Opinion
Case Nos. 393-38328-BJH-11, 393-38330-BJH-11, 393-38332-BJH-11, 393-38329-BJH-11 Substantively Consolidated Post-confirmation.
May 20, 2005.
MEMORANDUM OPINION AND ORDER ON REMAND
Walter O'Cheskey, the chapter 11 trustee (the "Trustee") for four related debtors — i.e., Chama Land Cattle Co. ("Chama"), American Elk Conservatory, Inc. ("AEC"), American Elk Conservatory Holdings, Inc. ("Holdings"), and the Lodge at Chama, Inc. ("Lodge") (collectively, the "Debtors") is before the Court on remand in connection with the Trustee's First Amended Motion to Determine Tax Liability (the "Motion") filed in September 1998 and originally heard by this Court in March 1999. At that time, this Court determined that the Trustee's distributions to Gary Vaughn ("Gary") under the Trustee's Plan of Reorganization for the Debtors (the "Plan") were non-deductible, reasoning that they were returns of stock equity to Gary and not payments on account of Gary's damages claims against the Debtors.
The author of this Memorandum Opinion and Order became responsible for these cases (and presided over the second remand hearings) upon the retirement of the judge who was originally assigned the cases and who presided over them through the first remand hearings.
The Plan was confirmed by Order of this Court entered on August 7, 1995. See Trustee Exhibit 1(D). That Order also confirmed plans filed in two other debtors' cases pending before the same judge — i.e., a chapter 11 case for Grady H. Vaughn, III ("Grady") and a chapter 11 case for The Antigone Corporation ("Antigone"). Confirmation of the Plan was conditioned on the Court also confirming the proposed plans for Grady and Antigone. See Trustee Exhibit 1(A) at p. 10, ¶ (b). The Court entered detailed findings of fact and conclusions of law in connection with its order confirming the Plan and the plans for Grady and Antigone. See Trustee Exhibit 1(C).
On appeal, the District Court ruled in its Memorandum Opinion and Order (the "Opinion"), entered on December 21, 2001, that this Court "erred in not allocating some of the distributions to Gary as payment for damages." Opinion at p. 16. In addition, the District Court found that two Qualified Settlement Funds ("QSFs") were established through confirmation of the Plan, which entitled the Trustee to certain tax benefits that this Court had not allowed during the original hearings on the Motion. Accordingly, the District Court remanded the case to this Court "for calculation of the amount of the payments to Gary that were for damages claims and for determination of the Trustee's tax liability in accordance with this order." Opinion at p. 34.
On remand, this Court, without re-opening the record, determined, in an alternative ruling, that of the total distributions to Gary, only $198,718 was made in payment of damages claims and the remainder was a return of equity. It is unclear if this Court considered the tax implications of the District Court's determination that two QSFs had been established through confirmation of the Plan on remand, or if it was necessary to do so in light of the de minimus amount of damages found in the alternative ruling.
The primary ruling was that the Court had correctly decided the issue in the first instance and that no portion of the Trustee's distributions under the Plan were on account of Gary's damages claims.
On further appeal, the District Court noted that "the Bankruptcy Court refused to permit the Trustee to present evidence relevant to the allocation of distributions to Gary Vaughn. . . . Because the record still lacks evidence as to the proper allocation of the distributions to Gary Vaughn, it is still impossible, as Judge Solis previously found, to determine the division of those distributions into equity payments versus the satisfaction of damages claims," see Order entered September 13, 2004 ("Order") at p. 2, and remanded the case once again to this Court.
Upon the retirement of the judge who had presided over the Debtors' cases, the author of this Memorandum Opinion and Order became responsible for the cases, including deciding the issues to be addressed in connection with the second remand Order. An initial scheduling conference on remand was held on October 28, 2004 and, after another scheduling conference, a scheduling order was entered. In accordance with that order, further evidentiary hearings were held on May 16 and 17, 2005, at which time the Trustee supplemented the prior record made in connection with the March 1999 hearing on the Motion with testimony from five (5) witnesses, some of whom had testified previously. This Memorandum Opinion and Order constitutes the Court's findings of fact and conclusions of law on remand.
