UNUM CORP. v. US, Civil No. 93-369-P-C.
| Decision Date | 23 May 1996 |
| Docket Number | Civil No. 93-369-P-C. |
| Citation | 929 F. Supp. 15 |
| Parties | UNUM CORPORATION and Unum Life Insurance Company of America, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — District of Maine |
William J. Kayatta Jr., Pierce, Atwood, Scribner, Allen, Smith & Lancaster, Portland, Maine, Barbara H. Furey, Barry W. Larman, Unum Life Insurance Company, Portland, Maine, for Plaintiffs.
David R. Collins, Asst. U.S. Atty., Office of the U.S. Attorney, Portland, Maine, Scott H. Harris, U.S. Department of Justice, Tax Division, Washington, D.C., for Government.
Plaintiffs UNUM Corporation ("UNUM Corp.") and UNUM Life Insurance Company of America ("UNUM America") sue Defendant United States of America ("the Government" or "the IRS") seeking a tax deduction valued at approximately eighty million dollars. Plaintiffs claim that the cash and stock distributed to their policyholders pursuant to Plaintiffs' Plan of Recapitalization and Conversion, Stipulated Record (Docket No. 42) Ex. 16 ("the Plan"), constitute "policyholder dividends" as defined in § 808 of the Internal Revenue Code, 26 U.S.C. § 1 et seq. ("the Code" or "I.R.C."), and so are deductible from income pursuant to § 805(a)(3) of the Code. Having denied Defendant's Motion for Summary Judgment, Memorandum and Order Denying Defendant's Motion for Summary Judgment (Docket No. 40), the Court now considers this case for final decision on a stipulated record. See Stipulated Record (Docket No. 42) ("Record"). For the reasons discussed below, the Court will find that neither the cash distribution nor the stock distribution constitutes a "policyholder dividend" and, therefore, that neither distribution is deductible from Plaintiffs' income.
Union Mutual Life Insurance Company ("Union Mutual") was organized as a mutual insurance company in Maine in 1848. Record Ex. 31. At all times relevant to this action, Union Mutual was engaged in the business of writing various forms of life insurance, health and accident insurance, and annuity products. Id. ¶ 1. As with mutual companies generally, Union Mutual had no outstanding capital stock and so was not owned by stockholders. Id. ¶ 4. As with mutual insurance companies generally, Union Mutual was owned, instead, by its participating policyholders. Id. Ex. 8 at 6, Ex. 12 at 15.
Union Mutual's participating policyholders owned the company by virtue of having contributed to Union Mutual's surplus by paying premiums that exceeded the actuarial cost of their policy coverage. Plaintiffs' Trial Brief (Docket No. 44) at 4-5, 18-19 ("Plaintiffs' Brief"); United States' Trial Brief (Docket No. 43) at 3-4 ("Government's Brief"); Record Ex. 8 at 6, Ex. 12 at 15. These excess amounts functioned in a way analogous to the capital raised when a stock insurer makes an offering of its stock. Plaintiffs' Brief at 12-13; Plaintiffs' Reply Brief (Docket No. 45) at 5; Government's Brief at 3-4. Accordingly, in proportion to that contribution to surplus, each Union Mutual policyholder had certain rights analogous to those of a stockholder, such as voting rights and preemptive rights upon conversion. Plaintiffs' Brief at 18-19; Government's Brief at 3-4; Record Ex. 4 at 5; Plan at A-2.
Taken as a whole, the surplus to which Union Mutual policyholders contributed represented the sum of all revenues in excess of the amount paid or accrued for benefits, reserves, dividends, taxes, and other expenses. Record ¶ 7. As such, Union Mutual's surplus also provided the source from which policyholder dividends were drawn in an amount determined by Union Mutual management on an annual basis. Id. Ex. 8 at 6.
As of December 31, 1985, Union Mutual had accumulated surplus, determined on the basis of generally accepted accounting principles ("GAAP"), in the amount of $652,050,097 ("GAAP Surplus"). Id. ¶ 9.
In December 1984, Union Mutual submitted its initial Plan of Recapitalization and Conversion, Record Ex. 9 ("Initial Plan"), to the Maine Superintendent of Insurance for approval. Record ¶ 15, 16. The Initial Plan detailed a transaction whereby Union Mutual would convert from a mutual insurer to a stock insurer that would be wholly-owned by a new holding company. See Initial Plan. The approval process was directed at ensuring that the Initial Plan complied with Maine law governing such a conversion. See 24-A M.R.S.A. § 3477. To that end, between June 1985 and July 1986, the Superintendent issued two legal rulings regarding the Initial Plan, and the Union Mutual Board of Directors amended the Initial Plan four times. Record ¶¶ 17-22, Exs. 10-15. Finally, on August 8, 1986, the Superintendent issued a Final Decision and Order approving the final version of the Plan. Id. ¶ 24, Ex. 17.
