In re Forman Enterprises, Inc.

• Decision Date: 02 August 2002
• Docket Number: Bankruptcy No. 00-20523-BM.,Adversary No. 00-2683-BM.
• Citation: 281 B.R. 600
• Parties: In re FORMAN ENTERPRISES, INC., Debtor. The Official Committee of Unsecured Creditors of Forman Enterprises, Inc., Plaintiff, v. Sam Forman, Lawrence Ashinoff, Brett Forman, Richard Forman, and Wendy Forman, Defendants.
• Court: U.S. Bankruptcy Court — Western District of Pennsylvania

281 B.R. 600

In re FORMAN ENTERPRISES, INC., Debtor The Official Committee of Unsecured Creditors of Forman Enterprises, Inc., Plaintiff, v. Sam Forman, Lawrence Ashinoff, Brett Forman, Richard Forman, and Wendy Forman, Defendants.

Bankruptcy No. 00-20523-BM.

Adversary No. 00-2683-BM.

United States Bankruptcy Court, W.D. Pennsylvania.

August 2, 2002.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Owen W. Katz, and Roman Iwanyshyn, Pittsburgh, PA, Co-Counsel for Carlota M. Bohm.

Carlotta M. Böhm, Houston Harbaugh, P.C., Pittsburgh, PA, Chapter 7 Trustee, Successor Plaintiff.

James L. Weisman, Samuel F. Reynolds, Jr., Weisman, Goldman, Bowen & Gross, LLP, Pittsburgh, PA, for Forman Defendants.

Philip E. Beard, N. Beaumont Beard, Stonecipher, Cunningham, Beard & Schmitt, P.C., Pittsburgh, PA, for Lawrence Ashinoff.

MEMORANDUM OPINION

BERNARD MARKOVITZ, Bankruptcy Judge.

The chapter 7 trustee seeks in this adversary action to recover tax refunds defendants as shareholders of an S corporation have received (or expect to receive) as a result of their carrying back a net operating loss (hereinafter "NOL") suffered by the S corporation to income taxes paid in previous years. Recovery is based on theories of unjust enrichment, breach of fiduciary duty and impermissible post-petition transfer. The trustee also seeks imposition of a constructive trust.

Defendants steadfastly deny that the chapter 7 trustee is entitled to any relief in this case.

We will enter judgment in favor of defendants and against the chapter 7 trustee for reasons set forth in this memorandum opinion.

FACTS

Debtor was incorporated by defendant Sam Forman on October 4, 1995. The next day it issued 1,000 shares of common stock, all of which were acquired by Sam Forman. At the time of the closing Sam Forman paid in capital to the debtor in the amount of $1,000,000 and loaned it the additional sum of $4,190,000.

Immediately thereafter debtor elected to become an S corporation in accordance with 26 U.S.C. § 1361 et seq., which election remained in effect through its tax year ending on January 4, 2000.

On February 19, 1996, Sam Forman sold thirty percent of his shares of stock to defendant Larry Ashinoff for the sum of $993,000 and sold him a thirty percent interest in the above note for the sum of $1,257,000.

Sam Forman and Larry Ashinoff executed a shareholder's agreement at the time Ashinoff acquired his shares of debtor's stock. Section 9.01 of the agreement provided in part as follows:

.... Commencing with tax-year 1996 and for each year thereafter for which the [debtor] is an S corporation for federal income tax purposes, the [debtor] shall pay a dividend to each of the stockholders to allow such stockholder to pay the federal and state income tax or tax estimates payable by such stockholders attributable to such stockholders' allocable share of the [debtor's] income computed for such year.

At some time after February 19, 1996, Sam Forman gave a portion of his remaining shares of stock as a gift to his children, defendants Brett Forman, Wendy Forman and Richard Forman. Sam Forman owned fifty percent of debtor's shares as a result of the gift whereas Larry Ashinoff owned thirty percent, Brett Forman and Wendy Forman each owned nine percent; and Richard Forman owned two percent.

Sam Forman, Brett Forman and Larry Ashinoff were members of director's board of directors at all times relevant to this case.

Sam Forman received dividend payments from debtor in April and June of 1996 totaling $550,000 to pay income tax he owed for 1995 on debtor's taxable income.

Defendants received dividend payments from debtor in January of 1997 totaling $850,001 to pay income taxes they owed for 1996 on debtor's taxable income.

Defendants received dividend payments from debtor in January and June of 1998 totaling $1,311,750 to pay income taxes they owed for 1997 on debtor's taxable income.

Defendants received dividend payments in June and September of 1998 and in January and April of 1999 totaling $721,038 to pay income taxes they owed for 1998 on debtor's taxable income.

Defendants received dividend payments in April and June of 1999 totaling $1,065,220 to pay income taxes they owed for 1999 on debtor's taxable income.

