Transpac Drilling Venture 1982-12 v. C.I.R.

• Decision Date: 26 June 1998
• Docket Number: Docket Nos. 95-4177
• Citation: 147 F.3d 221
• Parties: -5078, 98-2 USTC P 50,517 TRANSPAC DRILLING VENTURE 1982-12, et al., Petitioners, Guy J. Cutili, et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. (L), 95-4179, 95-4183, 95-4185, 95-4187, 95-4193, 95-4195, 95-4197, 95-4199, 95-4203, 97-4213 and 97-4219(CON).
• Court: U.S. Court of Appeals — Second Circuit

Page 221

147 F.3d 221

82 A.F.T.R.2d 98-5078, 98-2 USTC P 50,517

TRANSPAC DRILLING VENTURE 1982-12, et al., Petitioners Guy J. Cutili, et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Docket Nos. 95-4177(L), 95-4179, 95-4183, 95-4185, 95-4187,

95-4193, 95-4195, 95-4197, 95-4199, 95-4203,

97-4213 and 97-4219(CON).

United States Court of Appeals Second Circuit.

Argued April 22, 1998.

Decided June 26, 1998.

Richard J. Sapinski, Sills Cummis Zuckerman Radin Tischman Epstein & Gross, Newark, NJ (Charles W. Haydon, Mortimer Lipsky, and Bernard Kobroff, of counsel), for Petitioners-Appellants.

Pamela C. Berry, Tax Division, United States Department of Justice, Washington, DC, for Loretta C. Argrett, Assistant Attorney General (Richard Farber, of counsel), for Respondent-Appellee.

Before: WALKER and CALABRESI, Circuit Judges, and RESTANI, ^* Judge.

CALABRESI, Circuit Judge:

The specific question we address in this appeal is whether, as a result of being placed under criminal investigation by the IRS (and hence becoming subject to pressure by the IRS), the tax matters partners (TMPs) of various partnerships labored under a conflict of interest and thereby were disqualified from binding the partnerships. The Tax Court held that they had not lost their authority. We disagree and reverse.

I.

Seventy-one partnerships (the "Transpac partnerships"), each containing 30-50 limited partners, were promoted, primarily, by John Galanis, a convicted tax felon. Although these partnerships were ostensibly formed to explore oil and gas ventures, the government has alleged that the function of the Transpac partnerships was to serve as illegitimate tax shelters for their limited partners, who, as a result, were able to avail themselves of generous tax losses. Supposedly assisting Galanis in his scheme were at least three individuals who figure prominently in this appeal: John Volatile, Morris Cofman, and Douglas C. Adams. These three, and/or their corporate alter egos, served (at least at some time) either as sole general partners or as co-general partners of the numerous Transpac partnerships that are the petitioners in this litigation.

Since the taxation of partnerships is generally conducted at the individual level, the income and expenses of the partnership normally "flow through" to the several partners, who remain ultimately responsible for filing their own taxes. In 1982, however, Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), which, among other things, centralizes the treatment of many partnership taxation issues. See Pub.L. No. 97-248, § 402(a), 96 Stat. 324 (codified as amended at 26 U.S.C. §§ 6221--23). Under TEFRA, when the IRS wishes to deal with questions that affect the entire partnership, it may consult an entity called the "tax matters partner" (TMP), who has the authority to serve as the partnership's representative to the IRS and, in some matters, to bind the limited partners by its actions. See, e.g., id. § 6224(c)(3)(A). ¹ Volatile, Cofman, and Adams (and their various corporate alter egos) served as TMPs for the petitioning partnerships.

In the latter part of 1983, the IRS began a series of civil audits of the Transpac partnerships. By 1985, apparently in conjunction with information gleaned from an FBI bank fraud investigation, the IRS became aware that Galanis was involved with these partnerships. On November 7, 1985, the Transpac audits were sent to the IRS's criminal investigation unit, which "accepted" the referral in December. By January of 1986, Galanis had informed Volatile, Cofman, and Adams that the audits were "not going well," and that he had arranged for legal representation.

On February 5, 1986, Volatile and Cofman were served with subpoenas calling them to appear and to produce documents before a grand jury. ² The grand jury focused its investigation on Galanis and Adams; Volatile and Cofman appear to have been left in limbo--under criminal investigation, but not yet official targets of grand jury proceedings--until around May of 1986.

During the spring of 1986, as the various criminal investigation efforts continued, several meetings between Volatile, the IRS, and the FBI took place. And on May 7, 1986, Volatile formally agreed to become a co-operating witness in the Galanis investigation. Cofman also agreed to co-operate. As a result, both were granted immunity from prosecution. Adams, by contrast, remained the subject of grand jury indictment proceedings. But at some point in May 1987, he too agreed to co-operate with the government pursuant to a plea bargain (that resulted in a suspended sentence). In 1988, Galanis went to trial and, in part due to the participation of the three co-operating witnesses, was convicted.

