1120 G Street, NW
Suite 930
Washington, D.C. 20005-3801
Tel: (202) 789-1000
Fax: (202) 628-3834
NewslettersLegal UpdateClient Newsletter of Carr, Morris & Graeff, P.C. October-November 2004
View as PDF In This Issue: BUSINESS PLANNING Self-Cancelling Installment Notes Consider the following scenario: Mrs. Galsworthy is a successful businesswoman who owns and operates a restaurant and a small office plaza. She yearns to retire in Boca Ratón, Florida; and, she has a son, Taxpayer, who is willing to purchase the business from her. The business is worth $2,000,000, but Taxpayer does not have ready funds to buy it from his mother. On the advice of their lawyers, an excellent small Washington, D.C. law firm that shall remain unnamed, they structure the sale of the business to Taxpayer using a self-cancelling installment note (an "SCIN"). In exchange for the business, Taxpayer gives his mother a $2,000,000 promissory note secured by the property. The mortgage is duly recorded. At the time of the transaction, Mrs. Galsworthy has a life expectancy of roughly ten years, so the note is for a ten-year term. Mrs. Galsworthy is not terminally ill and enjoys satisfactory health. Prior to the sale of the business she had her annual physical, which she passed with flying colors. The business produces enough cash flow for the son to be able to repay the loan in ten years. On the advice of the attorneys, the parties add a self-cancelling feature to the note. If Mrs. Galsworthy dies before the loan is paid in full by her son, the loan is cancelled and Taxpayer owes her estate nothing. In order to compensate her and her estate for this feature, the attorneys insist that the note carry an interest rate one to two percentage points above the prevailing market rate for the type of note in question. (Alternatively, the attorneys could have insisted that the principal amount of the note be, say, 10% to 20% above the value of the business. Thus, the compensatory premium for the self-cancelling aspect of the note would be in the principal portion of the loan rather than in the interest rate). Mrs. Galsworthy achieves her dream of retirement in Boca. Unfortunately, five months later Mrs. Galsworthy succumbs to a sudden illness. Taxpayer had made five timely payments on the note before his mother’s demise. As executor of his mother’s estate, Taxpayer files a federal estate tax return declaring that the estate has no estate tax liability. The estate tax return properly identified the SCIN as an estate asset, but valued it at zero due to the cancellation-upon-death provision. The Internal Revenue Service (IRS) issued a notice of deficiency that proposed to increase Mrs. Galsworthy’s gross estate because the SCIN was not a bona fide transaction and was a "bargain sale." Following a trial, the U.S. Tax Court ruled in favor of the Service. Taxpayer appealed to the Federal circuit court, which reversed the Tax Court’s decision, and found that the transaction was bona fide and the sale of the business was not a bargain. In its opinion the Court of Appeals relied on the following four elements to reach its decision. First, the maturity of the note was co-extensive with Mrs. Galsworthy’s life expectancy and she was in good health. Second, the business produced cash flow adequate for repaying the loan. Third, a premium was included in the interest rate or in the face amount of the note to compensate the seller for the self-cancelling feature. Finally, Taxpayer made payments in a timely fashion. The fact situation described above is a composite of several cases over the years that have delineated the permissible limits of a well-structured sale of assets using a SCIN. Generally, the IRS subjects intra-family transactions to strict scrutiny because of the potential for abuse. Nevertheless, if the taxpayer can show that at the time of the transaction there existed a real expectation of repayment, an intention to collect the debt, and a SCIN that represented full consideration in money or money’s worth, then the transaction will be deemed valid for tax purposes, regardless of the family nexus. The result would have been different if Mrs. Galsworthy had been terminally ill or in bad health, the business was not expected to throw off enough cash to repay the note, there had been no premium payable for the self-cancelling feature, and/or the buyer had missed payments on the loan and the seller had not taken any steps to collect on the default.In most reported cases disallowing SCIN’s, the seller of the business was terminally ill or in very bad health, or the interest rate on the loan was below the market rate of interest. In such circumstances the courts have had no trouble reaching the conclusion that the transactions were a sham. On the other hand, a properly structured SCIN sale, as in the example above, will most probably survive an IRS challenge. Because tax law is not an exact science and intra-family wealth transactions that reduce taxes are subject to exacting review, there is always an element of risk in the use of SCIN’s—thus the importance of strict compliance.Please call Roy Morris or the author with any questions about SCIN’s or other available techniques. Néstor Cruz LITIGATION Business Torts: Sorting It Out Most business owners have had some experience dealing with a contract dispute – whether the issue involved an employee or third party. A great deal of business litigation deals with contract law. However, wrongful conduct in a business transaction can also give rise to a variety of claims based on tort law. Very generally, "torts" are actionable "wrongs." A tort