58 F.Supp.2d 1235 (D.Kan. 1999), 97-2666, Rogers v. United States
|Citation:||58 F.Supp.2d 1235|
|Party Name:||Robert B. ROGERS, Successor Executor for the Estate of Ewing M. Kauffman, et al., Plaintiffs, v. UNITED STATES of America, Defendant.|
|Case Date:||June 10, 1999|
|Court:||United States District Courts, 10th Circuit, District of Kansas|
Kelley D. Sears, M. Kevin Underhill, Stanley P. Weiner, Susan A. Berson, Shook, Hardy & Bacon L.L.P., Kansas City, MO, Eric T. Mikkelson, Sylvan Siegler, Shook, Hardy & Bacon L.L.P., Kansas City, MO, for Robert B Rogers, Julia Irene Kauffman, plaintiffs.
Seth G Heald, Charles P Hurley, U.S. Department of Justice Office of Special Litigation-Tax Div., Washington, DC, for United States of America defendants.
MEMORANDUM AND ORDER
LUNGSTRUM, District Judge.
This tax refund suit involves the Kansas City Royals Major League Baseball team, its former owner Ewing Marion Kauffman, now deceased, and former part-owner Avron B. Fogelman. At issue is the propriety of a $34 million bad debt deduction taken by the Royals on a purported loan to Mr. Fogelman and passed through to the tax return of Mr. and Mrs. Kauffman.
The matter is currently before the court on the parties' cross motions for full or partial summary judgment (Docs.68, 71). Also pending is the plaintiffs' motion to strike defense expert Paul McDaniel (Doc. 89). For the reasons set forth below, the plaintiffs' motion for partial summary judgment is denied, and the defendant's motion for summary judgment is granted. The motion to strike is now moot.
I. Background 1
In the late 1960s, Major League Baseball granted a franchise to the Kansas City Royals Baseball Corporation ("KCRBC" or "Royals"), an S corporation pursuant to I.R.C. § 1361. 2 KCRBC was wholly owned by Mr. Kauffman. Mr. Kauffman agreed in 1983 to sell Mr. Fogelman 49 percent of the Royals common stock for $10 million. For an additional $1 million, Mr. Kauffman also granted Mr. Fogelman an option to purchase the remaining 51 percent of KCRBC at some time in the future. The option exercise price was set at $10 million. In 1987, Mr. Kauffman
sold Mr. Fogelman an additional 1 percent of the Royals stock, whereupon both men held 50 percent of the Royals stock, subject still to Mr. Fogelman's option to purchase the remainder of the stock for $10 million on some future date.
At some point in approximately 1987, Mr. Fogelman began to experience severe financial difficulties related to his real estate business. He owed his primary creditor, Citicorp Real Estate, Inc. in Atlanta, Georgia, over $800 million and owed more than $100 million to other lenders. Mr. Fogelman's financial condition continued to deteriorate in 1988 and 1989, and he began to explore avenues by which he might restructure his affairs. It became apparent that Mr. Fogelman's only unencumbered asset was his Royals stock and option. The only feasible way to fund a reorganization was somehow to obtain cash from his Royals interests.
Mr. Kauffman, the Royals, Mr. Fogelman, and Mr. Fogelman's creditors engaged in a series of sometimes contentious on-again, off-again discussions concerning the future ownership structure of the Royals and the extent to which and form in which Mr. Kauffman was willing to assist Mr. Fogelman's reorganization. Mr. Fogelman's option became a subject of concern in these dealings. There was disagreement about whether Mr. Fogelman could exercise his option at his discretion, or whether the option was exercisable only upon the consent or death of Mr. Kauffman or after June 30, 2010. 3 Mr. Kauffman and Major League Baseball clearly did not want the option to be exercised with the potential result of having the Royals be owned by Mr. Fogelman's creditors. Eventually, the parties reached an agreement that has become the subject matter of this lawsuit.
The agreement, executed on July 31, 1990, included what the parties characterized as a $34 million loan from Mr. Kauffman to the Royals, and what they characterized as a corresponding $34 million loan by the Royals to Mr. Fogelman. 4 The Royals' purported loan to Mr. Fogelman was nonrecourse, secured by Mr. Fogelman's Royals stock and option. 5 The parties paid the State of Tennessee, Mr. Fogelman's state of residence, a $39,100 loan tax 6 from the proceeds of the alleged loan. The due date of Mr. Fogelman's nonrecourse note to the Royals was January 3, 1991, or earlier if the Royals were sold to a bidder at an auction process the parties had devised.
