In re Kelly
| Decision Date | 14 December 2021 |
| Docket Number | 18-60514 |
| Parties | In re: MARK A. KELLY and VANESSA C. KELLY Debtors. |
| Court | U.S. Bankruptcy Court — Northern District of New York |
APPEARANCES:
Hodgson Russ LLP
U.S Department of Justice Tax Division
Richard L. Weisz, Esq. Counsel for Debtors
Thelma Alejandra Lizama, Esq. Counsel for Creditor the United States of America (Internal Revenue Service)
This matter is before the Court following a bench trial on Debtors', Mark A. Kelly ("Mr. Kelly") and Vanessa C. Kelly ("Mrs. Kelly"), objection to the claim ("Objection to Claim") of the Internal Revenue Service of the United States of America (the "IRS"). On May 25, 2018, the IRS filed its initial Proof of Claim (Claim No. 8-1) that included a secured claim in the amount of $1, 644, 099.14, a priority claim in the amount of $2, 168, 618.18, and a general unsecured claim of $14, 079.73, for a total amount of $3, 826, 797.05. Debtors filed their Objection to Claim No.#8-1 pursuant to 11 U.S.C. § 502 and Federal Rule of Bankruptcy Procedure 3007. On November 30, 2018, the IRS filed an amended Proof of Claim (Claim No. 8-4) that included a secured claim in the amount of $1, 644, 099.14, a priority claim in the amount of $1, 991, 591.28, and a general unsecured claim of $727, 341.63, for a total amount of $4, 363, 032.05.
The IRS filed a response to Debtors' Objection on December 10, 2018 (the "Response," ECF No. 63). Because Debtors' 2013 amended 1040 tax return was under examination, Debtors did not file for tax returns for subsequent years until the audit closed. For this reason, the IRS amended its proof of claim multiple times and finally on February 22, 2019 to reflect amended Claim No. 8-5 with $1, 644, 099.14 in secured claims, $1, 997, 716.48 in unsecured priority claims, and $727, 341.63 in general unsecured claims (Claim No. 8-5). After numerous adjournments, this matter was heard virtually by Zoom for Government on March 16, 2021 (the "Hearing").[1] At the close of evidence, the Court requested the parties to submit post-trial briefs, which they did simultaneously on May 3, 2021 (ECF No. 166 and 167). At that time the matter was taken under advisement. After consideration of the parties' written submissions and arguments, the Court now makes the following findings of fact and conclusions of law.
The Court has jurisdiction over the subject matter and parties of this contested matter pursuant to 11 U.S.C. § 502 and § 505(a)(1), 28 U.S.C. §§ 1334(a), 1334(b), 157(a), and 157(b)(2)(B).
Debtors claim they are owed a refund in the amount of $64.00 for tax year 2013, a refund in the amount of $4, 762.00 for 2016, and a tentative refund in the amount of $1, 347, 250.00. Debtors argue that because they made capital contributions to the company, their tax basis in the company and their ability to claim certain deductions were preserved. Debtors further contend that after the IRS completes its examination of the company's 2013 amended tax return, either no taxes will be due or, at the most, only $75, 000 will be due as the tentative refund will cover all post 2013 taxes. For these reasons, Debtors ask this Court to disallow the IRS's proof of claim to the extent it exceeds tax obligations due.
Debtors also argue that they were insolvent when the company's secured lender took possession of and sold the company pursuant to an Article 9 Sale of the Uniform Commercial Code (the "Article 9 Sale"). Debtors claim that because they were insolvent at that time, they were relieved of any obligation to pay the IRS on cancelled debt resulting from the sale of that company.
The IRS argues Debtors failed to overcome the presumption of validity and correctness of its proof of claim because they failed to provide sufficient information to support their claim that no taxes are due. Further, the IRS contends that the significant losses incurred by the company eliminated any tax basis Debtors had in the company, thus negating their right to the deductions claimed on their personal tax returns. Finally, because the IRS has now completed its examination of Debtors' 2012 and 2013 tax returns, the IRS asks this Court to allow the proof of claim as filed.
There are two issues before the Court. First, whether Debtors are entitled to claim certain tax deductions, and the resulting tax refunds, related to their tax basis in a limited liability company that they owned and which incurred significant losses for the fiscal years relevant to an IRS audit of Debtors' personal tax returns. Second, whether Debtors were insolvent at the time the secured lender took possession of their company, thus relieving them of any tax obligations due to the cancellation of debtor related to the Article 9 Sale of their former company. The facts of the matter are highly disputed. Therefore, the Court's ruling is predicated on the evidentiary record which consists of the testimony elicited by both sides from three witnesses and documentary evidence. For the reasons set forth below, Debtors' Objection to Claim is denied.
