Buckrey v. Comm'r

• Decision Date: 11 July 2017
• Docket Number: Docket No. 16567-09.,Docket No. 15620-09,T.C. Memo. 2017-138,Docket No. 16566-09
• Parties: DONALD J. BUCKREY, TRANSFEREE, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

DONALD J. BUCKREY, TRANSFEREE, ET AL.,¹ Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

T.C. Memo. 2017-138

Docket No. 15620-09

Docket No. 16566-09

Docket No. 16567-09.

UNITED STATES TAX COURT

July 11, 2017

Ps were the sole owners of a corporation (C). C partially redeemed Ps' shares for its liquid noncash assets and then sold all its operating assets, which generated a large tax liability. Ps entered into a Midco transaction with (M), whereby C transferred its cash to M and a subsidiary of M (S) purchased Ps' shares of C. R was unable to collect C's large tax liability from M or S and decided to hold Ps liable as transferees of C. R sent Ps notices of liability, arguing that the entire series of transactions lacked economic substance. Ps assert that they are not liable under Minnesota fraudulent-transfer law, the governing state law.

Held: Under I.R.C. sec. 6901, the question of whether we can or must recast a series of transactions is a question of state fraudulent-transfer law.

Held, further, the partial stock redemption cannot be combined with the later distribution under Minnesota law, and the Minnesota Uniform Fraudulent Transfer Act does not apply to the stock redemption.

Held, further, Minnesota law requires a transfer-by-transfer analysis and does not allow us to collapse the transactions under a substance-over-form analysis.

Held, further, Ps did not receive a transfer directly from C because, even though C and M had commingled their funds for a brief time, the escrow agent had a contractual duty to deliver the specific funds from each party.

Held, further, there is a material fact in dispute as to whether S borrowed funds from M to purchase the shares or whether M paid for them directly, which precludes summary judgment on R's transferee-of-a-transferee and for-the-benefit-of theories.

Held, further, there is a material fact in dispute as to whether Ps actually intended to defraud R.

Held, further, Ps are not liable to R under the Minnesota Business Corporations Act because they did not receive a liquidating distribution from C.

Sue Ann Nelson, Masha M. Yevzelman, and Emily M. Chad, for petitioners.

Blaine Charles Holiday and John Schmittdiel, for respondent.

MEMORANDUM OPINION

HOLMES, Judge: After selling the assets of their business, Donald Buckrey, Richard Nyberg, and Robert Pribyl found themselves the owners of a corporation that had lots of cash, a sizable tax liability, and nothing else. They were approached by an all-too-familiar character in Tax Court caselaw--MidCoast. MidCoast offered them more for their company than what they would otherwise have received if they had simply liquidated it and divided what was left after taxes.

Background

The parties filed a lengthy (1,402 pages to be exact) stipulation of facts to accompany their cross-motions for summary judgment. We draw our discussion of the background facts from this comprehensive stipulation and its many exhibits, and rely solely on the facts as agreed.

I. The Stock Redemption and the Stock Sale

Buckrey, Nyberg, and Pribyl (the shareholders), and a man named John Hays incorporated BHNP Acquisition Company in Minnesota in 1994. They did so to buy the business assets of a company that manufactured gears and broaches²and had the uninspired name of Gear & Broach, Inc. After the acquisition, BHNP changed its name back to Gear & Broach, Inc. None of the shareholders had a four-year college degree, but they knew their business. The shareholders operated the company successfully for ten years, and revenues grew from $1 million to $20 million by 2003. Hays enjoyed this success too but was bought out in 2003. He remained as a consultant.

After a decade spent forging this success, the shareholders decided to see if they could sell. Buckrey went to a seminar on how to sell a business hosted by the Geneva Companies, Inc. The shareholders together retained Geneva and its representative Ted Polk to search for buyers. The mission was a success, and the company sold its gear-manufacturing assets to FastenTech, Inc., through a newly formed subsidiary of FastenTech called Gear & Broach (DE), Inc. (a Delaware corporation). The shareholders hired Arthur Dickinson and Yuri Berndt from a Minneapolis law firm as well as Mark Harrington from a local accounting firm to help them. They closed the sale in March 2004.

