Sunday, April 10, 2005

Family (Dis)Harmony

On Friday, the Court of Appeals handed down decisions in two separate cases involving estate administration questions. I will not comment on one of these cases, Piper Rudnick v. Hartz, because another attorney in this firm was involved in the case. The question before the Court in that case was the grounds that would support the approval by the Orphans' Court of attorneys' fees incurred by a personal representative.

The other case decided by the Court, Brewer v. Brewer, deals with so-called "family settlement agreements" (also referred to by the Court as "redistribution agreements") whereby members of a family agree to divide an estate differently than is prescribed by the decedent's will. The Court held that:

(1) redistribution agreements are permissible and, so long as they comply with the requirements of basic contract law, neither the personal representative nor the court has any authority to disapprove or veto them, but (2) if they are to be implemented as part of the Orphans' Court proceeding, through a deed from the personal representative pursuant to an approved administration account, they must be attached to that account or otherwise made part of the Orphans' Court record. The account must not simply show the distribution in accordance with the agreement but must identify the agreement, incorporate it by reference, and clearly reflect that the distribution is being made pursuant to the agreement rather than pursuant to the Will.


There are two major practical questions that were not addressed by the Court.

First, what does it mean to "comply with the requirements of basic contract law"? In the course of the opinion, the Court noted that "the existence of a dispute is not ordinarily a prerequisite" to the enforcement of such an agreement. However, absent a dispute which a redistribution agreement purports to settle, what is the consideration that supports the contract? Presumably, in certain cases there could be property swaps that would provide consideration (e.g., the will provides that legatees John and Mary will each receive a one-half interest in both Blackacre and Whiteacre, but John and Mary agree that John will receive a 100% interest in Blackacre and Mary will receive a 100% interest in Whiteacre). However, in other cases (e.g., John is rich and Mary is not, so he agrees to forego some or all of his inheritance) this would not necessarily be the case.

Second, there are potential tax implications that must be considered. Of course, these tax issues were not before the Court in Brewer, but should be taken into account when weighing a redistribution agreement. Specifically, if the agreement is entered into after the nine month disclaimer period, it would seem likely that it could be argued the parties to the agreement have created either a taxable event for income tax purposes (as could be the case in a Blackacre/Whiteacre swap illustrated in the first example) or a taxable gift (as could be the case if one sibling waived part or all of his or her inheritance, as might be the case in the second example).

Oddly, the outcome of the case did not turn on the substantive issue concerning the enforcement of redistribution agreements, but rather on whether the plaintiff could reopen the estate after it had been closed for 20 months. Judge Raker dissented, contending that since this issue had never been raised either below or in the petition for certioari, it was not before the Court.

Wednesday, April 06, 2005

I Remember Momma?

When looking at reported decisions, I'm always reluctant to criticize arguments attorneys make in tough cases. For one thing, courts have been known to misunderstand or misconstrue perfectly reasonable, even if incorrect, arguments in order to fortify their own decisions and the reported opinion may actually make a plausible case appear to look preposterous. For another, the facts that are presented at trial may not be the facts upon which counsel based the decision to undertake representation. Every attorney who has been in practice for even a few years has horror stories about cases that looked great at the beginning, but which crumbled as "new" facts came to light. There are, however, a small class of cases that raise the question: "Why did they bother?" Maloof v. Commissioner decided today by the U.S. Tax Court is such a case.

In Maloof, the taxpayer was a sole shareholder of an S corporation that suffered a long succession of tax losses. Because his ability to use the losses of the corporation were limited to his basis in the corporation's stock, the taxpayer attempted to increase his basis in the stock by including in basis $4 Million in bank loans made to the corporation. Apparently, except for a pledge of his stock in the corporation, the taxpayer was not at risk with respect to the loans.

The opinion reads like the Children's Goldenbook of S Corporation Taxation with the Court walking through fairly basis principles of S corporation taxation. The taxpayer's positions were so adverse to established law that I'm surprised that there was no mention of possible sanctions for taking a frivolous position. (My favorite ludicrous position taken by the taxpayer is that he was a resident of Florida and thus the precedent of the 11th Circuit applied to the case. Why was he a resident of Florida: He lived with his mother, not his wife, who lives in Ohio. Note to Counsel: Your client's name is "Maloof" not "Oedipus.")