Among other things, the final Plan provides that "in exchange for their Membership Interests, Eligible Policyholders will receive Conversion Stock or cash, all as described in Part VII of this Plan." Plan at A-4. Part VII, entitled "Subscription Offering," begins as follows:
Plan at A-4. Eligible Policyholders would receive their Equity Share in the form of Conversion Stock unless they qualified as "Cash Option Eligible Policyholders," in which case, they could choose to receive the same Equity Share in the form of cash. Plan at A-1, A-5. Moreover, once Eligible Policyholders thus exchange their Membership Interests for their Equity Shares (whether in stock or cash) of the Adjusted Surplus, "present and past policy and contract holders will have no Membership Interests in Union Mutual." Plan at A-4.
The Plan also provides three particularly important definitions, which this Court hereby adopts, for terms used above to describe the transaction. First, "Membership Interest" is defined as:
all rights and interests of each policy and contract holder of Union Mutual including, but not limited to, any right to vote, any rights which may exist with regard to the surplus of Union Mutual not apportioned by the Board for policyholder dividends, and any rights in liquidation or reorganization of Union Mutual, but shall not include any other right expressly conferred by a policyholder's insurance policy or contract.
Plan at A-3. Second, "Equity Share" is defined as "the dollar amount of that part of Union Mutual's Adjusted Surplus attributable to that Eligible Policyholder on the basis of the formulas provided elsewhere in the Plan for calculating Equity Share." Plan at A-1. Third, "Adjusted Surplus" is defined as "the amount of surplus as of December 31, 1985 ... as determined in accordance with generally accepted accounting principles...." Plan at A-1.
Maine law requires such a conversion plan to be approved by at least two-thirds of those policyholders who vote on it. See 24-A M.R.S.A. § 3477(2)(B). The Plan was approved by ninety-eight percent of those Eligible Policyholders who voted on it. Record ¶ 29.
The following series of transactions (collectively "Recapitalization and Conversion") occurred on or about November 14, 1986, the effective date of the Plan. Record ¶ 32. Union Mutual disbursed $129,129,082 in cash by check to the 105,098 Cash Option Eligible Policyholders who chose to exercise that option. See id. Ex. 24, ¶ 33. Union Mutual charged this entire amount against its statutory and GAAP surplus. Id. ¶ 34.
Union Mutual amended its charter both to convert the company from a mutual insurer to a stock insurer and to change the company name to UNUM Life Insurance Company ("UNUM Life"). Id. ¶¶ 5, 31, 32.
UNUM Life delivered all 6,000,000 of its newly-minted shares of stock to the new holding company, UNUM Corp. Id. ¶¶ 35, 36, Ex. 22. "In consideration for" those 6,000,000 shares of UNUM Life stock, UNUM Corp. issued 20,489,0721 shares of UNUM Corp. stock to the remaining 58,561 Eligible Policyholders. Id. ¶ 37, Ex. 22, 24. At a fair market value of $25.50 per share on the effective date, the total value of the UNUM Corp. Conversion Stock distribution to those Eligible Policyholders was $522,471,336. Id. ¶ 38, Ex. 24.
In addition, to the extent that the value of the Equity Share of those 58,561 Eligible Policyholders exceeded the value of a whole number of UNUM Corp. shares by the value of some fractional share, Union Mutual distributed to those Eligible Policyholders an additional $609,396 in cash to represent the value of those fractional shares. See Id. Ex. 24, ¶ 33.2
By the conclusion of the Recapitalization and Conversion, 163,659 Eligible Policyholders had received distributions of cash and stock in the amount of $652,209,814.3 Id. Ex. 24, ¶ 45.
The process of determining the federal tax consequences of the Recapitalization and Conversion began on October 12, 1984, over two years before the effective date of the Plan, when Union Mutual's tax counsel submitted a request for a letter ruling to the IRS. Record ¶ 11, Ex. 4. In that request, Union Mutual sought to convince the IRS that the distribution of UNUM Corp. stock in exchange for Membership Interests in Union Mutual constituted a tax-free exchange under I.R.C. § 351, and that the conversion of those Membership Interests into UNUM Life stock constituted a tax-free recapitalization under I.R.C. § 368(a)(1)(E). Id. Ex. 4 at 22, 24.
During the years 1984 through 1986, Union...
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