McDonald's of Zion v. Comm'r of Internal Revenue

Decision Date11 June 1981
Docket NumberDocket Nos. 8083-77—-8109-77.
Citation76 T.C. 972
PartiesMCDONALD'S of ZION, 432, ILL., INC., ET AL.,1 v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

McDonald's Corp. (McDonald's) wanted to acquire several franchised restaurants owned primarily by three individuals, Garb, Stern, and Imerman (the Garb-Stern group). McDonald's refused to offer any consideration other than its common stock because of financial accounting reasons. Although the Garb-Stern group wanted a cash transaction, they eventually agreed to accept 361,235 shares of unregistered common stock. The merger took place as of Apr. 1, 1973, whereupon McDonald's dropped down the acquired restaurants into wholly owned, operating subsidiaries (the petitioners herein). As part of the merger agreement, the Garb-Stern group received “piggyback” registration rights plus a demand registration right. From the beginning, the Garb-Stern group intended to sell virtually all of the McDonald's stock they received pursuant to the merger agreement. No member of the group, however, promised or obligated himself to sell any of the shares received. McDonald's was totally indifferent as to whether the Garb-Stern group retained or sold their stock. The Garb-Stern group sold all but 100 shares of their McDonald's stock on Oct. 3, 1973, by exercising their “piggyback” registration rights. This date was the group's earliest opportunity to sell the stock received pursuant to the Apr. 1 merger. Held: The acquisition by McDonald's of the franchised restaurants constitutes a valid “A” reorganization. The Garb-Stern group's intent to sell the McDonald's stock acquired pursuant to the statutory merger, coupled with their subsequent sale of such stock at the earliest opportunity, does not violate the continuity-of-interest principle. Sheldon I. Fink, Frederic S. Lane, and Steven W. Swibel, for the petitioners.

Seymour I. Sherman, for the respondent.

HALL , Judge:

Respondent determined deficiencies in petitioners' 1973 Federal income tax as follows:

+--------------------------------------+
                ¦            ¦            ¦Amount of   ¦
                +------------+------------+------------¦
                ¦Petitioner  ¦Docket No.  ¦deficiency  ¦
                +------------+------------+------------¦
                ¦            ¦            ¦            ¦
                +--------------------------------------+
                
McDonald's of Zion
                432, Ill., Inc     8083-77 $14,940
                
McDonald's of Castro Valley
                433, Calif., Inc             8084-77 22,766
                
McDonald's of Concord-Clayton
                434, Calif., Inc               8085-77 9,641
                
McDonald's of San Leandro
                435, Calif., Inc           8086-77 26,372
                
McDonald's of Oakland, 12th St
                436, Calif., Inc                 8087-77 15,444
                
McDonald's of Alameda
                437, Calif., Inc       8088-77 14,677
                
McDonald's of Pomona,
                438, Calif., Inc      8089-77 6,633
                
McDonald's of Grand Rapids—28th St.,
                439, Mich., Inc                      8090-77 34,106
                
McDonald's of Grand Rapids-Plainfield,
                440, Mich., Inc                        8091-77 28,487
                
McDonald's of Grand Rapids-Division,
                441, Mich., Inc                      8092-77 12,285
                
McDonald's of Walker,
                442, Mich., Inc       8093-77 16,492
                
McDonald's of Bethany,
                443, Okla., Inc        8094-77 16,167
                
McDonald's of Midwest City,
                444, Okla., Inc             8095-77 16,752
                
McDonald's of Norman,
                445, Okla., Inc       8096-77 21,659
                
McDonald's of Oklahoma City-29th St.,
                446, Okla., Inc                       8097-77 31,457
                
McDonald's of Oklahoma City-39th St.,
                447, Okla., Inc                       8098-77 29,697
                
McDonald's of Oklahoma City-May,
                448, Okla., Inc                  8099-77 29,237
                
McDonald's of Oklahoma City-Penn.,
                449, Okla., Inc                    8100-77 33,796
                
McDonald's of Oklahoma City-23d,
                450, Okla., Inc                  8101-77 23,760
                
McDonald's of Tulsa,
                451, Okla., Inc      8102-77 25,174
                
McDonald's of Tulsa-Yale,
                452, Okla., Inc           8103-77 16,457
                
McDonald's of Tulsa—11th St.,
                453, Okla., Inc               8104-77 25,892
                
McDonald's of Del City,
                454, Okla., Inc         8105-77 13,731
                
McDonald's of Moore,
                455, Okla., Inc      8107-77 15,203
                
McDonald's of Enid
                456, Okla., Inc    8106-77 14,188
                
McDonald's of Kenosha,
                457, Wis., Inc         8108-77 23,257
                
McDonald's of Kenosha-52d St.,
                458, Wis., Inc                 8109-77 28,133
                

Each petitioner obtained its assets from McDonald's Corp. following the latter's acquisition of those assets by merger. Due to concessions, the sole issue for decision is whether the transaction by which McDonald's Corp. obtained these assets qualified as a tax-free reorganization.