The case is instructive on one point: LLCs classified as partnerships or as disregarded entities have benefits over S corporations. Were the company an LLC classified as a partnership or a disregarded entity, the taxpayer would have obtained the benefits he sought. And, he wouldn't have had to run home to momma.

Tuesday, April 05, 2005

Tough to Breakup

In Renbaum v. Custom Holdings, Inc., the Court of Appeals made it clear shareholders must jump a high bar if they seek to force a judicial dissolution of a corporation on the grounds that the directors are deadlocked. In the Court's view, not any deadlock will do. The deadlock must be over an issue or issues that prevent the corporation from "perform[ing] its corporate powers."

In Renbaum, the corporation was a holding company, the sole business of which was to invest in publicly traded securities. The corporate stock was owned by two brothers and their wives. A serious dispute arose over the company's relationship with an attorney who simultaneously acted as the general counsel to the corporation and as the personal attorney for one of the brothers. Part of the dispute centered on the legal bills submitted to the corporation by the attorney. In addition to their inability to agree on who should serve as general counsel, the brothers also argued over whether and in what amount dividends should be paid. However, this dispute was resolved prior to the entry of a final judgment. Thus, by the time that the case was presented to the appellate courts, the only dispute extant between the parties was the general counsel issue. Curiously, however, the parties were in harmony concerning the management of the company's investment portfolio, agreeing to delegate that task to a specific third party investment manager.

Holding that, in order to justify a judicially ordered dissolution, there must be a deadlock concerning a "transcendant corporate function" which, if not broken, made "the object of corporate existence unobtainable." In order to make this determination the Court found that

[u]seful factors [that should be considered] . . . include: (a) whether the corporate function(s) have ceased; (b) the power in dispute is expressed as a discretionary or mandatory power in the corporation’s Articles of Incorporation, by-laws, or other corporate governing documents; (c) the role of that power in achieving the corporation’s primary function(s); and, (d) whether the corporation has exercised, as a matter of practice, that power routinely in its operations.


This case is significant because typical "canned" corporate forms (i.e., articles of incorporation, bylaws, etc.) often default to provisions that allow bare majorities of the shareholders to elect the majority of the members of the board of directors and allow a majority of directors to control the board. Absent fraud or some other basis upon which to demand a judicial dissolution, the minority shareholders can be frozen out. Thus, the ability of minority shareholders to pull the nuclear option of judicial dissolution is a power that the minority shareholders must bargain for at the inception of their relationship with the corporation.

It should be noted that the corporation in Renbaum is a general corporation, not a Maryland statutory close corporation. In the case of a close corporation, §4-602(a) of the Md. Corps. & Ass'ns Art. provides that a judicially ordered dissolution is available on the basis that "there is such internal dissension among the stockholders of the corporation that the business and affairs of the corporation can no longer be conducted to the advantage of the stockholders generally." That standard does not come into play outside of the context of a statutory close corporation. In the case of an LLC, it appears that the stricter standard applicable to general corporations applies, since LLCs can only be judicially dissolved if "it is not reasonably practicable to carry on the business [of the LLC] in conformity with the articles of organization or the operating agreement." See Md. Corps. & Ass'ns Art. §4A-903.

Stuffed and Mounted

The Washington Post reported today on an abusive tax avoidance scheme involving the donation of mounted big game animal trophies to various museums. Apparently, one particular appraiser has specialized in both valuing the trophies and arranging the donations. The valuations are often 5 to 10 times what the trophies will bring at established auctions. In one case, a museum sold mounts that had a total appraised value of $4.2 Million for only $67,000.

In addition to the tax abuse or, perhaps, tax fraud angle, the practice is in the sights of conservationists who content that "the trophies hunted are often endangered animals illegally brought into the United States." The question then is, Who Gnu?

Update

Senator Chuck Grasslely's office yesterday issued a press release where he said in part:

The phoniness of this kind of donation calls out for congressional action. It looks like it's time for these self-enriching hunters to become the hunted. Big-game trophies and other non-cash contributions that give more tax benefits to donors than help to the needy are in the Finance Committee's cross hairs. There's mounting evidence that some taxpayers are using these gifts to play big-money games for personal enrichment. This abuse is no different than what we saw with car donations. With car donations, someone cheated on his taxes to the tune of hundreds of dollars and the charity got $50 out of it. With taxidermy donations, the museum gets a pittance for a dusty boar's head that sits in a railway car until it sells, while the donor gets big tax breaks. This is completely unacceptable. We need to take the tax cheating out of taxidermy. We need to close loopholes in the tax laws intended to foster charitable donations, and Tuesday's hearing sets the stage for reform legislation.