occurs when someone carelessly or deliberately harms another person or his property. A variety of different torts can occur in a business or commercial setting, and these torts have come to be called "business torts." Three business torts are discussed below (other business torts will be discussed in subsequent articles): 1. Tortious Interference with Economic Relations There are several variations of this particular "interference" cause of action – for example, tortious interference with economic relationship, contract, prospective business advantage and prospective economic advantage. The idea behind this type of claim is that it is unlawful to wrongfully interfere with a third party’s existing contract, relationship or opportunity or prospective contract, relationship or opportunity. An existing contract provides certain protections to those who are parties to the agreement, but third parties are also under a duty not to interfere with the contractual relationship unless there is a legitimate reason to do so. Generally, it is easier to prove interference with an existing contract or relationship. A prospective contract or advantage is often speculative, and the future of the contract or relationship is dependent on outside factors. In the case of a prospective contract or relationship, it is also difficult to prove damages because it is necessarily uncertain what the outcome of the relationship would have been. In order to bring a claim for tortious interference with economic relations, a plaintiff must prove the following elements: (1) a valid contract or, in the case of a prospective economic advantage, an economic relationship containing the probability of future economic benefit, (2) knowledge by the defendant of the contract or relationship, (3) intentional acts by the defendant designed to disrupt the contract or relationship, (4) actual disruption of the contract/relationship, and (5) damages caused by the defendant’s acts. It is important to remember that this tort is an intentional tort, meaning the defendant must have intended to harm the relationship. 2. Fraud (intentional misrepresentation) This cause of action has, at various times and depending on location, been called fraud, deceit and/or intentional misrepresentation. Generally, fraud is the intentional misrepresentation of a material fact for the purpose of inducing another person to act. The elements of fraud are as follows: (1) the defendant made a false representation regarding a material fact, (2) the defendant knew the representation was false (or the representation was made recklessly without knowing whether it was true or false), (3) the defendant intended to defraud the plaintiff, (4) the plaintiff relied on the misrepresentation, and (5) the plaintiff suffered damages as a result of his or her reliance on the representation. Fraud may also include an intentional omission or failure to state a material fact. There are several issues worth noting regarding the above-discussed elements. First, the false representation must have been regarding a material fact. The misrepresentation must concern an important or significant matter, and the plaintiff must show that “but for” the misrepresentation he would not have made a particular decision or embarked on a particular course of action. In addition, the plaintiff must have actually relied on the misrepresentation. In some cases, courts require a plaintiff to prove that his reliance was justifiable. So, for example, if the plaintiff could have easily learned the truth or the falsity of the statement is obvious, his reliance is not justified. Finally, in business, a certain amount of “puffing” is permissible. A defendant will not be liable for expressing his opinion or making an indefinite statement. 3. Breach of Fiduciary Duties This tort applies to any situation where a fiduciary relationship exists – namely, a relationship in which one party places trust and confidence in another party (for example, a personal representative, therapist, trustee or lawyer). A fiduciary duty arises when one person assumes a duty to act for another’s interest, while subordinating his personal interest. For purposes of this article, we will focus on the fiduciary relationship that exists between corporate directors and shareholders. The directors of a corporation have a duty to act in good faith and take whatever steps or measures are in the best interest of the corporation. As fiduciaries, directors must adhere to a strict standard of care. Among other things, this standard requires that the fiduciary exercise good faith and loyalty and refrain from self-dealing. Directors are permitted to make mistakes; and, as long the mistake or miscalculation was innocent, directors are protected by the "business judgment rule." The business judgment rule recognizes that there is a certain amount of risk in running a business and that directors need latitude to run the company as they see fit. The business judgment rule is often evoked in business disputes. Courts are reluctant to second-guess the decisions of directors and involve themselves in the internal affairs of a business. The business judgment rule gives directors the benefit of the doubt. A cause of action for breach of fiduciary duty requires the plaintiff to plead: (1) the existence of a fiduciary relationship, (2) breach of the duty owed by the fiduciary to the plaintiff and (3) harm resulting from the breach. While similar and often used interchangeably, a claim for breach of fiduciary duty is distinct from a claim for malpractice. An example of a breach of fiduciary duty is when a