Opinion
NOT FOR PUBLICATION
Argued and Submitted at San Diego, California: January 23, 2008
Appeal from the United States Bankruptcy Court for the Southern District of California. Bk. No. 94-01921. Honorable Peter W. Bowie, Chief Bankruptcy Judge, Presiding.
Before: KLEIN, MARKELL and DONOVAN, [ Bankruptcy Judges.
MEMORANDUM
This is an appeal from an order sustaining the chapter 7 trustee's objection to a tax claim filed on behalf of the California Franchise Tax Board (" FTB") pursuant to 11 U.S.C. § 501(c). Appellant, the FTB, argues that the debtor and his former spouse owe taxes for tax year 1993 based on multiple modifications made to three promissory notes that encumbered certain real property owned by the couple's partnership. Appellees, the chapter 7 trustee and the former spouse, each dispute the alleged tax assessment of the debtor (hence, the bankruptcy estate) and the former spouse. The court held that the various modifications between 1987 and 1993 made to the notes did not trigger taxable gain and taxable discharge of indebtedness for 1993. We AFFIRM.
FACTS
Debtor Robert Adams and his former spouse, appellee Judith Adams, own an interest in Trails partnership, a limited partnership that had as its sole asset an apartment complex in Dallas, Texas. The partnership purchased the property in October 1982 and sold it on February 10, 1993.
As part of the consideration for purchase of the property in 1982, the partnership executed a Wraparound Promissory Note to the seller. Underlying the Wraparound Note were two promissory notes, the First Note and Second Note, secured by a First Trust Deed and Second Trust Deed, respectively. The Wraparound Note, the First Note, and the Second Note were all without recourse to the partnership and its partners. Thus, neither the partnership, the general partner, Robert nor Judith had personal liability for any of the notes.
Over the ten-year ownership period, numerous transactions occurred that affected the transfer of, or other modification to the terms of the First, Second, or Wraparound Notes.
The present dispute involves the tax treatment of some or all of these modifications, and the taxable obligations of Robert and Judith, and therefore debtor's estate, which arise from the modifications to the First Note, on the one hand, and the modifications to the Second and Wraparound Notes, on the other.
While the Stipulation of Facts by the parties filed on September 12, 2006, details the numerous transactions, a summary account of the most pertinent information is as follows.
On October 14, 1987, the then-owner of the Second Note and the Wraparound Note transferred the Second Note and Wraparound Note to Judith's attorney, George McGill, for $240,000 paid by Judith, and the then-owner of all stock in the general partner of the partnership transferred all such stock to McGill for $10,000 paid by Judith.
On December 18, 1990, McGill transferred the Second Note and the Wraparound Note to Jerrol L. McLeod in exchange for no money or other property. McLeod, a certified public accountant and real estate investor, was a former colleague of Judith's current certified public accountant.
With a downturn in the market and the notes all in default, on December 19, 1992, the partnership and McLeod signed a document entitled " Cancellation and Modification of Promissory Notes" (" Cancellation Agreement"), which provided that McLeod would cancel the Second Note and Wraparound Note on the following conditions: (1) the partnership would assume all obligations of the First Note; (2) Judith would issue a Full Recourse Promissory Note to McLeod for $50,000; and (3) the partnership would grant McLeod an option for him to purchase the property from the partnership for $50,000 payable by McLeod's cancellation of the $50,000 note, plus 85 percent of McLeod's profit on resale of the property. On the same day, the $50,000 note from Judith to McLeod was issued and the partnership and McLeod signed an option agreement to document the above-contemplated option to purchase.
On February 5, 1993, McLeod signed a release of lien with respect to the Second Note and another release of lien with respect to the Wraparound Note.
On February 10, 1993, in exchange for approximately $100,000 paid by the partnership, the then-owner of the First Note, Northern Trails Apartments, reduced the amount due on the First Note from approximately $3.6 million to $900,000.
Also on February 10, 1993, in exchange for $70,000 and cancellation of the First Note, McLeod conveyed the property to STA Investments, Inc., the new (that day) then-owner of the First Note. The same person was both the president of the managing general partner of Northern Trails Apartments and the president of STA Investments, Inc.
McLeod paid the partnership 85 percent of his profit from the resale of the property.
For 1992 and 1993, the partnership filed federal income tax returns and Robert and Judith filed joint California income tax returns, reflecting their tax treatment of the specific events that occurred during that particular calendar tax year. Robert and Judith claimed their liabilities exceeded their assets and that they were thus insolvent for 1992 and 1993.