After carefully considering the evidentiary record made in connection with the original hearing on the Motion, as well as the supplemental record just made on remand, this Court finds, for the reasons explained more fully below, that all of the payments made by the Trustee to Gary under the Plan were either on account of (i) debts owed to Gary, and/or one of the so-called Gary Entities under the Plan, or (ii) damages claims asserted by Gary against the Debtors and certain other persons, jointly and severally. Specifically, this Court finds that of the total distributions to the Gary Entities under the Plan (the aggregate sum of $7,615,271.74), (i) $3,766,966.00 was for debt repayment to the Gary Entities and (ii) $3,848,305.74 was on account of Gary's damages claims against Chama. The Gary Entities received distributions under the Plan over three years — i.e., 1995, 1996, and 1997. Of the total distributed, the Gary Entities received $5,272,303.55 in 1995, $1,009,268.01 in 1996, and $1,333,700.18 in 1997. Thus, if the scope of this remand hearing is limited to distributions actually received in 1995, this Court finds that of the total distributions to the Gary Entities under the Plan in 1995 (the aggregate sum of $5,272,303.55), (i) $3,766,966.00 was for debt repayment to the Gary Entities and (ii) $1,505,337.55 was on account of Gary's damages claims against Chama.
The Plan defined "Gary Entities" to mean "Gary, GWV, Ltd., Support Trust, The Grayrock Corporation, Oyster Bay Financial, Inc., and Antigone. See Trustee Exhibit 1(A) at p. 4.
Recognizing that Judge Solis originally concluded that this Court "erred in not allocating some of the distributions to Gary as payment for damages," Opinion at p. 16 (emphasis added), this Court finds, in the alternative, that of the total distributions made to the Gary Entities under the Plan (the aggregate sum of $7,615,271.74), (i) $3,766,966.00 was for debt repayment to the Gary Entities, (ii) $788,782 was on account of Gary's stock ownership in Chama, and (iii) $3,059,523.74 was on account of Gary's damages claims against Chama. Once again, if the scope of this remand hearing is limited to distributions actually received in 1995, this Court finds that of the total distributions to the Gary Entities under the Plan in 1995 (the aggregate sum of $5,272,303.55), (i) $3,766,966.00 was for debt repayment to the Gary Entities, (ii) $788,782 was on account of Gary's stock ownership in Chama, and (iii) $716,555.55 was on account of Gary's damages claims against Chama.
The legal standard to be applied by this Court on remand does not appear to be in dispute. The parties agree that the burden of proof is on the Trustee because, as the District Court noted, "an income tax deduction is a matter of legislative grace and the burden of clearly showing the right to the claimed deduction is on the taxpayer." Opinion at p. 7 (citations omitted). Moreover, the District Court has already concluded that the Trustee has satisfied the tests necessary for deductibility as a legal matter. See Opinion at pp. 19-23. Specifically, the District Court held that the "three requirements for deducting a settlement payment as a business expense are that the payment have the requisite relationship to the taxpayer's business, be `ordinary,' and be `necessary.'" Opinion at p. 19. After noting that there is "no dispute that the expenses were related to the taxpayer's business," Opinion at p. 19 (citations omitted), and that "[t]he ordinary nature of this expense is also not disputed," Opinion at p. 20 (citations omitted), the District Court concluded that "[t]he contentious point is whether the expenses were necessary." Id. After explaining that "[a] three-part test determines whether an expense paid to settle a lawsuit is `necessary,'" Opinion at p. 20, the District Court concluded that all three prongs of the test were satisfied as to Gary. Id. at pp. 20-23. Thus, this Court need only decide the factual predicate — i.e., of the distributions paid to the Gary Entities under the Plan, what portion were for Gary's damages claims and what portion were for his equity interest in Chama, to which we now turn.
The underlying facts of these cases are complex and are set forth in the prior opinions relating to the Motion. Since the issues on remand are narrow, this Court will not repeat all of those facts here. Rather, this Court will only restate the facts it believes are necessary to an understanding of this Memorandum Opinion and Order, along with its additional findings of fact and conclusions of law.