corporate director usurps a corporate opportunity. In such a case, a court may order the guilty director to return any profits he received and pay the corporation for its loss. Dana Theriot CRIMINAL Sentencing Guidelines Reviewed As a former federal prosecutor prior to implementation of the United States Sentencing Guidelines, I follow with some interest how the Guidelines have changed the criminal justice system and how recent criticism and judicial rulings challenge the integrity and viability of sentencing pursuant to the Guidelines. By way of background, prior to The Sentencing Reform Act of 1984, federal judges had broad discretion in determining an appropriate sentence as long as the sentence imposed was within the statutory limits defined for a specific offense. Similarly, federal prosecutors had considerable discretion in fashioning plea agreements with defense counsel that embodied recommended sentences believed to be a fair, just and appropriate—taking into consideration the specifics of each case presented. Balanced discretion and evenhanded application of the judicial process with its built-in checks and balances were deemed to be the cornerstones of the sentencing process. In 1984, based primarily on criticism that wide discrepancies and disparities existed in sentences imposed to similarly situated defendants and for street crimes as opposed to white color crimes, Congress passed the Sentencing Reform Act. The United States Sentencing Guidelines, resulting therefrom, dramatically reduced the sentencing and plea discretion of prosecutors and judges handling criminal cases in the federal system. Briefly, the Sentencing Guidelines provide for a points-determined range of sentences by assigning a specific number of points for specific factors such as the level of the offense, criminal history of the defendant, acceptance of responsibility by the defendant and many other factors that can increase or decrease the ultimate point determination. Many prosecutors, defense attorneys and judges find the Sentencing Guidelines to be complex, cumbersome and, more significantly, an infringement on their exercise of independent discretion and judgment. A case decided on October 26, 2004 by the United States Court of Appeals for the District of Columbia Circuit sheds some light on the level of judicial frustration that exists concerning the Sentencing Guidelines. UnitedStates vs. Tucker involved the June 20, 2002 arrest of Darin Tucker in the District of Columbia for assault on a police officer and for possession of two bags containing 45.3 grams of crack cocaine that was found on Tucker’s person in a lawful search incident to the arrest. Tucker pled guilty to possession with intent to distribute cocaine pursuant to a plea agreement with the prosecutor. Under the Sentencing Guidelines, given the level of the offense, Tucker’s criminal history and his acceptance of responsibility, and factoring in the absence of aggravating characteristics, the Guidelines range provided for 57-71 months imprisonment. Even though Tucker had recently violated his curfew and failed two drug tests, the sentencing judge noted that he had secured a full time job at a warehouse, was contributing to the support of his children, had received a letter of support from his new employer and had begun attending computer repair courses in hope of starting his own business. The sentencing judge viewed the fact that the Sentencing Guidelines left him “no choice but to send Tucker to prison for nearly 5 years” as being “counterproductive” for Tucker’s rehabilitation, the community and the criminal justice system. Expressing his frustration with the Sentencing Guidelines’ restrictions, the Judge downwardly departed from the mandates of the Guidelines and sentenced Tucker to five years probation and a $100.00 special assessment fine. At one point during the sentencing process, the Judge stated that he was “not going to be the instrument of the injustice in this case.” Not surprisingly, the U.S. Court of Appeals, after a lengthy review as to why the sentencing judge did not supply sufficient grounds to justify downward departure from the Guidelines’ required sentence, vacated Tucker’s sentence and remanded for resentencing consistent with the Guidelines. The appellate court closed by saying, “So long as these Guidelines are the law of the land, we—and the District Courts—are obligated to apply them.” It is interesting to note that some recent federal cases have attacked the constitutional underpinnings of aspects of the Sentencing Guidelines and have put into question the legitimacy of past sentences and future utilization. Regardless of the success of the constitutional challenges, it does appear that by resorting to a structured sentencing formula, the Sentencing Guidelines have diminished what should be the most valued aspect of the criminal justice process—the discretion, judgment and reasoned analysis of the prosecutors, defense attorneys and judges who have made the criminal justice system their life’s work. Stephen Graeff Durable Powers of Attorney – Questions and Answers 1. What is a Power of Attorney? A power of attorney is a legal document in which you name another individual as your “agent” or “attorney-in-fact.” In a power of attorney, you give your agent the authority to take specific actions on your behalf, for example, to sign checks and make deposits, pay bills, contract for medical or other professional services, and do all the things you do in managing your day to day affairs. When your agent acts under your power of attorney, it is as though you performed them yourself, and the actions are legally binding on you. The power of attorney can be general, specific or mixed. A general power of attorney gives the agent the authority to do whatever you can do. In a limited power of attorney, you authorize your agent to do only specific things for a limited period of time or under specific circumstances. 