Specifically, in its 1992 federal income tax return, the partnership reported discharge of indebtedness income of $12,395,989 for the reported cancellation in 1992 of the Second Note and Wraparound Note. In their 1992 California income tax return, Robert and Judith reported their 90 percent share of the $12,395,989 as income and excluded that share from taxable income because they were allegedly insolvent.
In its 1993 federal income tax return, the partnership reported discharge of indebtedness income of $2,626,121 for the reported reduction in 1993 of the amount due on the First Note. In their 1993 California income tax return, Robert and Judith reported their 90 percent share of the $2,626,121 as income and excluded that share from taxable income because they were allegedly insolvent.
On February 22, 1994, Robert Adams filed a chapter 11 bankruptcy case, which case was later converted to chapter 7. Appellee Richard M. Kipperman was appointed as chapter 7 trustee.
In 1996, the appellant California Franchise Tax Board audited Robert and Judith's 1992 and 1993 income tax returns. As to the 1992 income tax return, the FTB reviewed and analyzed the Cancellation Agreement, and acknowledged the consequences of the transactions and reported income from the cancellation of the Second and Wraparound Notes.
For the 1992 audit, the FTB issued a " no change to your tax liability" letter (" no change" letter), concluding that the partnership did not receive discharge of indebtedness income in 1992, and thus Robert and Judith had no tax deficiency for that year from the extinguishment of the Second Note and Wraparound Note. The 1992 audit and " no change" letter in effect confirmed only the $2,302 tax liability originally reported by Robert and Judith in their 1992 tax return.
As to the 1993 income tax return, the FTB sought to assess income tax of $1,361,746 (excluding interest and penalties) against Robert and Judith for that year based upon their 90 percent share of the amount realized on the partnership's sale to McLeod of the property while encumbered by the trust deeds securing the First Note, the Second Note, and the Wraparound Note. The FTB filed a Notice of Proposed Assessment on September 11, 1998 and filed a Notice of Action on October 18, 2001, indicating this additional tax amount owed.
After the trustee and Judith litigated the proposed 1993 tax assessment with the FTB through the state administrative system, the State Board of Equalization upheld the FTB's assessment of the 1993 taxes. The assessment of tax in the principal amount of $1,361,746 became final on October 11, 2002.
On June 24, 2004, the FTB recorded a Notice of Tax Lien in Orange County in the total amount of $3,004,725.31, which included tax plus interest, against Judith.
Although the FTB had filed proofs of claim in debtor's bankruptcy case for pre-petition tax years other than 1993, the FTB did not file a claim with respect to this assessment. Thus, on December 31, 2004, pursuant to 11 U.S.C. § 501(c), the trustee, on behalf of the FTB, filed amended Claim No. 50 to take into account the disputed FTB assessment.
On December 31, 2004, the trustee filed his objection to the FTB claim. Judith joined in the trustee's objection to the claim on the same day.
The parties agreed to a Stipulation of Facts and a trial by declaration of the witnesses (to be available for cross-examination) at a trial set on September 20, 2006. At trial, no cross-examination was requested. The trustee's counsel first asked the court to rule on the application of the duty of consistency and to determine who held the burden of proof before proceeding further. After the FTB conceded it bore the burden of proof, the court directed the parties to brief additional issues, including: (1) whether the FTB made a judicial admission that there was cancellation of debt in 1987; (2) whether the 1992 audit and FTB's issuance of a " no change" letter created a type of issue preclusion barring the FTB from claiming that 1992 income should be taxed in 1993; and (3) whether the FTB met its burden of proof to show a " step transaction" or " sham transaction" occurred which would uphold the tax assessment.
After continued proceedings on October 25, 2006, on the issues, the court sustained the trustee's objection to Claim No. 50 for $1,361,746 and any penalty and interest thereon for 1992 and/or 1993. It further ruled that the FTB judicially admitted that the Second and Wraparound Notes were cancelled in 1987.
Alternatively, the court concluded that the FTB was bound by the duty of consistency and principles of judicial estoppel and res judicata, all of which prohibited the FTB from asserting that the Second Note and Wraparound Note were cancelled in any year other than 1992. The court further determined that the FTB had not met its burden on showing a sham or step transaction. The court's rulings were memorialized in findings of fact and conclusions of law entered on February 2, 2007.
After the court ruled on the tax liability and forgiveness of debt for the Second Note and Wraparound Note, the court resumed hearing on February 26, 2007, of the tax liability on forgiveness of the First Note in 1993.
Specifically, two disputes remained: (1) the taxability of the extinguishment in 1993 of the First Note (which previously had been reduced from approximately $3.6 million to $900,000) after the partnership sold the property to McLeod and McLeod resold the property to the holder of the First Note, thereby cancelling the remainder of the First Note and (2) the taxable gain (resulting from the extinguishment in 1987 or 1992 of the Second Note and the Wraparound Note) to Judith in 1993 on the termination of the partnership.