It is undisputed that Gary sued various parties, including the Debtors, in state court, which action was removed here. See Adv. Pro. No. 393-3412-BJH. Gary's claims are reflected in his Ninth Amended Complaint filed in January 1994 (the "Amended Complaint"). See Trustee Exhibit 33. In general, the allegations in the Amended Complaint include claims that the Debtors, among others, (i) perpetrated fraud on Gary, (ii) were negligent, (iii) caused warrants and stock to be issued in the entities to which Gary's trust assets had been transferred in violation of Gary's rights, (iv) gained effective control of Gary's trust assets for the benefit of themselves as opposed to the best interest of Gary and, as a result, expended millions of dollars in cash and other assets owned by Gary for their own personal uses, (v) breached fiduciary duties to Gary, (vi) concealed certain transfers and expenditures from Gary in an attempt to defraud him, and (vii) intentionally inflicted emotional distress on Gary. In addition, Gary alleged in the Amended Complaint that the voting trust agreements entered into by the Lodge, AEC, and Holdings constituted actual and constructive fraud and a breach of fiduciary duty, and that two or more of the defendants conspired to divert, through unlawful means and in violation of legal and fiduciary obligations, substantial assets of Gary in order to use such assets for such defendants' own personal uses. Gary sought to recover actual damages in excess of $18 million, along with exemplary damages of not less than four times his actual damages. See Trustee Exhibit 33 at pp. 29-30. Gary also filed proofs of claims against each of the Debtors, attaching the Amended Complaint as the basis for his claims. See Trustee Exhibits 784, 785, 786, 787.
As the District Court noted, the facts of this case are largely undisputed. See Opinion at pp. 3-7. Litigation drove the Debtors, Malcolm Kelso ("Kelso"), his firm — Legal Econometrics, Inc. ("LEI"), Grady, and Antigone to file their respective chapter 11 cases. Unfortunately, the bankruptcy filings did not end the litigation — it just moved to the bankruptcy court. The record is clear — the Debtors' bankruptcy cases were largely driven by litigation between and among Gary (and the Gary Entities), Kelso, LEI, Grady, Grady's Children's Trusts, Antigone, and Regency Savings Bank, FSB ("Regency"), among others. Much of the litigation centered around the so-called 1990 Transactions, which the District Court generally described in the Opinion at p. 4.
As the Trustee testified at the second remand hearing, after his appointment and the proposed Ranch Sale (as defined in the Plan, see Trustee Exhibit 1(A) at p. 5), it became clear that the only way to bring the Debtors' bankruptcy cases to conclusion without spending even more of the proposed sale proceeds in continued litigation, was to propose a plan that would settle the ongoing litigation among the parties. Consequently, the Trustee suggested the basic framework of a possible plan of reorganization to the principal litigants. Specifically, the Trustee testified that he suggested that the proceeds from the Ranch Sale be used to pay all of the non-litigation claims against the Debtors and, once those creditors were paid, the remaining sale proceeds could be made available to the four principal groups of litigants — i.e., Kelso/LEI, the Gary Entities, Regency, and Grady/Grady's Children's Trusts. While Kelso/LEI were unwilling to settle, the other parties were and a largely consensual plan was finally proposed and confirmed — i.e., the Plan. See Trustee Exhibits 1(A), (C), (D). After this Court determined that Kelso/LEI had no valid claims against the Debtors, the Gary Entities and Regency became entitled to receive slightly in excess of 48% of the residual proceeds from the Ranch Sale after payment of Class 1-4 claims under the Plan. See Trustee Exhibit 1(A) at pp. 7-8. Other than this litigation with the Internal Revenue Service ("IRS") over the Debtors' tax liability, the Plan worked as the Trustee envisioned — the morass of litigation over the 1990 Transactions that threatened the successful conclusion of the Debtors' bankruptcy cases (as well as Grady's case and Antigone's case) was ended through the mutual releases that the settling parties agreed to sign in accordance with the Plan. See Trustee Exhibits 1(A) (B).
This brings us to the ultimate issue to be decided on remand — what was the Trustee's intent when he made distributions to Gary under the Plan? Did he think he was paying Gary to resolve Gary's damages claims against Chama and/or the other Debtors, or did he think he was paying Gary on account of his equity interests in Chama, or some combination of those alternatives?
Based upon the entirety of the record, this Court finds that other than the monies that were distributed to the Gary Entities to repay their liquidated debts against the Debtors (in the amount of $3,766,966, see IRS Exhibit 137), the Trustee was paying Gary to settle his unliquidated damages claims against Chama. The Court makes this finding for at least the following reasons.
