Driscoll v. Schuttler
Decision Date | 11 May 1988 |
Docket Number | No. 1:85-CIV-4615-RHH.,1:85-CIV-4615-RHH. |
Citation | 697 F. Supp. 1195 |
Parties | Mark J. DRISCOLL and Sylvia Driscoll, Plaintiffs, v. Barry L. SCHUTTLER, et al., Defendants. |
Court | U.S. District Court — Northern District of Georgia |
Michael W. Higgins, Higgins & Dubner, Atlanta, Ga., for plaintiffs.
Robert D. Feagin, III, James R. McGuone, Dinah Leigh, Hamilton, Gambrell, Clarke Anderson & Stolz, Atlanta, Ga., for defendants.
This case is currently before the court on Defendants' motions for summary judgment.
Plaintiffs are residents of Maryland and Virginia who invested in herds of cattle offered by Lovana Farms, Inc. Defendants are Financial Service Corporation and FSC Securities Corp. ("FSC") (the underwriters), Barry L. Schuttler (the registered representative), Andrews Davis Legg Bixler Milsten & Murrah, P.C. ("Andrews Davis") (the Lovells' and Lovana's attorneys), Joseph G. Shannonhouse, IV ("Shan-nonhouse") (a partner and shareholder in Andrews Davis), Lovell Cattle Company (the company that sold the animals to Lovana Farms which in turn were sold to Plaintiffs), Virgil Lovell (the President of Lovana Farms), Fred and Carlos Lovell (the partners who own Lovell Cattle Company) and Lovana Farms, Inc. (which sold the animals to plaintiffs).
In connection with their Lovana Farms investments, Plaintiffs made cash payments over three years and signed promissory notes for the balance of the purchase price of their herds of cattle. Plaintiffs also entered into management agreements with Lovana Farms, Inc., the sponsor of the investments, whereby they agreed to pay for Lovana's services in managing and maintaining the herds. Under the management agreement, plaintiffs were required to pay additional cash in annual installments during the first three years of the programs. In exchange, Lovana was obligated to breed and manage the herds, with the goal of earning investors profits from the long-term increase in herd size and quality.
The cattle management agreements obligated Lovana to breed and maintain the plaintiffs' cattle for the 9 or 10 year duration of the program. The agreement also empowered Lovana to sell cattle and make other decisions regarding the maintenance of the herds. In exchange, the investors were obligated to pay Lovana Farms a management fee in the amount of $650 per head for the first year, $325 per head for the next four six-month periods, and the greater of $337.50 per head or an amount computed under an agricultural index for all remaining six-month periods. Excess maintenance fee payments and the proceeds of sales of the investors' cattle were to be credited under the maintenance agreement to an investor reserve account and applied to future maintenance fees and interest on the notes. The offering materials projected that cattle sales throughout the years would be sufficient to pay the maintenance fees for the remainder of the program, pay the notes, and return a profit to the investors. If, however, at any time during the program the maintenance reserve was exhausted, the maintenance agreement permitted Lovana to ask plaintiffs to advance additional funds as set forth in the agreement, but plaintiffs had no personal liability to pay additional maintenance fees to Lovana.
In connection with their decision to invest in a Lovana Farms' herd, each plaintiff was to receive a Private Placement memorandum or prospectus and a Projected Model of Operations which included Notes and Assumptions or projections which projected the number of offspring to be born each year, and the amount of income to generated from the sale of those offspring in each year. Also indicated in the projections was the average price to be realized from the sale of each bull or heifer. As outlined in the private placement memoranda, the stated goal of the investments was to breed these registered heifers with champion bulls thereby developing superior offspring. The progeny of the original herd were then to be sold at various times during the nine year life of the investment.
The offering materials contained opinions of tax counsel that investors would be entitled to claim tax benefits, including an investment tax credit on the total (cash and note) purchase price of the herds in the first year and accelerated depreciation over the useful life of the cattle. Plaintiffs invested in the program partly as a tax shelter, and they claimed the deductions and credits described in the offering circular.