By way of background, Debtors owned multiple companies, including but not limited to VMR Electronics, LLC ("VMR") and VMR Realty Management, LLC (VMR Realty), each of which experienced financial difficulties. Tr. 61. VMR had a number of loans with NBT Bank (the "Bank") that were secured with a blanket lien on all of Debtors' assets and businesses. Tr. 25. In early 2013 the IRS began an audit of VMR's 2011 tax return based on a tentative refund issued in the amount of approximately $2.8 million dollars. Tr. 21-22. By April 2013, however, the Bank had taken control of VMR's assets (Tr. 15) and enforced its rights through the Article 9 Sale in June 2013 (IRS' Exhibit 3). In consideration of Debtors' cooperation in completing the sale, Debtors entered into a forbearance agreement with the Bank dated June 18, 2013. This agreement released the personal guaranty of Mrs. Kelly and limited Mr. Kelly's personal guaranty to $2, 707, 100.00. (IRS' Exhibit 6). Thereafter, all of VMR's assets were sold as a going concern to an unrelated third party named VMR Electronics Corporation. (Debtors' Exhibit 14).
At the Hearing, Debtors' counsel called both Debtors as witnesses and offered 48 exhibits into evidence. On direct examination, Mr. Kelly testified that after studying computer science for one year at a junior college, he went to work for a small electronics distributor in 1978. Tr. 8-9. He started at the bottom and by 1986, he was running the division and oversaw about six or seven divisions in the Northeast. Tr. 9. The company primarily served as a distributor to the department of defense. Id. Thereafter, he moved to Philadelphia and ran that division. Id. After working for the company for 16 years, Mr. Kelly purchased a manufacturer's representative firm, Fountain Young & Company, and moved to Syracuse, New York in 1994. Tr. 9-10. He worked at that firm until he started VMR in 2001. Tr. 10. VMR served as a real estate holding company for a building located at 137 Washington Avenue in the Binghamton area. Id. He and Mrs. Kelly were the sole owners of VMR with ownership interests of at 49 % and 51% respectively. Id.
In 2005, VMR received an order for slightly less than $10, 000, 000.00 and it started building cable assemblies for the Syracuse Research Corporation. Tr. 11-12. The order was for IED jammers[2] and was considered a high priority for national defense. Tr. 11. Mr. Kelly testified that he later secured patents for his antenna cable designs utilized by the IED jammers. Tr. 12. By mid-2006, the company had grown significantly, requiring Debtors to purchase a 22, 000 square foot facility located at 811 North Street. Id. By the end of 2009, VMR had 280 employees and generated $45, 000, 000.00 in revenue, and by the beginning of 2010 it was generating $46, 000, 000.00 in revenue. Id. VMR's accounting records were maintained by its then chief financial officer, a Certified Public Accountant, who had the records certified by an outside firm of Certified Public Accountants annually. Tr. 42.
In 2010, when the government funding for IED jammers evaporated, the military significantly reduced purchasing them from VMR. As a result, VMR had difficulty obtaining financing and began to struggle financially. Tr. 14. Mr. Kelly testified that in order to maintain operations, Debtors began using their own funds to provide the needed cash flow to operate VMR.
Between 2009 and 2010 Debtors "funded in millions" from royalties received from his patent. In 2012, they used funds from their retirement accounts, credit cards and by taking out a home equity line on their home, and by early 2013, Debtors used an additional $203, 000.00 in personal funds to pay VMR vendors. Id. Despite these financial infusions into VMR, which Mr. Kelly testified totaled approximately $700, 000.00, the Bank took possession of VMR and placed an agent onsite who then took possession of the company's assets and checking accounts. Tr. 14-15. Mr. Kelly also testified that any business transactions made during this time were not entered into VMR's accounting system. Tr. 23. After the Article 9 Sale, Mr. Kelly stayed on as an employee of subsequent owners. Tr. 16.
Also in early 2013, the IRS began an onsite audit of VMR's 2011 tax return, at which time Mr. Kelly retained attorneys and Certified Public Accountants who communicated directly with the IRS on Mr. Kelly's behalf. Tr. 21. According to Mr Kelly, VMR provided numerous documents to the IRS, which were "enough to fill a pallet." Tr. 22. At the request of the IRS, Mr. Kelly contacted VMR's creditors to determine which accounts payable had been paid and which...
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