First, it makes no sense that the Trustee was making payments to Gary on account of his equity interests in Chama. What drove the Trustee to propose the Plan was a desire to bring the Debtors' cases to a successful conclusion, which would enable the Trustee to pay the non-litigation claims (which were being held hostage by the ongoing litigation among the Debtors, the Gary Entities, Regency, Kelso/LEI, Grady, and Antigone, among others) and, hopefully, settle all of the litigation. So, the Trustee proposed the basic structure of the Plan to the principal litigants — i.e., to pay the non-litigation claims out of the proceeds from the Ranch Sale and then split the remaining proceeds among the principal litigants in exchange for the settlement of all of their litigation claims against each other and the Debtors. Stated most simply, Gary's equity interest in Chama was not preventing the Trustee from proposing a plan of reorganization for the Debtors. Gary's rights as a shareholder were clearly established under the Bankruptcy Code. In short, Gary was not entitled to any distribution on account of his equity interest until all creditors' claims were paid in full, including all of the unliquidated claims that were asserted against Chama by various parties, including Gary (as set forth in his proof of claim and the attached Amended Complaint). See, e.g., 11 U.S.C. § 1129(b)(2)(B). Rather, it was Gary's unliquidated damages claims (along with those of the other litigants) that were the obstacle to a viable plan of reorganization for the Debtors that could bring the Debtors' cases to a conclusion and insure that creditors were paid.
Second, while Gary's claims were never litigated to conclusion because he settled those claims under the terms of the Plan, it is undisputed that he had substantial claims against the Debtors, among others. The Debtors were alleged to be liable to Gary along with the other named defendants, jointly and severally. Gary testified at the second remand hearing about the damages he suffered as a result of the 1990 Transactions. Those damages were detailed on Trustee Exhibit 805 and included a loss of nearly $10 million of assets that were stripped out of the Support Trust (as defined in the Plan) and a dilution in value to his stock interest in Chama of over $17.5 million. After adding in lost earnings from other oil and gas properties and certain other items, Gary's damages calculation totalled $28,770,771. See Trustee Exhibit 805. It is also undisputed that Gary received certain assets under the plans of reorganization confirmed in the Antigone and Grady cases. After crediting Gary's damages calculation for the value of the assets received under the Antigone and Grady plans, and after correcting a double-counting error on Trustee Exhibit 805 identified by the Trustee's expert witness Richard Holmes ("Holmes"), Gary's damages calculation still shows actual damages remaining to be paid in excess of $14 million. See id. at p. 2. Finally, it is undisputed that Gary and/or the Gary Entities received aggregate distributions from the Trustee under the Plan of $7,615,271.74, of which $5,272,303.55 was received in 1995, $1,009,268.01 was received in 1996, and $1,333,700.18 was received in 1997. It is also undisputed that $3,766,966.00 of the monies paid in 1995 was in payment of liquidated debts owed to certain of the Gary Entities. Gary's remaining unliquidated damages claims exceed the remaining amounts distributed to him by a multiple of 3.5 x.
Third, while the so-called absolute priority rule generally applicable in bankruptcy cases was not directly implicated by confirmation of the Plan (because Gary and Regency agreed to accept the Plan), it is relevant by analogy. In accordance with the absolute priority rule, senior classes of creditors must be paid in full (or vote to accept the plan as a class) before value can be distributed on account of an equity interest in a debtor. See 11 U.S.C. § 1129(b)(2)(B). This bankruptcy absolute priority rule has a state law analog — i.e., in a corporate liquidation under state law, creditors get paid before equity holders. The Debtors were New Mexico corporations. New Mexico's Business Corporation Act provides that upon a corporate dissolution, the corporation shall
proceed to collect its assets, convey and dispose of such of its properties as are not to be distributed in kind to its shareholders, pay, satisfy and discharge its liabilities and obligations and do all other acts required to liquidate its business and affairs and, after paying or adequately providing for the payment of all of its obligations, distribute the remainder of its assets, either in cash or in kind, among its shareholders according to their respective rights and interests.
N.M. Stat. Ann. § 53-16-6 (Michie 1978) (emphasis added); see generally Garcia v. Coe Mfg. Co., 123 N.M. 34 (N.M. 1997) (stating that creditors' claims must be satisfied before any distribution may be made to shareholders of a dissolving corporation). Thus, under either bankruptcy law or state law, Gary's claims against the Debtors were entitled to be paid in full before any value could be legally distributed on account of his equity interest in Chama. Since Gary's unliquidated damages claims were well in excess of what he was paid under the Plan (either before or after the payment of the liquidated debt claims of the Gary Entities), it makes no sense to allocate any portion of the distributions to Gary's equity interest in Chama.
