Indeck Energy Services, Inc. v. Commissioner
| Decision Date | 11 April 2003 |
| Docket Number | Docket No. 21586-97.,Docket No. 23943-97. |
| Citation | 85 T.C.M. 1128 |
| Parties | Indeck Energy Services, Inc., and Subsidiaries v. Commissioner. Michael P. and Maya Polsky v. Commissioner. |
| Court | U.S. Tax Court |
Thomas C. Borders, James L. Malone III, and David J. Duez, for the petitioners Indeck Energy Services, Inc., and Subsidiaries.
Ronald A. Stein, for the petitioners Michael P. and Maya Polsky. Jan E. Lamartine and Robert Little, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
By separate notices of deficiency, respondent determined the following deficiencies and penalties with respect to petitioners' Federal income taxes:
Indeck Energy Services, Inc. and Subsidiaries
Docket No. 21586-97
Penalty
Year Deficiency Sec. 6662(a)
FYE 11/30/93..... $1,542,339 $231,108
FYE 11/30/94...... 4,994,929 999,468
FYE 11/30/95....... 536,715 107,343
Michael P. and Maya Polsky
Docket No. 23943-97
Penalty
Year Deficiency Sec. 6662(a)
CY 1994 ....... $ 660,910 $132,182
These cases were consolidated for trial, briefing, and opinion. After concessions, we must decide the following issues:
(1) Whether $4,856,922 of a $19,886,922 settlement payment made by petitioner Indeck Energy Services, Inc. (Indeck), to petitioner Michael P. Polsky (Mr. Polsky) on May 16, 1994, constitutes interest deductible by Indeck and recognizable as ordinary income by petitioners Michael P. and Maya Polsky in their respective taxable years ended in 1994, or instead is part of the purchase price for shares of Indeck stock sold by Mr. Polsky to Indeck; and
(2) Whether petitioners Indeck Energy Services, Inc., and Subsidiaries or petitioners Michael P. and Maya Polsky are liable for accuracy-related penalties under section 6662(a) for their respective taxable years ended in 1994.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Some of the facts have been stipulated and are so found. The stipulation of facts and first supplemental stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners Michael P. and Maya Polsky (the Polskys) resided in Northbrook, Illinois, at the time their petition was filed.
Indeck is the common parent of an affiliated group of corporations making a consolidated return. Indeck's principal office was located in Buffalo Grove, Illinois, at the time its petition was filed.
Prior to and during the year in issue, Indeck was engaged in the power supply business, principally through cogeneration, the simultaneous generation of electricity and another form of useful thermal energy, such as steam, from the same fuel source.
Mr. Polsky was hired to serve as president of the Indeck Energy Services Division of Indeck Power Equipment Co. (Indeck Power) in June 1985 by Indeck Power's president, Gerald R. Forsythe. Indeck Power's Indeck Energy Services Division was subsequently incorporated as petitioner Indeck in 1985. Mr. Polsky became its president in 1986.
On January 21, 1987, Mr. Polsky and Indeck executed an employment agreement (Employment Agreement) and a shareholders' agreement (Shareholders' Agreement),1 both retroactive to June 1, 1986. The Employment Agreement provided that Indeck would employ Mr. Polsky for 7 years; i.e., until June 1, 1993. The Employment Agreement further conferred upon Mr. Polsky salary, bonuses, and additional compensation measured as a percentage of Indeck's net profits, as well as certain stock options and deferred compensation rights that entitled him to acquire up to 30 percent of Indeck's outstanding shares of common stock. The Shareholders' Agreement restricted the sale of any Indeck shares acquired by Mr. Polsky, providing in general that Mr. Polsky was required to sell, and Indeck to purchase, such shares in the event that Mr. Polsky's employment with Indeck were terminated under prescribed conditions, including voluntary or involuntary termination during the 7-year term of employment provided in the Employment Agreement, and thereafter.
While the Employment Agreement provided for Mr. Polsky's employment by Indeck for 7 years until June 1, 1993, it further entitled Indeck in its sole discretion to terminate Mr. Polsky's employment after 4 years in prescribed circumstances.2 Specifically, under paragraph 12.c. of the Employment Agreement, Indeck was entitled to terminate the agreement (with 30 days' notice) if, as of the fourth anniversary of the effective date of the agreement, Indeck had a negative net worth of $500,000 or more, as determined from its audited statements for the 4 previous fiscal years ended November 30, 1986, 1987, 1988, and 1989.