While the foregoing criminal investigation was proceeding and escalating, the Service pursued its civil audits of the Transpac partnerships with respect to the 1982, 1983, and 1984 tax years. The statute of limitations to file Final Partnership Administrative Adjustments (FPAAs) is generally three years. ³ See 26 U.S.C § 6229(a)(2). And so, as early as November 1985, the statute was about to run on the first tax year in question, 1982. Under TEFRA, however, the Commissioner may receive an extension if he secures the permission of the partner whose return would be affected. See id. § 6229( b)(1)(A). If the extension applies to the return of the whole partnership (i.e., if the extension affects all of the limited partners) then the Commissioner--unless he is willing to seek the consent of every partner--must get the approval from the partnership's TMP. See id. § 6229(b)(1)(B).

In the instant case, the Service originally (in November of 1985) sought extensions from the individual partners. Most of those who were contacted declined the IRS' requests. Having been rebuffed by the limited partners, the IRS, in February 1986, began to contact the TMPs--who by this point were under criminal scrutiny--and asked them to approve extensions on the three-year statute of limitations. Not surprisingly, this solicitation was received more warmly: Volatile, Cofman, and Adams, and/or their corporate analogues and their duly authorized attorneys, all executed the extensions sought by the Service. Extension requests continued to be sought and given through March 1988 (since the last of the tax years in question was 1985). As the government did not file the FPAAs until November 1989, the FPAAs would have been untimely, but for the extensions.

Various limited partners duly objected to the FPAAs and requested the appropriate administrative and judicial review. (Ordinarily, objections to FPAAs are filed by the TMP. See id. § 6228(a)(1).) Eventually, in 1990, the Tax Court, under Tax Court Rule 250, removed the TMPs and named several limited partners to that status. See Tax Ct. Rule 250 (allowing the Tax Court to fill vacancies or remove and replace disqualified TMPs).

In the ensuing civil litigation, some of the limited partners argued that the extensions granted by the TMPs were invalid because a conflict of interest existed by virtue of the TMPs' status, first as targets and finally as co-operating participants, in the criminal proceedings regarding the Transpac partnerships. For expeditious resolution of this legal question, the parties agreed to consolidate their actions and to address the single question of whether, under the circumstances of these events, the TMPs were permitted to bind the partnerships to the extensions. The Tax Court (Clapp, Judge ), ruled against petitioners. See Transpac Drilling Venture 1982-16 v. Commissioner, 67 T.C.M. (CCH) 19995 (1994). This appeal followed. ⁴

II.

This case turns on whether the TMPs had authority to bind the partnerships, so that the extensions the TMPs signed were valid. Specifically, the petitioners claim that the circumstances surrounding the criminal investigation of the TMPs--viewed in the light of the fact that the TMPs subsequently became co-operating government witnesses in grand jury proceedings--created a conflict of interest that precluded the faithful exercise of the TMPs' fiduciary duties to the limited partners and the partnerships. Accordingly, petitioners contend that the statute-of-limitations extensions signed by the TMPs are invalid. Respondent never really meets this argument head on, but insists, for a variety of reasons, that the extensions had to have been valid. ⁵ None of the Commissioner's arguments has merit.

A.

First, the respondent suggests that the TMPs, as "creatures of statute," exist solely at the pleasure of the Secretary and owe no fiduciary duty to the limited partners. This position is contrary to settled law. See Computer Programs Lambda, Ltd. v. Commissioner, 89 T.C. 198, 205, 1987 WL 42563 (1987) ("Lambda I "). ⁶ By centralizing tax-related proceedings of the partnership in one person or entity, Congress created a statutory analogue of the class representative in class action proceedings. And just as class members, though entitled to due process safeguards, can be bound by the results of a proceeding to which they are non-parties because the class representatives owe them fiduciary duties, see, e.g., Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 811-12, 105 S.Ct. 2965, 86 L.Ed.2d 628 (1985), so the limited partners secure their due process protection as a result of the fact that the TMP stands in a fiduciary relationship toward them. We conclude that the TMP's duty to the individual limited partners and to the partnerships in general is beyond question.

The second argument advanced by the Commissioner is that any conflict of interest is, in this case, harmless, because a fully competent fiduciary would most likely have executed the extensions sought by the IRS. The assertion is frivolous. Even assuming, arguendo, that the government's proposition might be true in some cases, it is manifestly false in this appeal. The...