Finally, the Trustee did not "redeem" Gary's equity interest in Chama under the Plan. Rather, the Plan "fully satisfied and discharged" all of Gary's claims and equity interests in the Chama Estates (as defined in the Plan). See Trustee Exhibit 1(A) at p. 8 (Article 6). Then, in the "Means of Execution of Plan" section of the Plan, the Plan provided for the "irrevocable transfer" of the equity interests in the Debtors to the Trustee so that the Trustee could dissolve the Debtors under New Mexico state law. Specifically, Article 8(e) of the Plan, entitled "Dissolution of Debtors," provided that
[a]fter the Debtors and their assets have been completely liquidated and this Plan and the New Antigone Plan and the New Grady Plan have been consummated, the Debtors' charters will be canceled by the Trustee and the Trustee shall dissolve the Debtor corporations. All Equity Interests in the Debtors shall be irrevocably transferred to the Trustee as of the Distribution Date, in exchange for the right to receive distributions under this Plan.
Trustee Exhibit 1(A) at p. 10, ¶ (e). Accordingly, Gary's equity interest in Chama was irrevocably transferred to the Trustee in exchange for his right to receive Plan distributions. In this Court's view, however, neither of these Plan provisions establish that Gary received distributions from the Trustee on account of his equity interest in Chama. Rather, taken together, these provisions simply provide the mechanism for the Trustee to bring the Debtors' bankruptcy cases, and their corporate existences, to an end.
While the Court's conclusions are consistent with the opinion offered by the Trustee's expert, Holmes, the Court would have come to its conclusions without regard to Holmes' testimony. While Holmes was well qualified to offer expert testimony here, he essentially did what the Court did in preparing for the remand hearings. He reviewed certain documents in formulating his expert opinion. See Trustee Exhibit 834(A) at Exhibit B. However, it appears that Holmes reviewed fewer documents than did the Court, who reviewed substantially all of the evidentiary record made in connection with the original hearing on the Motion (including all of the items designated by the parties), all of the appellate briefs and decisions, as well as the further evidence offered at the second remand hearing.
In reaching the conclusions stated herein, this Court has carefully considered, and rejected, the arguments made by the IRS for at least the following reasons. First, the IRS argues that the judge formerly presiding over the Debtors' cases "got it right" originally, and in connection with the first remand hearings, when he concluded that no distributions were made by the Trustee on account of Gary's damages claims against the Debtors. Or, that he "got it right" on remand when he allocated a de minimus amount to damages as an alternative ruling. Of course, that argument ignores the fact that two District Court judges have disagreed with the prior determinations and have remanded the case back to this Court for further evidentiary hearings, which have now been concluded. Moreover, the author of this Memorandum Opinion and Order simply disagrees with the prior determinations after considering the prior evidentiary record as supplemented on remand.
Second, the IRS argues that the inconsistent treatment of the distributions on the Gary Entities' respective tax returns for 1995 demonstrates that the distributions were really intended as equity repayment, not payments on account of damages claims. This Court is not troubled by the perceived inconsistency for several reasons. First, the District Court seems to have rejected this same argument on appeal. See, e.g., Opinion at p. 16. Second, the significance of the inconsistency is overstated. At the outset, this Court notes that it cannot find any inconsistency between the Trustee's 1995 Chama tax return and the 1995 tax returns filed by The Grayrock Corporation, Petro-Vaughn, Inc. (formerly known as Oyster Bay Financial, Inc.), and Antigone. Those Gary Entities reported the Trustee's distributions under the Plan as either repayment of notes receivable or accounts receivable. In fact, that is what those payments were for. See, e.g., IRS Exhibits 46 137. Moreover, the perceived inconsistency between the Trustee's original 1995 Chama tax return and the original 1995 Gary tax return is overstated. On the Trustee's original 1995 Chama tax return, the Trustee took a $3,345,446 deduction for Gary's damages claims. See Trustee Exhibit 662. The IRS perceives a significant inconsistency because that claimed deduction exceeds the amounts actually distributed by the Trustee to Gary in 1995. As previously noted, the Trustee distributed $5,272,303.55 to the Gary Entities in 1995. Of that amount, $3,766,966.00 was distributed on account of debts owed to Antigone, Petro-Vaughn, Greyrock, and the Support Trust (certain of the Gary Entities). See IRS Exhibit 137. Of the monies actually distributed in 1995, that leaves only $1,505,337.55. Of the $1,505,337.55 remaining, it is undisputed that the Trustee initially reported a return of equity to Gary from Chama of $788,782, leaving only $716,555.55 for possible allocation to deductible damages claims. From these facts, the IRS cries foul, because the Trustee claimed a damages deduction for Gary of $3,345,446 in 1995 — an amount well in excess of the remaining amount actually distributed to Gary in that year, and inconsistent treatment between the Trustee and Gary, who admittedly failed to report the receipt of any monies on account of damages claims on his 1995 return. However, Gary's failure to show the receipt of damages distributions on his 1995 return is not the relevant inquiry. As the IRS notes in most of its briefs on file in connection with the Motion, and as the District Court concluded, in deciding whether the three-part test to determine whether an expense paid to settle a lawsuit is "necessary," it is the taxpayer's intent (here, the Trustee's) that is the relevant inquiry. Gary's intent in receiving the distribution is simply not relevant. Moreover, the Trustee's accountant, David Bowlin, testified at the original hearings on the Motion that he believed it was appropriate for the Trustee to claim the entire damages deduction in 1995 because Chama was an accrual taxpayer and because the Trustee already knew he would distribute substantial additional funds (another $2,342,968.19 in fact) to Gary in 1996 and 1997. See, e.g., Transcript of March 11, 1999 hearings, at Volume 1, pp. 157-165. So, according to Bowlin, he believed it was appropriate to claim the entire damages deduction in 1995. Id. While it may have been legally incorrect to claim a deduction for more than the amounts actually distributed in 1995, the Court does not see a significant inconsistency from these facts. The Trustee has consistently taken the position from the time of the filing of the original 1995 Chama tax return that he had distributed (or would distribute) significant monies to Gary on account of his damages claims. Finally, any inconsistency in treatment between the Trustee and Gary will have to be cured. It is undisputed that Gary will be legally required to amend his tax returns to reflect the treatment finally determined to be appropriate in connection with these hearings on the Motion. Accordingly, the IRS will be able to tax either the Trustee or Gary. So, even if the parties' initial returns are inconsistent, that inconsistency will be resolved.
Under the Internal Revenue Code, the parties agree that Gary is required to report damages payments to him as ordinary income, which he failed to do.
By agreement of the parties, the Court has bifurcated the issues on remand. This Memorandum Opinion allocates payments to Gary between damages claims and equity. Thereafter, the parties will be directed to calculate the Trustee's tax liability and, if agreement is not reached, the Court may conduct further hearings in connection with the determination of the amount of the Trustee's tax liability. Accordingly, the Court expresses no current view on the legal issue of whether it is appropriate to deduct more than the amounts actually distributed in 1995 and/or the legal effect of the District Court's finding that two QSFs were established upon confirmation of the Plan.
Next, the IRS argues that no allocation should be made to Gary's damages claims because as a legal matter, the mutual release of claims by all of the settling parties was sufficient consideration to make the release document legally binding on the parties. In short, the IRS argues that no monies needed to be paid for the release, as the document was legally valid with just a mutual release of claims. And, according to the IRS, the logical conclusion that flows from this premise is that the Trustee's payments to Gary must have been made on account of his equity interests in Chama. This logic is flawed. While the mutual release of claims might be legally sufficient consideration to make the document binding on the parties, that is not dispositive of the issue of the Trustee's intent in making the Plan distributions. Moreover, it overlooks the fact that Gary would not likely have signed the release and settled millions of dollars of damages claims had he not received monetary benefits for the release of his claims. In any event, it is undisputed that neither the Plan, nor the Release attendant to the Plan, contains an allocation of what monies were being paid under the Plan on account of (i) liquidated debts owed to the Gary Entities, (ii) Gary's damages claims, and/or (iii) Gary's equity interest in Chama. And, as the IRS concedes, even if those documents had contained an allocation, this Court would still be required to consider all of the surrounding facts and circumstances to determine what allocation was appropriate. After considering all of those surrounding facts and circumstances, the Court simply disagrees with the IRS' contention that the Trustee's payments to Gary were for a return on equity.
