, thus have an incentive to go to the legal gaming table.
In 1944, Shafer married one of the daughters of Mr. and Mrs. Deibert. Shafer and his wife lived with his parents until 1968 when then moved to the Deibert family farm. Mr. and Mrs. Deibert had previously moved their personal residence to a parcel across the road that they had purchased, but, even after the Shafers moved in, they were on the farm virtually every working day.
The Shafers paid virtually nothing to the Deiberts over the years. In fact, they had borrowed money from the Deiberts from time to time. The Deiberts paid all of the property taxes on the farm, and, except for certain improvements that the Shafers had made, the Deiberts paid all of the insurance premiums on the farm and its improvements.
Mr. Shafer declared bankruptcy in 1996. He did not list the farm as an asset in his bankruptcy estate.
Mr. Diebert died in 1990 and Mrs. Diebert died in November, 1998. In May of 1998, Mrs. Shafer died. In Mrs. Diebert's will she made a provision with regard to the farm, declaring it to be an "advancement" on the bequest to Mrs. Shafer under the will, with the amount of the advancement being $125.00 times the number of months that the Shafers had lived on the farm from March 1, 1969. Subject to the advancement and some other advancements noted in the will, Mrs. Diebert bequeathed her estate in equal shares to her children.
Trouble had begun brewing even before Mrs. Diebert's death. Shortly before she died, Mrs. Diebert's two other daughters, acting under a power of attorney from their mother, entered into a contract to sell the farm for a little less than $600,000.00 and attempted to get Mr. Shafer to vacate the farm. Mr. Shafer refused to vacate the premises. After Mrs. Diebert's death, these same two daughters, acting as the personal representatives of her estate, brought an ejectment action against Mr. Shafer.
Shafer responded with a counterclaim that a lease had existed for over 20 years, but that no rent had been paid or demanded. Thus, under the provisions of Section 8-107 of the Real Property Article of the Maryland Annotated Code, he argued that the estate could not seek rent or any right of reversion with respect to the property.
The matter was tried before a jury. The jury returned a special verdict in favor of Shafer, finding that a lease existed and that no rent had been paid or demanded for more than twenty years. Consequently, the trial court entered a judgment declaring that Shafer had title to the property.
The Court of Appeals rejected Shafer's position, resting its conclusion on two principles.
First, one of the pivotal issues was whether Shafer's possession of the farm was pursuant to a license from his in-laws or pursuant to a lease. The Court concluded that, because there was no dispute as to the underlying facts, the question of whether the arrangement was a lease or a license was a question of law for the court to determine and should not have been submitted to the jury.
Second, the Court outlined the distinction between a license and a lease. In particular, two elements that would argue that Shafer had leased the farm, the right to exclusive possession and the obligation to pay rent, were not present. Shafer lacked the right of exclusive possession to the farm, since the Dieberts had both been present at the farm virtually every working day, ceasing that activity only when physical infirmity overtook them. Additionally, it was clear that there was never a request or demand that either of the Shafers pay rent. Thus, the Court concluded that the arrangement was a license, not a lease. Consequently, the Court held that the provisions of Section 8-107 were not applicable and it reversed the circuit court.
What are the lessons with respect to dispute resolution?
First, it is likely that, as a practical matter, the case could not be settled since Shafer lacked the financial resources to make a reasonable settlement. After all, for the first 24 years of his marriage he lived at home with his parents. Thereafter, he lived rent free on his in-laws' property. Even then, he had to declare bankruptcy.
Second, the circuit court had abdicated its role when it allowed a jury to make the legal conclusion that the property was held by Shafer pursuant to a lease. To the extent that trial judges allow basic legal questions (as opposed to factual questions) to be resolved by a jury, litigation becomes a crap shoot. Litigants such as Shafer, who feel that they have nothing to lose, thus have an incentive to go to the legal gaming table.
Subscribe to:
Posts (Atom)