Wachner v. Commissioner
| Decision Date | 02 March 1995 |
| Docket Number | Docket No. 6291-93. |
| Parties | Linda J. Wachner v. Commissioner. |
| Court | U.S. Tax Court |
Robert A. Jacobs, 1 Chase Manhattan Plaza, New York, N.Y., for the petitioner. Stephen C. Best, John Aletta, and Powell W. Holly, Jr., for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency in petitioner's 1986 Federal income tax in the amount of $820,730. The issue to be decided1 arises out of a settlement of a lawsuit concerning a failed leveraged buyout of a subsidiary of Revlon, Inc. (Revlon). We must decide whether the portion of the settlement proceeds received by petitioner during 1986 is taxable as ordinary income or is entitled to long-term capital gains treatment. Unless otherwise indicated, all section references are to the Internal Revenue Code for the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Some of the facts and certain documents have been stipulated for trial pursuant to Rule 91. The stipulated facts are incorporated in our findings of fact by reference and are found accordingly. At the time the petition was filed in the instant case, petitioner resided in New York, New York. Petitioner reported her income for her taxable year 1986 on the cash receipts and disbursements method of accounting. During 1984, 1985, and part of 1986, petitioner held the position of managing director at Adler & Shaykin (A&S). A&S was a partnership formed under the laws of the State of New York. A&S' partners included Frederick R. Adler and Leonard P. Shaykin. During 1985 and 1986, Philip H. Behr, John G. Quigley, Michael R. Bruce, and John J. Murphy were also partners in A&S. Petitioner was never a partner in A&S.
A&S managed a leveraged buyout fund (the Fund) on behalf of its investors. The Fund was established to acquire equity or equity equivalents in a series of leveraged acquisitions. Once A&S identified an acquisition target, it would organize a limited partnership to facilitate the Fund's investment in the target company. A&S would then contribute capital to the limited partnership on behalf of the Fund's participants. Petitioner assisted A&S in negotiating and consummating leveraged buyout transactions, and consulted and advised A&S regarding any target companies in the retail or consumer products industries. On December 18, 1984, petitioner and A&S executed an agreement specifying petitioner's responsibilities with regard to A&S' leveraged buyout activities and petitioner's compensation. The December 18, 1984, agreement, in pertinent part, provides:
1. A&S hereby agrees to employ you as Managing Director, Consumer Products for a period beginning on December 18, 1984 and ending on November 30, 1985 (the "Term").
2. During the Term, A&S will pay you $10,000 at the beginning of each month * * * and will, in addition, reimburse you, upon presentation of receipts, for reasonable out-of-pocket business expenses of up to $2,000 per month incurred in connection with your performance of duties hereunder. It is contemplated that A&S will be reimbursed for all amounts paid to you hereunder as part of the closing costs of any leveraged buyout or other transaction that you will have brought to the attention of A&S or for which you will have provided substantial consulting services (if such a transaction is ultimately closed).
* * *
5. a. For target companies in the retail and/or consumer products industry that A&S invests in and that you brought to the attention of A&S or for which you provided substantial consulting services, A&S will provide you with the following additional compensation:
(i) If you are appointed chief executive officer of the target company and you are expected to devote more than 20% of your business time to the affairs of the target company, you will receive one-fourth of A&S's closing fee for consummating the transaction and you and your management group will have the right to buy no less than 20-30% of the target company, as determined in the discretion of A&S. Your right to buy a portion of the target company shall be on substantially the same terms as those at which A&S is purchasing target company stock, except that you and your management group may pay a portion of the consideration for such stock with notes as reasonably determined by A&S.
(ii) If you are not appointed chief executive officer of the target company (or if you are appointed chief executive officer but are not expected to devote more than 20% of your business time to the affairs of the target company), you will receive one-half of A&S's closing fee for consummating the transaction and will have the right to buy 10% of the Co-Investment, as defined in the Commitment Agreement dated October 3, 1983. Your right to buy a portion of the Co-Investment shall be on substantially the same terms as those at which A&S is purchasing target company stock.
b. For target companies not in the retail and/or consumer products industry in which A&S invests during the Term, you will be made aware of all such target companies and have the right to purchase up to 5%, as determined in your discretion, of the Co-Investment. Your right to buy a portion of the Co-Investment shall be on substantially the same terms as those of A&S.