Finally, the IRS complains, again, of the "uncontested, nonadversarial, and entirely tax-motivated, allocation" between the Trustee on the one hand and the Gary Entites on the other hand. Brief of United States on Remand Concerning Allocation of Trustee's Distributions To Gary Vaughn in 1995, filed in connection with the first remand hearing on October 2, 2002, at p. 10. However, the District Court rejected this argument in connection with the first appeal when it noted that:
Appellee is correct that a court is not bound by the settling parties' allocation between tort damages and other compensation for tax purposes, but may ascertain the proper allocation for itself. Appellee notes that the Trustee's allocations between damages and equity changed between the debtors' original and amended returns. Appellee offers undisputed evidence of ongoing cooperation amoung the Trustee, Regency, and Gary Entites in deciding how to characterize the plan distributions on the debtors' tax returns. From evidence that the Gary Entities and Regency wanted the Trustee to treat their distributions as damages, Appellee would infer an undue deference by the Trustee, in deference to Regency and Gary's status as shareholders. Even if this were true, it does not indicate that the distributions created through the cooperation of the parties would not be properly characterized as damages rather than as stock distributions. Further, this evidence seems equally consistent with an effort by Appellant to establish consistency of treatment of the plan distributions on each party's tax return, and the desire by the distributees to maximize their distributions by freeing up more money by way of a business expense deduction by the Trustee.
Opinion at p. 16 (citation omitted).
In sum, this Court concludes that Gary had significant damages claims against the Debtors, including Chama, for which each debtor could be jointly and severally liable. The Trustee needed substantially all of the litigating parties to agree to settle their claims against each other (including the Debtors) in order to propose a meaningful plan of reorganization for the Debtors. It was the morass of litigation claims pending in the bankruptcy cases, not the equity interests in the Debtors, that was precluding the formulation of, and confirmation of, a plan of reorganization for the Debtors. The fact that the equity interests in the Debtors were irrevocably transferred to the Trustee as of the Distribution Date does not mean that the Trustee "redeemed" Gary's Chama stock or made payments to Gary on account of that stock. After considering all of the relevant facts and circumstances, including the size of Gary's remaining claims against Chama (after crediting those claims for payments from other co-liable parties), the most logical conclusion from the evidence is that the Trustee's payments to Gary (other than those payments the parties agree were for repayment of liquidated debts) were made on account of his unliquidated damages claims.
Alternatively, in light of the District Court's original conclusion that this Court "erred in not allocating some of the distributions to Gary as payment for damages," Opinion at p. 16 (emphasis added), this Court finds that of the total distributions made to Gary under the Plan (the aggregate sum of $7,615,271.74), (i) $3,766,966.00 was for debt repayment to the Gary Entities, (ii) $788,782 was on account of Gary's stock ownership in Chama, and (iii) $3,059,523.74 was on account of Gary's damages claims against Chama. Once again, if the scope of this remand hearing is limited to distributions actually received in 1995, this Court finds that of the total distributions to the Gary Entities under the Plan in 1995 (the aggregate sum of $5,272,303.55), (i) $3,766,966.00 was for debt repayment to the Gary Entities, (ii) $788,782 was on account of Gary's stock ownership in Chama, and (iii) $716,555.55 was on account of Gary's damages claims against Chama. The amount allocated to equity is derived by multiplying Chama's paid in capital surplus as stated on line 23 of Chama's 1995 tax return, see Trustee Exhibit 662, by Gary's percentage of stock ownership in Chama. As noted previously, this is the amount the Trustee originally allocated to a return on equity to Gary in the original 1995 Chama tax return. See also Trustee Exhibit 663 at p. 3 (where the Trustee claims an additional damages deduction on the first amended 1995 Chama tax return of $788,782, the amount previously allocated to equity).
Accordingly, counsel for the Trustee and the IRS are directed to confer with each other and prepare calculations determining the Trustee's tax liability in a manner consistent with this Memorandum Opinion and Order (both the primary and alternative rulings) and the Opinion. If the parties cannot agree on the calculations, the Trustee and the IRS shall each submit their respective calculations to the Court in a pleading filed with the Court no later than June 10, 2005. If the Court decides it is necessary, or if requested by any party in the pleading which contains its tax liability calculations, the Court will hold further evidentiary hearings in connection with the proper calculation of the Trustee's tax liability.
SO ORDERED.