Thornock v. Comm'r of Internal Revenue

• Decision Date: 19 March 1990
• Docket Number: Docket No. 29123-86.
• Citation: 94 T.C. No. 25,94 T.C. 439
• Parties: RUSSELL D. THORNOCK AND CATHY A. THORNOCK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

94 T.C. 439

94 T.C. No. 25

RUSSELL D. THORNOCK AND CATHY A. THORNOCK, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 29123-86.

United States Tax Court

Filed March 19, 1990.

Petitioner, Russell D. Thornock, invested in a partnership that invested in a multiple-party equipment leasing transaction involving computer equipment. The partners had no realistic economic liability on the partnership debt obligations because of guarantees made to the partners by other participants in the transaction, because of the nonrecourse nature of the underlying third-party debt on which the transaction was based, and because of other features of the transaction. HELD: The partners were not at risk under sec. 465(b), ¹ I.R.C. 1954, with regard to the partnership debt obligations. Stephen E. Silver, Brad S. Ostroff, and Stephen D. Gardner, for the petitioners.

Theodore J. Kletnick and Sandy E. Freund, for the respondent.

OPINION

SWIFT, JUDGE:

This matter is before the Court on the parties' cross motions for partial summary judgment. Rule 121(b). The motions raise essentially legal issues or issues of ultimate fact that the parties ask us to resolve, in the context of these motions, solely on the basis of the relevant undisputed stipulated facts, documents, and applicable law. This is a test case that will affect the outcome of other cases filed by investors in this and other transactions. The parties suggest that the resolution of the issues by summary judgment will significantly reduce and may eliminate entirely the need for what otherwise would be a lengthy trial in this case. We commend the parties for utilizing this procedure, and we appreciate the thorough manner by which their respective arguments have been made.

The issue presented by these motions is whether petitioner Russell D. Thornock (‘petitioner‘) was at risk within the meaning of section 465 with respect to partnership debt obligations associated with a computer equipment leasing transaction.

Stipulated Facts

ORIGINAL PURCHASE TRANSACTION AND END-USER LEASE

On May 7, 1979, Alanthus Corporation (‘Alanthus‘), an equipment leasing corporation, purchased certain computer equipment from International Business Machines Corporation (‘IBM‘) for $3,535,000. Simultaneously, Alanthus sold the computer equipment to Alanthus Computer Corporation (‘Alanthus Computer‘), one of its wholly owned subsidiary corporations, for the same amount.

In connection with its purchase of the computer equipment, Alanthus Computer borrowed $3,248,151 on a nonrecourse basis from Citicorp Industrial Credit, Inc. (‘Citicorp Credit‘), a lending subsidiary of Citicorp Bank unrelated to Alanthus and Alanthus Computer. The loan proceeds were used by Alanthus Computer, with additional cash of $286,849, to pay Alanthus the full purchase price of the computer equipment. Alanthus apparently used the proceeds received from Alanthus Computer to pay IBM the full purchase price due on its purchase of the computer equipment.

Under Alanthus Computer's seven-year promissory note to Citicorp Credit, monthly payments of principal and interest at 11.5 percent per annum were due as follows: From June 1, 1979 through April 1, 1983 -- $72,000; from May 1, 1983 through April 30, 1986 -- $25,000.

As indicated, Citicorp Credit's $3,248,151 loan to Alanthus Computer was made on a nonrecourse basis. As collateral for the loan, Citicorp Credit received a security interest in the computer equipment and in the lease payments due under all end-user leases of the computer equipment until the full amount of the loan was paid off.

On March 27, 1979, in anticipation of its acquisition of the above computer equipment, Alanthus Computer entered into an end-user lease agreement with J.P. Stevens & Co., Inc. (‘J.P. Stevens‘), a company unrelated to Alanthus or Alanthus Computer, with respect to the computer equipment. The initial term of the lease was for seven years, from May 1, 1979, through April 30, 1986. Thereafter, the lease could be renewed for successive three-month terms until terminated by either party. Monthly lease payments were due, effectively matching the payments due on the promissory note to Citicorp Credit, in the following amounts: From June 1, 1979, through April 1, 1983 -- $72,500; from May 1, 1983, through April 30, 1986 -- $25,000.