6. A&S further agrees that, during the Term, you will be entitled to receive medical insurance benefits customarily accorded to employees of A&S of like stature.
7. The parties to this Agreement will review their relationship and the terms of this Agreement beginning in September 1985.
During 1985, A&S paid $120,000 to petitioner, which A&S reported on Form 1099-MISC. During 1986, A&S paid $55,000 to petitioner, which A&S reported on Form 1099-MISC.
Petitioner identified Revlon's Beauty and Fragrance Division (the RBFD) as a suitable acquisition target and brought it to the attention of A&S. Petitioner, on behalf of A&S, negotiated the purchase price for the RBFD, the outside financing for the transaction, and the asset purchase agreement with Revlon. Petitioner, on behalf of A&S, also developed cash flow projections, balance sheets, inventory, debt and account receivables schedules, and performed a due diligence investigation, which included analyzing legal contracts, visiting plants and operations, and interviewing employees of the RBFD. If the purchase and sale of the RBFD had closed, the amount of A&S' closing fee that petitioner would have received under the December 18, 1984, agreement would have been compensation for services.
On October 1, 1985, to facilitate the purchase of the RBFD, A&S organized a Delaware corporation, Beauty Acquisition Corp. (BAC).2 BAC's certificate of incorporation named Mr. Shaykin as BAC's sole director. On October 1, 1985, Mr. Shaykin, as BAC's sole director, elected the following officers of BAC: Mr. Shaykin, president; petitioner, vice president/treasurer; Mr. Quigley, vice president/secretary; and Mr. Kevin R. Evanich, vice president/assistant secretary.
The equity financing for the purchase of the RBFD was to be provided by the following parties The Equitable Life Assurance Co. (Equitable); Outside Investors/Directors; Revlon Partners;3 A&S' partners; and BAC's management team, which included petitioner. On October 2, 1985, Equitable executed a letter confirming that, subject to certain conditions, it would provide BAC with $375 million in debt financing and $34,500,000 in equity financing in order to facilitate BAC's purchase of the RBFD.4 On October 2, 1985, Bankers Trust Co. (Bankers Trust) and Manufacturers Hanover Trust Co. (Manufacturers Hanover) issued a letter to A&S confirming their willingness to provide credit in the aggregate amount of $495 million to finance BAC's purchase of the RBFD. On October 3, 1985, A&S issued a letter in which it unconditionally committed to purchase 55 percent, approximately $42 million, of the $76,670,000 of equity securities to be issued by BAC. An outline of BAC's equity financing arrangements prepared by Mr. Quigley, dated December 20, 1985, is attached as the appendix.5
On October 3, 1985, Revlon entered into an asset purchase agreement (the RBFD contract) with BAC for the sale of the RBFD to BAC. A&S negotiated and obtained for BAC a right to specific performance if Revlon failed to perform under the terms of the RBFD contract. Section 8.16 of the contract provides:
Right to Specific Performance. The parties agree that the assets of the * * * [RBFD] are unique and that Buyer is entitled to specific performance of this Agreement. In consideration of the execution of this Agreement by Buyer, Seller agrees that, if a court refuses to grant Buyer specific performance of this Agreement against Seller, Seller will promptly deliver to Buyer $20 million in immediately available funds as a break-up fee. Buyer's right to receive payments pursuant to section 8.16 is in addition to, and not in lieu or derogation of, Buyer's right to seek specific performance under this Agreement.
The RBFD contract was signed by Mr. Shaykin as president of BAC. The RBFD contract contained a provision in which A&S guaranteed the performance of BAC under the contract. Mr. Shaykin signed the guarantee as a general partner in A&S. Petitioner did not sign the contract or the guarantee. On October 9, 1985, A&S issued Communication #21 to its investors, which in pertinent part, states:
Pursuant to section 3.01(a) of the Commitment Agreement for the Adler & Shaykin Fund, you are hereby notified of Adler & Shaykin's upcoming investment. On or about November 15, 1985, Adler & Shaykin will fund an investment in connection with the acquisition of Revlon, Inc.'s Beauty Products Group. * * *
The estimated aggregate investment by the Adler & Shaykin Fund will be $20 million or 20% of each limited partner's total commitment. In addition, the general partners of Adler & Shaykin, pursuant to section 1.01 (c) of the...
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