In re Refco Pub. Commodity Pool, L.P., Case No. 14–11216 BLS
| Decision Date | 02 August 2016 |
| Docket Number | Case No. 14–11216 BLS |
| Citation | 554 B.R. 736 |
| Parties | In re: Refco Public Commodity Pool, L.P., Debtor. |
| Court | U.S. Bankruptcy Court — District of Delaware |
554 B.R. 736
In re: Refco Public Commodity Pool, L.P.1 Debtor.
Case No. 14–11216 BLS
United States Bankruptcy Court, D. Delaware.
Signed August 2, 2016
George B. Abney, Suzanne N. Boyd, Dennis J. Connolly, William S. Sugden, Alston & Bird LLP, Atlanta, GA, Russell C. Silberglied, Amanda R. Steele, Richards, Layton & Finger, P.A., Wilmington, DE, for Debtor.
OPINION2
Brendan Linehan Shannon, Chief United States Bankruptcy Judge
MAA, LLC, the plan administrator for the confirmed plan of Refco Public Commodity Pool, L.P., (the “Debtor”) asks this Court to disallow the amended proof of claim (the “Claim”)3 filed by the Internal Revenue Service (the “IRS”) and determine that the Debtor owes no tax or penalty under applicable tax law and Bankruptcy Code sections 505(a) and 502(b)(1). It is undisputed that that the Debtor failed to file its tax returns for the years 2006 to 2008; and that for such failure, the Debtor incurred penalties totaling $3,662,000. The question before the Court is whether these penalties should be waived under Internal Revenue Code (“IRC”) sections 6724(a) and 6698(a)(1) because the Debtor's failure to file was due to reasonable cause and not willful neglect. For the reasons set forth below, the Court holds that the penalties should be excused and will disallow the Claim.
I. BACKGROUND
The Debtor formed in 2003 as a partnership to track the performance of the Standard
& Poor's Managed Futures Index. The Debtor invested substantially all of its assets in SPhinX Managed Futures Fund, SPC (“SMFF”), a Cayman Islands domiciled segregated portfolio company that was part of a group of affiliated companies knows as the SPhinX Group. SMFF used Refco, LLC as its regulated futures commission merchant to execute futures and other trades; and maintained assets in excess of its required margin with Refco Capital Markets, Ltd. In late 2005, the Debtor was placed in extremis when these Refco entities, along with certain affiliates, (“Refco”) filed for bankruptcy, and shortly thereafter, the SPhinX Group, including SMFF, filed for liquidation in the Grand Court of the Cayman Islands.
A. Refco Bankruptcy
In October 2005, Refco filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. (The Debtor was not among the Refco entities that filed for bankruptcy in 2005.) The primary event precipitating the filing was the announcement that Refco had discovered a sizable undisclosed related party receivable. Almost immediately, Refco was in the throes of a liquidity crisis as investors began withdrawing their funds. Among these investors was SMFF, which shortly before Refco filed bankruptcy, withdrew approximately $312 million.
In December 2005, a $312 million avoidance action under Bankruptcy Code section 547 was filed against SMFF. On the same day this action was filed, the bankruptcy court froze SMFF's assets. SMFF eventually settled this preference action for $260 million (the “Preference Settlement”).
B. SPhinX Group Liquidation and Chapter 15 Filing
In December 2005, the Debtor sought to redeem its entire investment in SMFF. Instead of honoring this request, SMFF issued the Debtor “special situation shares” (“S Shares”). The S Shares were illiquid and in alleged satisfactions of SMFF's obligation to honor the Debtor's redemption request. Other than the S Shares, the Debtor had no material assets.
In June 2006, the SPhinX Group, including SMFF, voluntarily placed itself into liquidation in the Grand Court of the Cayman Islands (the “Grand Court”). The Grand Court appointed Kenneth Krys and Christopher Stride as the joint official liquidators (the “Liquidators”) and ordered the winding up of each of the funds in the SPhinX Group. In July 2006, the Liquidators filed for recognition under Chapter 15 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York.
