Matter of Federated Dept. Stores, Inc.
| Decision Date | 18 July 1994 |
| Docket Number | No. C-1-93-175. Bankruptcy No. 1-90-130.,C-1-93-175. Bankruptcy No. 1-90-130. |
| Citation | 170 BR 331 |
| Parties | In the Matter of FEDERATED DEPARTMENT STORES, INC., et al., Debtors. UNITED STATES of America, Appellant, v. FEDERATED DEPARTMENT STORES, INC., et al., Appellees. |
| Court | U.S. District Court — Southern District of Ohio |
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Gerald C. Miller, Washington, DC, for appellant.
Jeffrey Alan Lipps, Columbus, OH, for appellees.
The government appeals the bankruptcy court's decision allowing Federated Department Stores, Inc. ("Federated") to deduct certain tax attributes.1 This action arises out of Federated's acquisition of Twin Fair Distributors Corporation's ("TFDC") stock in May 1982. Following this stock purchase, the seven TFDC stores Federated acquired were operated as Gold Circle stores, a retailing division of Federated. TFDC operated as a separate subsidiary of Federated. In April 1985, Federated liquidated and dissolved TFDC. Consequently, Federated acquired all of TFDC's assets and liabilities, including certain net operating losses ("NOLs") of TFDC. The stores continued to operate as part of Federated's Gold Circle division until Federated sold all of its Gold Circle stores in 1988.
This dispute centers around Federated's use of the NOLs. In its 1986 tax return, Federated deducted the NOLs acquired from TFDC. The Internal Revenue Service ("IRS") disallowed Federated's use of these tax attributes and filed proofs of claim against Federated. Federated filed an objection to the proofs of claim. The government appeals the bankruptcy court's decision sustaining Federated's objection to the government's claim for unpaid taxes. In re Federated Dep't Stores, 135 B.R. 962 (Bankr. S.D.Ohio 1992).
This Court has jurisdiction to review on appeal the bankruptcy court's decision pursuant to 28 U.S.C. § 158(a).
For the reasons that follow, the bankruptcy court's decision is AFFIRMED.
In its appellate brief, the government incorporates by reference the findings of fact contained in the bankruptcy court's decision. (Doc. 5, p. 4). The government then sets forth "additional facts from the record." The government represents that these additional facts are consistent with the bankruptcy court's findings. Federated argues that the government's statement of facts either grossly distorts or simply misstates the factual record.
Given that the bankruptcy court's factual findings are undisputed, the relevant facts from the bankruptcy court's decision are set forth below. The government's "additional facts" and Federated's response to these additional facts will be noted when necessary.
Federated formed its Gold Circle division in the early 1970's. Gold Circle was Federated's entry into the mass merchandising business, which included stores offering moderately priced lines of hard and soft goods with a high degree of customer self-service.
Federated operated Gold Circle as one of its retailing divisions. Federated's divisions operate separately from Federated but are not separate subsidiaries or separate taxable entities. As of June 1981, Gold Circle operated 41 stores in the Midwest and Northeast. In 1981, Gold Circle continued to have a significant gap in its operating territory, particularly in the Northeast.
On July 8, 1981, Gold Circle issued a Long Range Plan (1981-1986). Gold Circle established plans to expand in the Northeast market. Buffalo, New York was determined to be an ideal location for Gold Circle under the criteria of the Long Range Plan. The Plan also stated that the acquisition of an established business would allow expansion at approximately one half the investment required for a new store.2
TFDC was a subsidiary of Twin Fair, Inc. ("Twin Fair"), a publicly traded corporation. TFDC, like Gold Circle, was a discount retailer offering a broad range of national brand name merchandise at promotional prices.3 In 1980, after eighteen profitable years, TFDC was the leading discount retailer in western New York, holding nearly a 50% market share.
TFDC began to experience a financial downturn in 1980.4 TFDC experienced increased erosion of its profit margins. To reduce its increasing bank debt, TFDC sold its Ohio stores in the second quarter of 1981.
From 1980 to 1982, TFDC generated net operating losses. For the year ending December 31, 1981, Twin Fair's tax return showed NOLs of $18,900,000, the majority attributable to TFDC. In 1982, Twin Fair incurred an additional $10 million in NOLs. For the year ending December 31, 1982, Twin Fair's tax return showed NOLs of $25,755,657. TFDC had an investment tax credit carry forward of $934,061.