In an order entered on May 15, 2007, the court ruled on the " remaining disputed items" arising out of trustee's objection to the FTB's claim regarding the tax liability of Robert and Judith for 1993: (1) the income generated by the write-down of the First Note to $900,000 was properly treated as discharge of indebtedness income; (2) the First Note was properly included as a liability for purposes of determining Robert and Judith's insolvency; and (3) the gain to Judith on termination of the partnership was as provided in the Stipulation of Facts.
As a result of the FTB's argument that the actual numbers for tax liability depended on the court's rulings stated above, the May 15, 2007, order directed the parties to calculate the amount of taxes owed for tax year 1993, and allowed the parties to submit figures for the taxes owed for 1990 and 1991.
Thereafter, it was made clear at a status conference that the FTB wanted an order fixing the amount of Robert and Judith's liability for 1993, presumably to appeal.
On July 2, 2007, the bankruptcy court filed a document entitled " Memorandum" following the parties' efforts to come to an agreement regarding the disputed tax issues. The court concluded that no tax liability was owed for 1993.
On July 12, 2007, the FTB appealed the July 2, 2007, order as our No. SC-07-1283. The trustee moved to dismiss the appeal as untimely, arguing that the FTB should have appealed the May 15, 2007, order on grounds that it was the final order because the tax calculations to be determined were merely ministerial. On October 2, 2007, the Panel issued an order denying trustee's motion to dismiss. The Panel further determined that the May 15, 2007, order was interlocutory, and the July 2, 2007, order entitled " Memorandum, " was a final order.
JURISDICTION
The bankruptcy court had jurisdiction via 28 U.S.C. § 1334. We have jurisdiction under 28 U.S.C. § 158(a)(1).
ISSUES
(1) Whether the FTB's appeal of the July 2, 2007, order entitled " Memorandum" was correct and its subsequent appeal of the May 15, 2007, order was timely.
(2) Whether the court erred in ruling that Robert and Judith had no taxable gain and no taxable discharge of indebtedness for 1993 from the cancellation of the Second and Wraparound Notes.
(3) Whether the court erred in ruling that the FTB's 1992 " no change" letter (concluding no tax deficiency in 1992 by Robert and Judith for the extinguishment of the Second and Wraparound Notes) estopped the FTB from now assessing taxes in 1993 for extinguishment of the two notes that occurred upon sale of the property that year.
(4) Whether the court erred in ruling that no additional tax was due for 1993 relating to the reduction of the First Note.
STANDARDS OF REVIEW
Whether an order is a final order is a question of law reviewed de novo. Silver Sage Partners, Ltd. v. City of Desert Hot Springs (In re City of Desert Hot Springs), 339 F.3d 782, 787 (9th Cir. 2003), cert. denied, 540 U.S. 1110, 124 S.Ct. 1076, 157 L.Ed.2d 897 (2004).
We review findings of fact for clear error and issues of law de novo. Hoopai v. Countrywide Home Loans, Inc. (In re Hoopai), 369 B.R. 506, 509 (9th Cir. BAP 2007). Clear error exists when, on the entire evidence, the reviewing court is left with the definite and firm conviction that a mistake was committed. Id .
The trial court's application of judicial estoppel to the facts of a case is reviewed for abuse of discretion. Hamilton v. State Farm, 270 F.3d 778, 782 (9th Cir. 2001).
We review rulings regarding the availability of rules of res judicata, including claim and issue preclusion, de novo as mixed questions of law and fact. Khaligh v. Hadaegh (In re Khaligh), 338 B.R. 817, 823 (9th Cir. BAP 2006). However, once it is determined that preclusion doctrines are available to be applied, the actual decision to apply them is left to the trial court's discretion. Id .
A trial court necessarily abuses its discretion if it bases its decision on an erroneous view of the law or clearly erroneous factual findings. Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 110 L.Ed.2d 359 (1990). Otherwise, to reverse for an abuse of discretion, we must have a definite and firm conviction that the court committed a clear error of judgment in the conclusion it reached. S.E.C. v. Coldicutt, 258 F.3d 939, 941 (9th Cir. 2001); Hansen v. Moore (In re Hansen), 368 B.R. 868, 874-75 (9th Cir. BAP 2007).
DISCUSSION
Before delving into the substance of this appeal regarding tax issues, we address the preliminary matter of the appellees' position that the FTB's appeal of the July 2, 2007, order entitled " Memorandum" was incorrect and the FTB's appeal of the May 15, 2007, order was untimely.