Early on in the liquidation proceeding, the Liquidators uncovered serious accounting issues. In 2006, the Liquidators advised the Debtor and other investors in the SPhinX Group that the accounting work performed by Derivatives Portfolio Management LLC (“DPM”), the SPhinX Group's administrator responsible for maintaining the accounting records, was inaccurate and incomplete. Of note, certain DPM prepared spreadsheets that detailed the year-to-date change in net asset values among the SPhinX Group funds (hereinafter, the “NAVINC Files”) contained serious deficiencies. In an affidavit submitted to the Grand Court on June 20, 2007, Mr. Krys discussed a host of significant accounting issues: extensive co-mingling of funds; misstatements of cash; failure to process redemptions; inadequate documentation of transactions within the SPhinX Group; failure to properly allocate shares; two sets of books; and the net asset value calculations not accounting for
the Preference Settlement. Due to these issues and others, the Liquidators advised investors that they could not give assurances regarding the accuracy of the net asset value calculations disseminated to investors since 2002. The Liquidators also began including strongly worded disclaimers warning against relying upon or using any financial reports regarding the SPhinX Group.
After 2005, SPhinX Group did not file Form 1065 with the IRS, or provide its investors with a Schedule K–1 (together, the “Partnership Returns”). In July 2011, the Liquidators filed a motion under Bankruptcy Code section 505 in its Chapter 15 proceeding seeking a determination that the SPhinX Group owed no penalties for not filing Partnership Returns for the years 2005 to 2007. In a declaration submitted with the motion, Mr. Krys noted that the Liquidators would not be filing Partnership Returns for any year after 2005. He explained that to prepare these returns would cost between $5 and $7 million because an accounting firm would have to reconstruct thousands of records.4 The IRS and the Liquidators settled the matter and SPhinX Group was absolved from having to file Partnership Returns for the years 2005 to 2007.
Before making distributions to investors, the Liquidators identified twenty-three issues (the “Liquidation Issues”) they had to resolve. These issues consisted of a broad range of disputes between various investors and creditor constituents. The two more notable of these issues concerned the allocation of the Preference Settlement among the SPhinX Group funds and the treatment of the S Shares.
In November 2013, after many years of litigation and negotiation, the Grand Court approved the “Second Scheme of Arrangement.” In compliance with this scheme, the Liquidators made an initial distribution to investors in March 2014. At that time, the Debtor received approximately 36% of the remaining net asset value of its investment in SMFF, which equated to approximately $11.5 million.
C. The Debtor's Liquidation Proceeding and Chapter 11 Filing
In November 2006, Richard Butt, the President of Refco Fund Holdings, LLC, the Debtor's general partner, petitioned for the appointment of a liquidating trustee to oversee the Debtor in the Delaware Court of Chancery. The Chancery Court appointed MAA, LLC as the liquidating trustee and authorized it to take control of the Debtor. At the time MAA was appointed, the Debtor had approximately 1,600 investors and assets of approximately $39 million.
On May 13, 2014, the Debtor filed a voluntary Chapter 11 petition with this Court. On the same date, the Debtor filed a disclosure statement and plan.5 On September 9, 2014, the Court confirmed the plan and appointed MAA as the plan administrator charged with liquidating the Debtor's remaining assets. According to the Debtor's approved disclosure statement, its only material non-cash asset was its investment in SMFF.
On November 10, 2014, the IRS filed the Claim asserting a general unsecured claim
of $4,112,000 for penalties stemming from not filing Partnership Returns for years 2005 through 2008.6 On January 20, 2015, the Debtor objected to the Claim (the “Objection”) under IRC sections 6724(a) and 6698(a)(1) and Bankruptcy Code sections 505(a) and 502(b)(1).7 The IRS filed a response to which the Debtor replied.8 The Court heard oral argument and testimony on June 16, 2016 (the “Trial”) and took the matter under advisement. The matter has been fully briefed and is ripe for decision.
II. JURISDICTION AND VENUE
The Court has jurisdiction over this matter under 28 U.S.C. §§ 1334 and 157(a)(b)(1). Venue is proper in this Court pursuant to 28 U.S.C. §§ 1408 and 1409. Consideration of this Objection constitutes a core proceeding under 28 U.S.C. § 157(b)(2)(B).
III. DISCUSSION
As part of the claims allowance process, bankruptcy courts may adjudicate a debtor's tax liability. 11 U.S.C. § 502(a) ; see 11 U.S.C. § 505(a)(1) ( “[T]he court may determine the amount or legality of any tax, any fine, or penalty relating to a...
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