As a part of the transaction, Mr. Fogelman granted the Royals an option to purchase his stock and option for a price equal to the outstanding balance of his alleged Royals loan. 7 The Royals had the right to
exercise the option at any time on or after the date it was granted, but the resultant securities transfer was not to occur until January 4, 1991, some five months after the reorganization agreement was signed and only one day after the due date on Mr. Fogelman's nonrecourse note. The Royals retained the right to decide not to close on the exercised option. As was apparently anticipated in the discussions leading up to the July 31, 1990 agreements, the Royals exercised the option immediately upon Mr. Fogelman's execution of the July 31, 1990 agreements. 8
Also as part of the transaction, Mr. Fogelman agreed (1) to resign as a director and officer of the Royals and have no further management role in the Royals, (2) to waive all rights concerning Mr. Kauffman's exclusive right to manage the Royals, (3) to give Mr. Kauffman an irrevocable proxy to vote Mr. Fogelman's shares in the Royals, (4) to not enter Royals Stadium (now Kauffman Stadium) without the express permission of the Royals or Mr. Kauffman, and (5) to give up all of the owners perquisites he had previously enjoyed. 9 The parties agreed to modify Mr. Fogelman's option to purchase the Royals so that it could not be exercised before January 31, 1991 and would in any event terminate upon (1) foreclosure of the Royals' purported loan to Mr. Fogelman, (2) closing of the sale of Mr. Fogelman's Royals interest to the Royals pursuant to the Royals' option, or (3) the sale of the Royals at the planned auction. There was to be no cash distributed to either shareholder while the purported debt was outstanding. The parties also agreed that Mr. Fogelman had no obligation to meet capital calls, although he did retain and exercise the right to enjoy the tax benefits of any losses the Royals might pass through to him.
The parties hired the investment banking firm of Morgan Guarantee and Trust Company of New York ("Morgan") to conduct the planned auction of the Royals. The auction process was a part of the parties' agreement for a number of reasons, including protecting Mr. Kauffman from fraudulent conveyance claims in the event Mr. Fogelman's reorganization failed and assuring Mr. Fogelman's creditors that $34 million was adequate value for Mr. Fogelman's Royals interest. Conceptually, the parties designed the auction process so that the impact on Mr. Fogelman and his creditors would be the same as it would have been if Mr. Fogelman exercised his existing option to purchase the remainder of Mr. Kauffman's stock. Mr. Fogelman's creditors agreed to release claims to Mr. Fogelman's interest in the Royals provided they were placed in the same position as they would have been in if they obtained 100 percent of the Royals stock from Fogelman after he exercised his option for $10 million. One hundred percent of the Royals stock was up for auction, and the parties set a minimum price of approximately $80.86 million. The $80.86 million figure was sufficient to pay (1) all amounts the Royals owed to Mr. Kauffman, (2) all amounts that Mr. Kauffman
and Mr. Fogelman guaranteed for the Royals, (3) all of Morgan's fees, (4) Mr. Kauffman's attorneys fees, (5) all amounts guaranteed to certain Royals officers, and (6) the $10 million option exercise price on Mr. Fogelman's option to purchase the remainder of the Royals stock. Mr. Kauffman had the right to match any bid received at the auction. Mr. Fogelman agreed that neither he nor any related entities or persons would bid in the auction. The auction produced no acceptable bids and Morgan issued an opinion that the Royals equity was of nominal value.
Mr. Fogelman "defaulted" on his purported loan from the Royals on January 3, 1991, the nonrecourse note's due date. On that same day, Mr. Fogelman signed a waiver and consent in lieu of foreclosure in which Mr. Fogelman agreed to the Royals retaining his Royals stock and option. The parties also agreed that the fair market value of the collateral on January 3, 1991 was substantially below the face amount of the purported loan and that the Royals could not collect any deficiency from Mr. Fogelman because the note he signed was nonrecourse.
Asserting that the collateral it received on January 3, 1991 had no value, the Royals deducted the full amount of the alleged loan, plus interest, as a bad debt deduction pursuant to I.R.C. § 166 in 1991. The Royals, as an S corporation, passed the bad debt loss through to Mr. Kauffman, who utilized the loss on his 1991 joint tax return with Mrs. Kauffman. Defendant denied the bad debt deduction and assessed additional taxes against the Kauffmans' estates. The plaintiffs paid the amount of the assessment and properly filed administrative claims for a refund. The claims were denied, and the plaintiffs instituted this action.
A. Summary Judgment Standards
Summary judgment is appropriate if the moving party demonstrates that there is "no genuine issue as to any material fact" and that it is "entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). In applying this standard, the court views the evidence and all reasonable inferences therefrom in the light most...
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