Alanthus Computer and J.P. Stevens entered into a remarketing agreement under which Alanthus Computer was to be the exclusive agent to assist J.P. Stevens to remarket or sublease the equipment if J.P. Stevens chose to sublease the equipment. Under the remarketing agreement, Alanthus Computer agreed to reimburse J.P. Stevens for losses arising from the discontinuance of use or from a sublease of the equipment during the fifth through the seventh years of the original end-user lease, less Alanthus Computer's reasonable costs relating to its remarketing efforts. Also, during the fifth through seventh years of the initial lease, J.P. Stevens was to pay Alanthus Computer all amounts received under any sublease to the extent the monthly income received exceeded $25,000, the monthly amount due Alanthus Computer on the primary lease.

PURCHASE BY PARTNERSHIP AND RELATED TRANSACTIONS

On May 31, 1979, three additional and essentially simultaneous transactions occurred involving the computer equipment with the apparent ultimate objective, among other things, of transferring ownership ² of the computer equipment and assignment of the end- user lease (subject to the secured interest therein of Citicorp Credit) to Tiger Lily Leasing Associates (‘Tiger Lily‘), the equipment leasing partnership in which petitioners invested and through which petitioners now claim the losses and expenses at issue in this case.

The first transaction was a sale of the computer equipment and assignment of the end-user lease by Alanthus Computer to A-F Associates. That transaction was followed by the immediate resale of the computer equipment and reassignment of the end-user lease by A-F Associates to Alafund Associates. Both transactions, of course, were subject to the prior security interest of Citicorp Credit in the equipment and end-user lease payments due.

The stated purchase price for the purchase of the computer equipment by A-F Associates from Alanthus Computer was $3,777,297 -- $529,145 in cash and the assumption by A-F Associates of the $3,248,151 nonrecourse debt obligation of Alanthus Computer to Citicorp Credit. The stated purchase price for the purchase by Alafund Associates of the computer equipment from A-F Associates is not disclosed in the record, but Alafund Associates executed a $3,005,854 promissory note in favor of A-F Associates with respect to its purchase of the computer equipment. Although not completely clear, it appears that this $3,005,854 promissory note purports to be a recourse promissory note.

A-F Associates and Alafund Associates are two equipment leasing limited partnerships that, through subsidiary corporations, were owned and controlled by the same two corporate leasing companies. The general partner and one-percent owner of A-F Associates was Alanthus. The sole limited partner and 99-percent owner of A-F Associates was Funding Systems Leasing Corporation (‘Funding Systems‘).

The general partner and one-percent owner of Alafund Associates was Alanthus Venture Corporation (‘Alanthus Venture‘), a wholly owned subsidiary of Alanthus Computer, which as previously stated was a wholly owned subsidiary of Alanthus. The sole limited partner and 99- percent owner of Alafund Associates was F.S. Venture Corporation, a wholly owned subsidiary of Funding Systems.

The ownership of Funding Systems and of F.S. Venture, the sole limited partners of A-F Associates and of Alafund Associates, apparently was unrelated to Alanthus.

Under the respective limited partnership agreements of A-F Associates and Alafund Associates, Funding Systems and F.S. Venture had no personal liability or responsibility for any liability of the partnerships except for their obligations to make their required capital contributions. Accordingly, in the event A-F Associates and Alafund Associates were unable to meet their respective debt obligations, only Alanthus and Alanthus Venture, the wholly owned second-tier subsidiary of Alanthus, would be liable for all such obligations as general partners of the partnerships.

Simultaneously with the above transactions between Alanthus, Alanthus Computer, A-F Associates, and Alafund Associates, Alafund Associates sold the computer equipment to the Tiger Lily partnership for a stated purchase price of $3,888,500, represented by a cash down payment of $64,808 and a promissory note of $3,823,691. Interest was to accrue on the promissory note at 12 percent per annum, and payments designated as prepaid interest were to be made as follows: $356,445 on May 31, 1979, $39,511 on June 1, 1979, $18,794 monthly from July 1, 1979 through December 1, 1981, and $241,005 on February 15, 1980. Monthly payments of principal and interest in the amount of $66,495 were to be made from January 1, 1982 through February 1, 1989.

Tiger Lily's $3,823,691 debt obligation to Alafund Associates is referred to generally in the promissory note as a nonrecourse obligation of Tiger Lily. As such, the note could not be enforced against Tiger Lily or any of the assets of Tiger Lily other than the stated collateral. However, under the terms of the note and the Tiger Lily partnership agreement, each limited partner is stated to be personally and on a recourse basis liable on the Tiger Lily promissory note to Alafund Associates to the extent of 436.600 percent of the partner's total capital contribution to the partnership. Under this provision, a limited partner of Tiger Lily (such as petitioner Russell D. Thornock) who subscribed to a $10,000 interest in Tiger Lily would be subject to a potential liability of $43,669.90 with respect to Tiger Lily's promissory note to Alafund Associates...