FINDINGS OF FACT

At all pertinent times, each petitioner was a wholly owned subsidiary of McDonald's Corp. (McDonald's), a Delaware corporation. Each petitioner had its principal place of business in Oak Brook, Ill., when it filed its petition in these cases. All petitioners maintain their books and records on the accrual method and file their tax returns on a calendar year basis.

McDonald's and its subsidiaries operate, license, and service a system of self-service restaurants offering a substantially uniform menu. The McDonald's restaurant operations include proprietary outlets owned and operated by independent licensees or franchisees. Between January 1, 1968, and June 30, 1973, McDonald's acquired the stock or assets of corporations or other entities which owned an aggregate of 303 franchised restaurants.

Melvin Garb, Harold Stern, and Lewis Imerman (sometimes hereinafter referred to as the Garb-Stern group) first became involved with the McDonald's organization in the late 1950's when they obtained franchise rights to operate a restaurant in Saginaw, Mich. They subsequently expanded their McDonald's restaurant operations to include stores in other areas of Michigan, and in certain areas of Oklahoma, Wisconsin, Nevada, and California. Certain of the Garb-Stern restaurants were placed in wholly or partially owned subsidiaries of McDonald's Distributing Corp. (Distributing), a Michigan corporation, owned equally by Garb, Stern, and Imerman. Each subsidiary contained one restaurant. The remainder of the Garb-Stern interests were held by affiliated companies. 2 (Distributing, its subsidiaries, and the affiliated companies will sometimes be referred to collectively as the Garb-Stern Cos.)

Garb, Stern, and Imerman always owned equal shares in their McDonald's endeavors. They each owned one-third of the outstanding stock in Distributing as well as the same number of shares in each of the affiliated corporations in which they were shareholders. Any decision relating to their McDonald's interests generally required the unanimous approval of the group. Garb generally acted as the group's spokesman in its dealings with the McDonald's organization.3

In 1968, McDonald's, Distributing, Garb, Stern, and Imerman entered into an agreement whereby McDonald's acquired all the outstanding common stock of 14 subsidiaries of Distributing in exchange solely for $2.3 million par value, convertible, 6-percent preferred McDonald's stock. The preferred shares received by Distributing were not registered under the Securities Act of 1933 nor were they transferable for 2 years pursuant to the terms of the 1968 agreement.

For many years, the Garb-Stern group and the McDonald's organization maintained a congenial and successful relationship. The Garb-Stern group led by Garb, an outspoken and gregarious individual, became one of the largest and best-known franchisees within the McDonald's organization. Sometime after the 1968 transaction, however, the relationship between McDonald's and the Garb-Stern group soured.

In the fall of 1971, McDonald's and the Garb-Stern group met to discuss the possible acquisition by McDonald's of certain restaurants in Oklahoma. These negotiations proved to be unfruitful because accounting rules then in effect precluded McDonald's from treating the proposed acquisition as a “pooling of interests”4 unless all the operations of the Garb-Stern group were acquired. At that time, McDonald's was unwilling to acquire all of the Garb-Stern interests.5

The parties resumed their negotiations in November 1972 with a meeting at La Costa, Calif. At that meeting, the parties explored the possibility of McDonald's acquiring all the Garb-Stern Cos.6 Most of the discussion at La Costa related to the nature and amount of consideration McDonald's would pay for the Garb-Stern interests. Garb, the spokesman for the group, indicated a desire for all cash. McDonald's, however, would only consider an acquisition that could be accounted for as a pooling of interests.7 Under then-prevailing accounting rules, the acquisition could qualify as a pooling of interests only if McDonald's issued its common stock in exchange for the Garb-Stern interests.8 McDonald's representatives suggested that the conflicting interests of both sides could be satisfied through the following procedure: McDonald's would acquire the Garb-Stern Cos. in exchange for McDonald's common stock, and McDonald's would permit the Garb-Stern group to include their shares for sale in a June registration then planned by McDonald's.9

The 2-day meeting at La Costa ended at an impasse primarily because the parties could not agree on the value of the Garb-Stern interests. By the conclusion of the meeting, however, both parties recognized that any eventual acquisition would be in exchange for McDonald's common stock.

In early March 1973, Stuart Greenberger, the attorney for the Garb-Stern group, met with McDonald's general counsel in order to convey an offer on behalf of the Garb-Stern group. On March 12, 1973, Greenberger wrote the following letter to McDonald's general counsel setting forth the basic terms of his clients' offer:

As you requested, I am writing this letter in order to put in writing the basic terms of the “offer” which, on behalf of my clients, I transmitted to you at our breakfast meeting last Wednesday with respect to the sale by Messrs. Garb, Stern and Immerman [sic] (and...

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