Before the closing Polk contacted Dickinson about the shareholders' selling their stock to MidCoast Investments, Inc. Dickinson and Berndt told the shareholders about this opportunity, and the attorneys received a letter from MidCoast later that month. In it was a promise to pay a premium for the stock and a claim that MidCoast was in the "asset recovery" business, which could somehow make the company a profitable acquisition. Dickinson and Berndt reviewed the terms of this letter with an eye to its tax consequences to their clients. Buckrey became the contact for the shareholders, and Dickinson sent him a copy of MidCoast's letter to review. After some revisions the shareholders countersigned a letter of intent in March 2004.

Berndt sent MidCoast a list of due-diligence requests that included:

• Independent references regarding MidCoast's financial capabilities, including banking and credit references;

• a list of references of attorneys or accountants who had previously worked with MidCoast and who had evaluated a transaction similar to this one;

• a list of the principals, officers, and directors of MidCoast Investments, Inc., and its parent companies;

• evidence as to the source of the funds to be used in the purchase; and

• names of affiliated operating companies related to MidCoast.

The record reveals that MidCoast did provide references, but it doesn't reveal whether MidCoast provided answers to the other questions. Berndt called the references and got no negative comments about MidCoast. Berndt also had a paralegal look up some UCC filings for MidCoast, and a firm librarian researched some publicly available information and articles about MidCoast.

MidCoast itself retained Thomas Doyle of another Minneapolis law firm to assist in the acquisition. MidCoast's subsidiary, MidCoast Acquisitions Corp., formed another subsidiary, BNP, LLC, to acquire the stock from the shareholders. MidCoast Acquisitions was BNP, LLC's sole member. At the request of MidCoast the shareholders changed the name of their company to BNP of Minnesota, Inc. (though we'll call it just BNP from now on). MidCoast was only interested in acquiring a company that held nothing but cash and tax liabilities, so the shareholders had to redeem a portion of their stock, which they did on May 19, 2004. This redemption caused BNP to distribute all its remaining noncash assets--accounts receivable from the three owners, tax refunds, prepaid insurance refunds, and future cash from FastenTech from the earlier asset sale--to the shareholders in redemption of approximately 36% of their total shares.

BNP now had only cash and a tax liability--specifically, approximately $3.7 million in cash and a tax liability of approximately $1.5 million from the asset sale. The magic could begin. On the same day as the redemption, the shareholders and a representative of MidCoast entered into a share-purchase agreement in which BNP, LLC, promised to pay nearly $2.7 million for the shareholders' remaining BNP stock. This price was a more than $500,000 premium over what the shareholders would have received in a simple liquidation of BNP.³

The purchase agreement was executed by BNP, LLC; BNP; and the shareholders. MidCoast Credit Corp.--yet another MidCoast affiliate--was also a party, and it guaranteed that the purchase price would be paid. The agreement said that BNP, LLC, would buy the shares by wiring the purchase price according to the instructions set out in a separate closing agreement. The agreement also said that BNP would deliver all its cash to BNP, LLC. By its terms, all of the events at closing would be deemed to occur simultaneously. This is what would happen:

• First, BNP would transfer its funds to a general escrow account, opened by agreement among BNP, another firm named Morehead Capital, LLC,⁴ and Associated Bank Minnesota.

• Second, once MidCoast's counsel received confirmation that BNP made this transfer, funds in the amount of the purchase price would be wired to the same account. (The memo was silent as to who exactly would be wiring these funds.)

• Third, once the escrow account held both amounts, the escrow agent would transfer the cash that came from BNP to BNP, LLC's lender's counsel. This "lender" was defined to be MidCoast Investments, Inc.

• Fourth, the escrow agent would wire some of the remaining money (i.e., the purchase price) to a couple other escrow accounts. These were known as the "holdback escrow account" and the "tail escrow account."

• Finally, once all this was done (which, in reality, could be accomplished in minutes), the balance of the money was to be wired to the shareholders.

The escrow agent was Associated Bank Minnesota, and all three escrow accounts were held there. The parties signed three separate escrow agreements to create the three escrow accounts. The general escrow account was the main account used to facilitate the transaction. The tail escrow account held $30,000 tocover any insurance premiums on policies for BNP's discontinued operations. As of the date of the audit, the $30,000 was still in this account. The holdback escrow account was created as insurance for MidCoast. The agreement required that $350,000 of the purchase price be placed into this holdback escrow account in case BNP (which at this point would be owned by BNP, LLC) was required to pay FastenTech a working-capital adjustment under the terms of the earlier asset sale. The escrow agreement stated that any working-capital adjustments would be reimbursed up to the $350,000, and if there was anything left, the remainder would go to the shareholders. (The shareholders later got the full...