This post was originally published on Forbes Feb 18, 2015
The District Court decision in the case of Herbert Allen Andrew et. al. v. United States of America (Sorry, can't find a free link) has inspired me to add to Reilly's Laws of Tax Planning. I think this will be Reilly's Fourth Law. It goes "Execution isn't everything, but it is a lot". The case is about another Midcoast deal. Midcoast was a company operating around the turn of the millennium that helped the owners of C corporations net more from corporate liquidations. The problem with a C corp, ever since the Tax Reform Act of 1986 repealed the General Utilities doctrine, is that on liquidation there are two taxes. First the corporation pays a corporate level income tax form the sale of its assets. Then the shareholders as they receive cash pay capital gains tax. This is what has made flow through entities so popular.
MidCoast expressed an interest to Mr. Watkins in purchasing an investment club's stock. (Testimony of T. Watkins.) Mr. Watkins then conveyed MidCoast's interest to Mr. Lee, and Mr. Lee authorized Mr. Watkins to share GNC's information with MidCoast. MidCoast retained Mr. Watkins to represent it in negotiations with GNC. MidCoast sent a letter of intent to Mr. Watkins on October 17, 2000, stating terms for a deal to buy 100% of GNC's stock. MidCoast proposed that it or its designee would acquire the GNC shareholders' stock as an alternative to the shareholders liquidating GNC. MidCoast required that GNC liquidate its stock portfolio before the closing date. MidCoast provided a schedule showing that the GNC shareholders would receive more money from selling GNC's stock to MidCoast than from liquidation, taking into account the tax consequences. Specifically, MidCoast represented that the shareholders would collectively receive $401,325 more in proceeds from the stock sale to MidCoast than if they liquidated GNC; this constituted a premium of approximately 10%.
The same day Mr. Watkins received the letter of intent from MidCoast, he met with the Dissolution Committee members and communicated MidCoast's proposal to them. At a shareholder meeting that night, the shareholders considered and accepted MidCoast's proposal.
After accepting MidCoast's proposal, the Dissolution Committee checked MidCoast's business references. Jack Dixon, a GNC shareholder and partner at KPMG, informed the Committee that his company had some dealings with MidCoast in the past, and a Committee member checked with Dun & Bradstreet and reported that MidCoast was a viable company. On October 20, 2000, the Committee reported to the other shareholders that the MidCoast references were favorable and that GNC would move forward with negotiating a stock purchase agreement with MidCoast. On November 3, 6, and 7, 2000, GNC liquidated its publicly traded stock and received a total of $4,955,000. Ms. Allen represented GNC and its shareholders in connection with the sale to MidCoast.
Through November 2000, GNC and MidCoast finalized arrangements for the transaction. MidCoast arranged for Battery Street, Inc., a newly formed corporation, to acquire GNC's stock. Mr. Watkins continued to represent MidCoast, and also represented Battery Street. The shareholders, through Ms. Allen, reviewed Battery Street's certificate of incorporation and confirmed that it was an existing company. The shareholders made no additional inquiries about MidCoast or Battery Street because Battery Street planned to pay cash and because they trusted Mr. Haley's ability to review the arrangement with Battery Street and Mr. Watkin's business reputation.
What do the leaders of this industry have to say about it? Most wouldn’t discuss it. KPMG even sent around a memo warning staffers not to talk to Forbes.
The November 28 transfers resulted in the sale of GNC to Battery Street and consist of Battery Street's transfer of $3,818,000 to the plaintiffs to buy their GNC shares and, in exchange, GNC's transfer of $4,932,676 from its pre-closing accounts to the new GNC account set up by Battery Street at Golden Gate Bank, which gave Battery Street control over GNC and its assets. The Government contends that these transfers were fraudulent under three NCUFTA provisions: § 39-23.5(a), § 39-23.4(a)(2), and § 39-23.4(a)(1). The Court finds and concludes that the November 28 transfers were not fraudulent under any of these provisions.
Under § 39-23.5(a), a transfer made by GNC would be fraudulent if, inter alia, GNC did not receive “a reasonably equivalent value in exchange for the transfer” and GNC “was insolvent at that time or ... became insolvent as a result of the transfer.” N.C. Gen. Stat. § 39-23.5(a). As a result of the November 28 transfers, GNC transferred $4,932,676 from its existing accounts, and $4,932,676 was deposited into the new GNC account. A “separate and distinct” $3,818,000 was transferred from Battery Street to the plaintiffs. See Starnes, 680 F.3d at 432.
Because GNC had the same $4,932,676 before and after the November 28 transfers, the Court finds and concludes that GNC received a reasonably equivalent value in exchange for the transfer of its cash from one bank account to another account.
The Government's theory fails for two reasons. First, this theory depends on findings of fact that the November 29 through December 1 transfers occurred as described by the Government, and the Court is not satisfied by the preponderance of the evidence that those facts exist. Second, the transfers can be collapsed for NCUFTA purposes only if the plaintiffs had actual or constructive knowledge of Battery Street's post-closing plans, that is, if the plaintiffs “knew or should have known before the deal closed that [Battery Street] would cause [GNC] to fail to pay its ... taxes.”
The real difference, though, was that Sawyer was a much bigger deal and was better executed. Another company, Fortrend, was pulled into the mix and they actually borrowed money from a bank to pay the Sawyer Trust and waited a couple of days before pillaging the taxi corporations. Also, the Sawyer interests had no curiosity whatsoever about how it was that Midcoast and Fortrend were avoiding the corporate tax. They just assumed it was legitimate.