I
In denying the appellees' motion to dismiss the FTB's appeal of the July 2, 2007, order, the Panel previously ruled that the May 15, 2007, order was interlocutory and the July 2, 2007, order was final. When the FTB filed a notice of appeal of the May 15, 2007, order, the Panel ultimately responded by ruling that the FTB's appeal of the July 2, 2007, order and its subsequent appeal of the May 15, 2007, order were consolidated. It instructed that the parties could provide supplemental briefs regarding any additional issues concerning the May 15, 2007, order.
Appellees contend that the FTB's filing of the notice of appeal from the May 15, 2007, order on October 11, 2007 was untimely because the May 15, 2007, order was a final decision that satisfied the separate judgment rule of Fed.R.Civ.P. 9021 to start the 10-day window of time to appeal. See Fed. R. of Civ. P. 58 incorporated by Fed.R.Bankr.P. 9021.
In contrast, the FTB argues that, despite its filing a notice of appeal of the July 2, order, it also filed a notice of appeal of the May 15, 2007, order solely as a protective measure in the event that the Court of Appeals for the Ninth Circuit decides, contrary to the Panel, that the May 15, 2007, order was final. The FTB also contends that, because the May 15, 2007, order was a 15-page opinion concluding with further directions and a suggestion to the parties without a separately documented judgment, the order violated the separate judgment requirement of Rule 58, thereby triggering a 160-day deadline to appeal. Fed.R.Civ.P. 58(b)(2)(B) incorporated by Fed.R.Bankr.P. 9021. The FTB filed its notice of appeal of the May 15, 2007, order within the 160-day deadline.
Under Rule 58, which requires that orders disposing of contested matters be set forth in separate documents, " separate document" means one separate from an opinion or memorandum. United States v. Schimmels (In re Schimmels), 85 F.3d 416, 420 (9th Cir. 1996); Horton v. Rehbein (In re Rehbein), 60 B.R. 436, 439 (9th Cir. BAP 1986). While the separate judgment rule does not always require the filing of two separate documents, the separate judgment rule requires that the court enter a judgment or an order; it does not require that the court enter an initial memorandum or opinion. Schimmels, 85 F.3d at 421.
Since the May 15, 2007, order was not separate from the opinion, containing findings of fact and conclusions of law, the May 15, 2007, order did not comply with the separate judgment rule, thereby triggering Rule 58(b)(2)(B). Therefore the FTB had 160 days in which to file its appeal. Thus, the FTB appeal filed on October 11, 2007, was timely.
Alternatively, because we previously ruled that the May 15, 2007, order, was interlocutory, the May 15, 2007, order merged into the July 2, 2007, final order and it was unnecessary for the FTB to appeal the May 15, 2007, order. See Baldwin v. Redwood City, 540 F.2d 1360, 1364 (9th Cir. 1976) (" [A]n interlocutory appeal is permissive, not mandatory. When an appeal is not taken, the interlocutory order merges in the final judgment and may be challenged in an appeal from that judgment.").
The FTB's appeal of the July 2, 2007, order, in spite of its " Memorandum" title, was timely. Furthermore, the conclusions of law set forth in the May 15, 2007, order were merged into the July 2, 2007, final order.
In short, we treat the FTB's appeal of the July 2, 2007, order and its appeal of the May 15, 2007, order as consolidated.
II
The first issue regarding Robert and Judith's tax liability is whether the court erred in ruling that they had no taxable gain and no taxable discharge of indebtedness income for 1993 from the cancellation of the Second and Wraparound Notes. In making its ruling, the court held that the rule of consistency estopped the FTB from arguing that the Second and Wraparound Notes were cancelled in any year other than 1987, and further determined that the two notes were cancelled in 1992. In addition, the court concluded that the modifications of the Second and Wraparound Notes were not a sham, step or single transaction in 1993.
We review each of the court's bases of decision in turn.
A
The appellees argue that the Cancellation Agreement in 1992 effectively cancelled the Second and Wraparound Notes. The FTB counters that the two notes were cancelled in 1987 when Judith purchased the two notes for her attorney McGill, and Judith did not report the taxable discharge of indebtedness income in 1987.
After reviewing the evidence submitted and the parties' arguments, the court concluded that the FTB made a judicial admission that there was a cancellation of the Second and Wraparound Notes in 1987.
In addition, the court turned the FTB's rule of consistency argument back on the FTB, holding that the rule of consistency prohibited the FTB from taking a position contrary to its admission that the two notes were cancelled in 1987, the statute of limitations having run for 1987 taxes.