The Shareholders' Agreement, which incorporated and cross-referenced the Employment Agreement, provided that Mr. Polsky was required to sell, and Indeck required to purchase, any Indeck shares owned by Mr. Polsky in the event of the involuntary termination of his employment after 4 years pursuant to paragraph 12.c. of the Employment Agreement. The Shareholders' Agreement further provided that the price to be paid by Indeck in these circumstances was an amount equal to the greater of: (1) 100 percent of the net book value per share as of the last day of the month preceding the date of the notice of termination; or (2) the highest purchase price offered in all bona fide third-party offers to purchase 100 percent of Indeck's total voting stock received within 1 year from the date of employment termination. The Shareholders' Agreement further provided that the closing date for the purchase of Mr. Polsky's shares was to occur within 13 months of the date of termination, at which time Indeck was to pay Mr. Polsky 20 percent of the purchase price, with the remaining 80 percent to be paid equally over four annual installments with interest on the unpaid balance at a rate equal to the applicable Federal rate as defined in section 1274(d) (). For purposes of setting the purchase price of Mr. Polsky's shares by means of third-party offers, the Shareholders' Agreement authorized Mr. Polsky to solicit offers to purchase Indeck's shares and required Indeck to provide "reasonable assistance" in connection with the solicitations.
The Employment Agreement provided that any controversy or claim arising out of the agreement was required to be settled by arbitration. The Shareholders' Agreement provided that, in addition to any other remedies available to the parties thereto, any controversy concerning the right or obligation to purchase or sell Mr. Polsky's shares was enforceable in a court of equity by a decree of specific performance.
On August 2, 1990, Gerald R. Forsythe, Chairman of the Board of Indeck, notified Mr. Polsky by letter that his employment with Indeck would terminate on September 5, 1990, in accordance with paragraph 12.c. of the Employment Agreement, on the ground that Indeck's negative net worth exceeded $500,000 as of November 30, 1989. Shortly thereafter, Mr. Polsky and Mr. Forsythe met regarding the termination letter and the possibility of renegotiating the terms of Mr. Polsky's employment. When Mr. Polsky did not accede to terms of a new agreement, he received a letter on September 21, 1990, advising that his employment with Indeck would terminate on September 22, 1990. Mr. Polsky's employment with Indeck did terminate on that date. At that time, Mr. Polsky held 30 of Indeck's 100 issued and outstanding shares of common stock.
Mr. Polsky commenced an arbitration proceeding against Indeck on September 21, 1990. In the arbitration, Mr. Polsky sought an award of compensatory damages for breach of the Employment Agreement, including the amount he would have received in salary, bonuses, and percentage compensation, as well as the value to which his Indeck shares would have appreciated by June 1, 1993, the expiration of his term of employment under the Employment Agreement.
Mr. Polsky also began soliciting potential purchasers for Indeck's outstanding stock in an attempt to set a value for his shares under the third-party offer provisions of the Shareholders' Agreement. As a result of Mr. Polsky's efforts, on November 9, 1990, PowerLink Corp. (Power-Link), the subsidiary of a private utility holding company with assets of $2.5 billion, offered to purchase all 100 of Indeck's outstanding shares from its shareholders at a price of $1 million per share, subject to certain contingencies and a due diligence financial review. PowerLink revised its offer to $501,000 per share in a letter to Indeck received on January 31, 1991. After Indeck's board of directors reviewed PowerLink's offer, Mr. Forsythe wrote to PowerLink on February 6, 1991, stating that shareholders owning more than 50 percent of Indeck's outstanding common stock had advised the board that they were unwilling to sell their shares. On February 14, 1991, PowerLink advised Mr. Polsky by letter that its offer to purchase Indeck's outstanding shares had not been accepted and had expired.
As a result of further efforts by Mr. Polsky, CMS Generation Co. (CMS Generation), the subsidiary of a private utility company with $8 billion in assets, made an offer on August 6, 1991, to purchase the outstanding stock of Indeck for $75 million subject to a due diligence financial review. On September 24, 1991, Mr. Forsythe, acting on behalf of Indeck, advised CMS Generation by letter that Indeck's obligation to cooperate with Mr. Polsky under the Shareholders' Agreement had expired and that, as a shareholder, he was not interested in selling his shares of...
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