In September 1981, Twin Fair decided to sell the remaining operations of TFDC.5 Twin Fair retained Merrill Lynch to sell TFDC. In late 1981, Federated and a variety of other retailers received an unsolicited inquiry from Merrill Lynch concerning the possible acquisition of TFDC. Merrill Lynch prepared a prospectus, favorably describing TFDC's current business and portraying TFDC as an excellent candidate for acquisition. Merrill Lynch acknowledged that TFDC had suffered some economic setbacks in 1980, but projected that TFDC could be made profitable through the significant overhead savings that could be achieved if TFDC was integrated with an existing retail mass merchandise organization. Merrill Lynch emphasized TFDC's favorable position in the Buffalo market, its cost effective advertising campaign, and that TFDC owned its own real estate.6
Gold Circle began an investigation of TFDC after receiving the prospectus. After visiting the Buffalo stores, Gold Circle's Chairman concluded that the TFDC acquisition fit squarely within Gold Circle's expansion program for the following reasons: (1) TFDC was in the appropriate geographical region, (2) TFDC was in a relatively low competitive market, (3) TFDC was a broadly based mass merchandiser, and (4) the TFDC stores were already established store locations.7
A number of Federated and Gold Circle departments then analyzed TFDC. Their research recommended that Federated acquire only the most profitable locations.
Based on the analyses, Gold Circle and Federated began negotiations in fall 1981.8 Federated and Gold Circle expressed a desire to purchase only the assets of TFDC. It was not the practice of Federated or Gold Circle to acquire the stock of a company. Twin Fair was not willing to sell only assets because it desired to divest TFDC in its entirety.9
Another topic of negotiations was the number of stores Federated would acquire. In the end, Federated acquired seven of the fifteen available stores. These stores were demographically acceptable and had been, and were projected to be, the most profitable.
In January 1982, TFDC's net operating losses became an issue in negotiations. According to the bankruptcy court, the NOLs were an important aspect of the transaction for Twin Fair because they were a vehicle for Twin Fair to obtain value. The bankruptcy court also concluded that the NOLs were never the principal or even a significant subject of the negotiations for Federated or Gold Circle. Even though the NOLs were considered part of the analysis of the acquisition for Federated, according to the bankruptcy court, the deal was structured so Federated would receive no economic benefit if the NOLs were realized. The bankruptcy court concluded that the NOLs did not weigh heavily in Federated's decision to approve the acquisition of TFDC.10
In March 1982, a Capital Expenditure Request ("CER") was submitted for the TFDC acquisition.11 The CER indicated a return on investment of 46.1%, which was higher than Gold Circle's standard of 21%. The CER also indicated a discounted cash flow return of 25.5%, which was also higher than Gold Circle's benchmark of 15%. Further, the CER indicated that if the benefit of the NOLs was not realized, the impact on the discounted cash flow was only 0.5%.12
The government submits that the CER also showed that TFDC had a pre-tax NOL of $20 million and that in the event of acquisition, Gold Circle intended to write off $6.4 million in unusable assets (fixtures and equipment). The CER discussed Gold Circle leasing some of the locations, and showed that liabilities exceeded assets by $2,916,000.
According to the government, the CER projected that Gold Circle would save $13.2 million in taxes during the first three years by using the $20 million in NOLs and $6.4 million in write-offs from fixtures.
On March 25, 1982, Federated's Board of Directors approved the acquisition of TFDC stock. The government submits that the Board members discussed the tax attributes before approving the deal.
Moreover, the government states that the April 28, 1982 minutes from the Twin Fair Board of Directors' meeting reveal that difficulties were experienced in the negotiations regarding the tax loss credits and the legal ramifications. The minutes also reveal that if the contract was not executed by May 4, the appropriate action was to file for bankruptcy.
On May 5, 1982, Federated and Twin Fair entered into an Agreement of the Purchase and Sale of TFDC. Under the Agreement, Federated acquired the stock of TFDC in exchange for $550,000 cash; a non-interest bearing promissory note with a principal amount of $8.1 million due on August 3, 1988; a non-interest bearing contingent note with a principal amount of $5.4 million;13 a $2 million loan to Twin Fair with a 12% annual interest rate to be repaid in 36 monthly installments beginning July 1, 1984; and a $500,000 loan to Twin Fair with a 12% annual interest rate to be repaid on February 3, 1983.
The government contends that Federated and Twin Fair had an unwritten agreement regarding the disposition of TFDC's fixtures. The government asserts that Federated planned on obtaining a $6.4 million write-off from the abandonment of fixtures; thus, for tax reasons, Federated...
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