Plaintiffs were attracted to the investment because of the possibility of long-term capital gain, substantial tax benefits (including investment tax credit, deduction of operating expenses and accelerated depreciation), and a rate of financing substantially below market rates. In theory, plaintiffs' herds would operate at a loss for the first few years, offering the possibility of tax benefits. In later years, the sale of the offspring and eventually of the herd itself would generate sufficient revenue to satisfy plaintiffs' obligations under the promissory notes, and possibly net long-term capital gains.
The offering circulars disclosed that the cattle could be purchased by Lovana from Carlos and Fred Lovell, the partners in Lovell Cattle Company, a Georgia partnership. It also disclosed that Carlos and Fred Lovell were, respectively, the father and the uncle of Virgil Lovell, the sole shareholder of Lovana Farms, Inc.
Approximately half of the Plaintiffs invested in one program offered by Lovana Farms, Inc. that was financed by both recourse and nonrecourse promissory notes. The other plaintiffs invested in three other programs that were financed solely by recourse notes. The notes and the interest were not to become due until 1987.
As disclosed in the offering materials, Lovana purchased the plaintiffs' heifers from Lovell Cattle with a long-term promissory note. On resale of the cattle to plaintiffs, they assumed notes and became indebted to Lovell Cattle.
The structure of the note portion of the purchase price permitted plaintiffs to defer payment of the bulk of the purchase price until the end of the program. The notes all bore interest at a 9 percent annual rate. Payment of interest and principal was deferred until the end of each note's term and was required to be made in roughly equal installments during the last two or three years of the 9 or 10 year terms. Payment of the notes was secured by the investors' initial cattle herds and all offspring generated during the programs. The noteholders, either Lovell Cattle Company (in the case of all recourse notes) or Lovana Farms, Inc. (in the case of all Brangus non-recourse notes), were required first to seek payment of the notes out of the proceeds of the herd liquidation.
Because it was offered prior to the enactment of pertinent tax law changes in late 1981, the 1981 Brangus program involved substantially different notes. In that program, roughly half of the purchase price for each animal was paid with a "non-recourse" note payable to Lovana Farms, Inc., which could only be collected from the proceeds of the sale of the cattle herd beginning in the eighth year of the program. Brangus investors were not personally liable on the non-recourse notes. The remaining notes in the Brangus program and the entire note balance in the other three programs were fully recourse, plaintiffs were personally liable to Lovell Cattle Company on all these notes.
After plaintiffs made their first payments, they began to receive quarterly herd reports which indicated the status of those animals belonging to their own herd and whether any of those animals had generated any offspring. In addition, if any herd animals or offspring were sold, the herd report indicated the price brought by each bull or heifer. By July of 1984, Plaintiffs had each owned their herds for approximately two and one-half years. Their July 1984 individualized herd report indicated, for example, that the herds had generated from two to six offspring. By contrast, the projections indicated that each of the original herds should have generated approximately fifteen or sixteen offspring by that time. The figures for total average sales also did not nearly meet the prices projected for this time period.
In January and September of 1983, Lovana sent plaintiffs two communications which indicated that investors in Lovana Farms programs sold in 1978, 1979, and 1980 were being examined or audited by the Internal Revenue Service. Those communications explained the basis of the Service's challenges to those investors' returns. Specifically, plaintiffs were told that the IRS was contending that (1) the investors had not invested in Lovana for profit; (2) the benefits and burdens of ownership had not passed from Lovana to the herd owner; (3) the basis on which investors had computed their depreciation and investment tax credit was excessive because it was based on a purchase price in excess of fair market value; and (4) the management fee was not an ordinary and necessary expense, and therefore was not deductible.
Plaintiffs were also told that the IRS had obtained a list of the 1981 and 1982 Lovana investors and that it was threatening to disallow all deductions related to the herds unless investors agreed to limit their deductions to an amount equal to cash payments made.
On December 7, 1983, Virgil Lovell was arrested for paying a bribe to an IRS agent in an effort to stop an investigation of Lovana Farms investments. This bribe, alleged to be $400,000 which was thought to be the largest in the history of the IRS, received substantial publicity including articles in the Washington Post, The Atlanta Journal/Constitution, and Newsweek.
After the arrest, Lovana Farms wrote to plaintiffs informing them that everything was "business as usual" at Lovana Farms. On December 22, 1983, Virgil Lovell wrote to each investor indicating that he had a "fine team of defense lawyers" who were going to...
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