"Take the tax cheating out of taxidermy"? Who writes this stuff?

Thursday, March 31, 2005

Scout Update

On March 28, H.B. 296, the bill to award college scholarships to all Eagle and Gold Star Scouts (my previous discussion here) was reported out of the Appropriations Committee unfavorably. This effectively kills the bill for this year.

Thursday, March 24, 2005

Making an S of Yourself

The Service today issued a new Form 2553, Election by a Small Business Corporation. The revised instructions can be found here.

Tuesday, March 22, 2005

Previews of Coming Attractions

Maryland follows the so-called lex loci delicti rule with respect to choosing the law to apply in tort actions. That is, the courts will apply the law of the jurisdiction where the wrong occurred. However, it is unclear where the "wrong" occurs in cases of fraud or negligent misrepresentation if the alleged wrong and alleged loss occur in different jurisdictions. In the case of Hardwire, LLC v. The Goodyear Tire & Rubber Co., Judge Bennett certified that question and sent it to the Court of Appeals. He also certified the similar question of what jurisdiction's substantive law governs in the case of tortious interference with economic relationships where the wrongful act and the plaintiff's injury occur in two different jurisdictions.

Choice of law issues presented in cases such as Hardwire are taking on new importance due to the rapidly falling telecommunications prices and the growth of the internet. Even as late as fifteen years ago, most business activity could be tied to a specific physical location. For instance, business deals, even if negotiated via fax or letter, were typically concluded at a discrete place. That is no longer the case, since negotiations are often concluded electronically with even the closing of a deal taking place in more than one location.

Wednesday, March 16, 2005

Gut Equity

In a case that is likely to be appealed, Judge Deborah Chasanow of the District Court re-affirmed that hard cases make, if not bad law, then strained law. The case, Valley Forge Life Insurance Co. v. Liebowitz, involved a $2 Million life insurance policy.

Bruce Liebowitz was married to Shelley Liebowitz. His father, Howard Liebowitz, is an independent insurance agent. In the late spring of 2000, Bruce applied for a life insurance policy from Valley Forge with a death benefit of $2 Million. His father was the issuing agent. The policy was formally issued on November 1, 2000. Bruce died of esophageal cancer on September 5, 2002.

The application for the policy directly asked about the insured's foreign travel, both past and prospective. Bruce had traveled extensively in the Mideast and had lived in Spain in the two years prior to the date of the application and continued to travel extensively after the application was submitted. However, on the application he denied any foreign travel in the two years prior to the date of the application and he denied any plans to travel out of the country in the future. After his death, Valley Forge brought this action alleging that Bruce had made a material misrepresentation with respect to the policy application and requested that the policy be declared a nullity.

On cross motions for summary judgment, the Court ruled in favor of Mrs. Liebowitz, holding that (i) Howard was the agent of Valley Forge, (ii) that Howard knew of the falsity of the statements on the applications, (iii) Howard's knowledge could be imputed to Valley Forge, and therefore (iv) Valley Forge was estopped from denying coverage due to Bruce's false statements concerning his foreign travel. The Court also ruled that the statements on the application were representations, not warranties, and that Valley Forge, due to its knowledge of the misstatements (via imputation from Howard) waived its right to rescind the contract. The Court did not address the question of whether the misstatements were material, perhaps because that would have required a weighing of conflicting facts, taking it out of summary judgment territory.

Cases like this give insurers a bad reputation. Even though Bruce essentially lied on his application, it is unlikely that Valley Forge would have refused to issue the policy even had it known about Bruce's extensive foreign travel, although there may have been a slight surcharge added to the premium, a trivial amount in the context of this case. Moreover, Bruce's death can in no way be traced to his foreign travel. Going one step further, had Bruce lived another 55 days or so, the policy would likely have become incontestable. Thus, under the circumstances of the case, it appears that Valley Forge was asking to be relieved of its obligations under the contract due to misrepresentations that caused it no material harm.

On the other hand, Howard and Bruce do not present an altogether savory picture. At the least, Howard failed to honor his fiduciary duties to Valley Forge. However, the claimant here was a young widow who was left to care for the toddler child of the deceased. There were no facts that would indicate that she had been in any way complicit in a scheme to cheat the insurer. Under these circumstances, the gut equities clearly favored her and the judgment followed.