The duty of consistency prevents a taxpayer who has already had the advantage of a past misrepresentation (in a year now closed to government review) from changing his position and, by claiming he should have paid more tax before, avoiding the present tax. Eagan v. United States, 80 F.3d 13, 16-17 (1st Cir. 1996); Estate of Posner, T.C. Memo 2004-112, 87 T.C.M. (CCH) 1288 (2004).
The court held that the appellees had not violated the rule of consistency, as the FTB contends, because neither the trustee nor Judith ever took the position that there was a cancellation of the Second or Wraparound Notes in 1987. The court further concluded that Robert and Judith were not bound by the duty of consistency as to their mistake of law in believing that McGill's acquisition was not taxable discharge of indebtedness income in 1987. See Posner, T.C. Memo 2004-112, 87 T.C.M. (CCH) 1288. In addition, it ruled that the appellees met their burden of proof in showing that the Cancellation Agreement was effective in 1992.
We agree with the trial court. The court did not abuse its discretion in holding the FTB to its admission that the Second and Wraparound Notes were cancelled in 1987, and thereupon ruling that the rule of consistency prohibited the FTB from taking a contrary position. In admitting that the two notes were cancelled in 1987, the FTB cannot now argue that the extinguishment of those notes occurred in 1993 upon sale of the property, and, thus, cannot now assert a tax deficiency for 1993.
Moreover, perceiving no clear error in the findings of fact, we hold that the trial court did not err in ruling that appellees met their burden of proof in showing that the Cancellation Agreement was effective in 1992.
B
Accordingly, we will not disturb the trial court's conclusion that Robert and Judith had no taxable gain and no taxable discharge of indebtedness income for 1993 from the cancellation of the Second and Wraparound Notes.
III
Next, the FTB contends that the 1992 " no change" letter it issued (concluding that the partnership did not receive a discharge of indebtedness income in 1992, and thus, Robert and Judith had no tax deficiency in that year from the cancellation of the Second and Wraparound Notes) did not estop the FTB from assessing a tax deficiency in 1993 when the two notes were extinguished that year upon sale of the property they encumbered.
The court based its ruling on principles of res judicata (claim and issue preclusion), judicial estoppel, and the rule of consistency. On those bases, it estopped the FTB from taking a position inconsistent with the FTB's 1992 " no change" letter.
While the court correctly applied the doctrine of judicial estoppel and the rule of consistency to the facts, it is arguable whether res judicata principles applied in this case. We need not explore the matter in detail, however, because judicial estoppel and the rule of consistency are adequate independent bases for the court's conclusion. See Alary Corp. v. Sims (In re Associated Vintage Group), 283 B.R. 549, 565 (9th Cir. BAP 2002).
Judicial estoppel precludes a party from gaining an advantage by asserting one position, and then later seeking an advantage by taking a clearly inconsistent position. Hamilton, 270 F.3d at 782; Associated Vintage Group, 283 B.R. at 566. As noted, the rule of consistency (which is in the nature of an estoppel) also estops a party from gaining an advantage by taking inconsistent positions. See Eagan v. United States, 80 F.3d at 16-17; Posner, T.C. Memo 2004-112, 87 T.C.M. (CCH) 1288.
Furthermore, independent of unfair advantage from inconsistent positions, judicial estoppel may be invoked: out of " general consideration of the orderly administration of justice and regard for the dignity of judicial proceedings; " to " protect against a litigant playing fast and loose with the courts; " and " to protect the integrity of the bankruptcy process." Hamilton, 270 F.3d at 782 & 785; Associated Vintage Group, 283 B.R. at 566.
It is to the trial court's discretion as to the appropriate circumstance to apply judicial estoppel or a quasi-estoppel under the rule of consistency. Although res judicata principles were not applicable, the court nevertheless did not abuse its discretion in concluding that judicial estoppel and the rule of consistency estopped the FTB from assessing a tax deficiency in 1993 for the alleged cancellation of the Second and Wraparound Notes in 1993 when it had previously concluded that Robert and Judith did not incur a tax deficiency in 1992 for the cancellation of the two notes in that year. We are not definitely and firmly convinced that the bankruptcy court committed a clear error in judgment in its conclusion. See Coldicutt, 258 F.3d at 941; Hansen, 368 B.R. at 874-75. Thus, we perceive no error.
IV
The appellees contend that discharge of indebtedness income resulting from the reduction of the First Note, reported in their 1993 tax return, was not included in gross income as non-taxable pursuant to 26 U.S.C. § 108(a)(1)(B) because they were insolvent.
On the other hand, the FTB argues that the cancellation of indebtedness income is taxable and Robert and Judith cannot take advantage of the insolvency exception to the general rule of inclusion of discharge of indebtedness in