All of these dividend payments to defendants were made in accordance with § 9.01 of the above shareholders' agreement executed on February 19, 1996.

Debtor's CFO projected in September of 1999 that debtor would suffer a loss of $1,000,000 to $1,500,000 for 1999. He recommended that each shareholder execute a promissory note evidencing repayment of his or her pro rata dividend for 1999 by December 31, 1999.

All four of the Forman defendants agreed to repay dividends they had received from debtor in 1999 to pay income taxes they owed for 1999 on debtor's taxable income. To this end, they executed promissory notes in favor of debtor which were then assigned to PNC Bank, debtor's secured lender.

Defendant Ashinoff, however, refused to repay the dividends he had received from debtor in 1999 to pay income tax he owed in 1999 on debtor's taxable income. Without his consent, debtor carried on its books as an account receivable the dividends paid to Ashinoff in 1999 for his estimated 1999 income tax payment. Debtor then assigned the account receivable to PNC Bank.

Debtor filed its federal income tax return for taxable year 1999 in July of 2000. It reported an NOL in the amount of $16,695,074, some fifteen to sixteen million dollars greater than it had projected in September of 1999.

Defendants thereafter filed their personal income tax returns for taxable year 1999. As shareholders of an S corporation, they availed themselves of debtor's NOL and carried it back to taxable years 1998 and 1997 seeking to recover tax refunds for those years exceeding $5,289,000 in the aggregate. Defendants either have received or are awaiting receipt of tax refunds as a result of debtor's 1999 NOL.

Debtor filed a voluntary chapter 11 petition on January 26, 2000. A creditors' committee was constituted several days later. Many and various activities occurred during the period when debtor languished in chapter 11. None of said activities appeared to direct debtor toward reorganization. To the contrary, debtor's assets were sold, leaving debtor a base shell and the proceeds were paid to the secured creditor and the professionals. When the tangible assets and possibility of reorganization were gone, the case was converted to a chapter 7 proceeding and was reassigned to this member of the court on June 6, 2001. A chapter 7 trustee was appointed the same day.

On December 21, 2001, while debtor's bankruptcy was still a chapter 11 proceeding, the committee of unsecured creditors commenced the above adversary action against defendants seeking to recover the above tax benefits and refunds received by defendants arising out of debtor's 1999 NOL. The chapter 7 trustee stepped into the shoes of the committee and took over prosecution of the adversary action after conversion of the case.

Count I of the complaint states a claim for unjust enrichment and requests that defendants be required to pay over any tax refunds they receive as a result of utilizing the 1999 NOL. Count II seeks imposition of a constructive trust in favor of debtor for any refunds defendants receive as a result of utilizing the NOL. Count III asserts that defendants' election not to waive loss carrybacks arising from the NOL and to utilize it instead to offset debtor's taxable income in future years constitutes an avoidable post-petition transfer under § 549(a) of the Bankruptcy Code. Count V seeks pursuant to § 550 to recover for the benefit of creditors the full amount of the refunds received by defendants.¹ Count VI asserts that defendants breached their fiduciary duty to debtor and its creditors by causing debtor to pay them dividends then utilizing the NOL to obtain tax refunds for themselves. Plaintiff seeks to recover the tax refunds received.

The case was tried on May 22, 2002, at which time the parties were given an opportunity to offer evidence on the issues raised.

DISCUSSION

Federal Preemption

On October 5, 1995, debtor elected in accordance with 26 U.S.C. § 1362(a) to be an S corporation. In its simplest terms, this means that the tax attributes of the corporation pass through to the shareholders. If the corporation earns a profit in a particular year the shareholders may elect to take same, pay the tax and keep the balance. If the corporation sustains a loss, the shareholders may utilize same by offsetting other income and reducing their tax due. In the case at hand, these shareholders elected not to generally take profits as they accrued but, instead, decided to only take a sum sufficient to pay the tax due and leave the balance of the profits earned in the corporation as a capital infusion.

The election remained in effect until it was terminated in January of 2000. Once the election was made, responsibility for payment of taxes owed on debtor's income and the right to utilize its NOLs passed through to debtor's shareholders based on each shareholder's pro rata share of debtor. 26 U.S.C. § 1366(a)(1)(A).

An NOL from a given taxable year can be carried back to each of the two taxable years preceding the loss 26 U.S.C. § 172(b)(1)(A)(I). The entire amount of the NOL for any taxable year is first carried back to the earlier of these taxable years. The portion of the loss which is carried back to the other taxable year is the excess, if any, of the amount of the loss over the sum of the taxable income for the prior taxable year to which it may be carried. 26 U.S.C. § 172(b)(2). A taxpayer entitled to a carryback period under § 172(a) may elect to relinquish the entire carryback period with respect to an NOL for a taxable year. The relinquishment, once it is made, is irrevocable. 172(b)(3).

The chapter 7 trustee does not dispute that defendants complied with the...