2. What makes a power of attorney durable? An ordinary power of attorney is automatically revoked when the person who made it becomes incapacitated. A durable power of attorney is created by including certain magic language, as determined by the courts or laws of a state or territory, such as: “This power shall not terminate on disability of the principal and such disability shall not affect the authority herein granted.” A durable power of attorney allows your agent to continue to act on your behalf after you become incapacitated. With a durable power of attorney, an agent may continue making decisions for you after an accident, stroke, onset of Alzheimer’s or other incapacitating illness, allowing your agent to pay your bills, contract for nursing services, pay hospital bills, and take care of your day to day expenses and issues. 3. What are Springing Powers of Attorney? A durable power of attorney can be effective when it is signed, or it can become effective only when you are incapacitated. If a durable power of attorney becomes effective upon incapacitation, it is considered a “springing” power of attorney, because it springs into action upon your incapacitation. To create a springing power of attorney, language such as “this power of attorney shall become effective upon my disability” is included in the document. A springing power of attorney needs to include a method for determining if you are incapacitated, so third parties will know they can rely upon the authority of your agent. 4. How are durable powers of attorney terminated? All powers of attorney (general, specific or durable) are terminated upon your death. You may revoke your power of attorney at any time you choose, as long as you are competent. A third party, however, may rely on a power of attorney that is terminated or revoked until the third party has actual notice of the termination. 5. Are there specific authorities that can be given in a durable power of attorney? A general power of attorney gives your agent the power to act on your behalf as you would act. These are very broad in what your agent can do. The power of attorney can also authorize your agent with specific powers by listing them in the document. Some powers that may be specifically authorized are: - Pay for support and care;
- Conduct banking transactions;
- Handle legal claims;
- Gain entry to safety deposit boxes;
- Prepare and file tax returns;
- Exercise stockholder rights;
- Contract for services;
- Collect Social Security and other benefits.
6. Who should be named as agent, and can there be more than one? The agent may be either an individual or bank. An individual must be an adult and over 18 years old, and mentally competent. You should select a person you have confidence in and trust to handle your day-to-day activities, and a person willing to do so. The first person most people choose for their agent is their spouse, since they generally already deal with most of the issues that will arise. You may name more than one agent. If you do so, you should specify whether they must act jointly or whether they can act independently. You may also name one agent to act with an alternate in the event the first agent is unable to act. 7. What are the agent’s obligations? Your agent must act in your best interest, follow any instructions you have given, and act in a prudent manner. The agent must keep accurate and complete records of anything she does on your behalf. Your agent is legally responsible for any damages to you while they are acting as your agent. In the event you agent abuses her authority under a durable power of attorney, anyone interested in your welfare can ask a probate court to intervene. 8. What are some advantages to a durable power of attorney? The first is that you select who your agent will be, not a court. A durable power of attorney gives you and your family comfort in knowing who will handle your affairs in the event something happens to you. It will save time, in that if something happens, the individual selected in your power of attorney can quickly begin taking care of things. 9. What are the disadvantages to a durable power of attorney? The largest is that there is no absolute guarantee that a third party will accept or recognize the power of attorney. For example, to act upon someone’s behalf with the Internal Revenue Service or the Veterans Administration, they require that you use their special forms. Also, the person you choose for your agent can step down or decide she does not want to act as your agent. Brenda Hankins Staff Notes Movin’ on up. Congratulations to Larry Carr’s wife, Kris, for her appointment as Principal of St. Agnes Catholic School in Arlington. (Understandably, Kris’s status is something of a source of conflict in the Carr household…Larry’s experiences as a young man dealing with the executive branch of the Catholic School system were uniformly unsatisfactory…on the bright side, maybe Kris can help get Larry’s “permanent record” expunged.) * * * Who’s your Daddy? Negotiating the “age handicap” between Ray Jones and Scott Cummings for the Baltimore Marathon was a challenge. Ray demanded that Scott either carry his infant daughter, Ainsley, in a snuggly or push her in a stroller. Scott rejected that notion and suggested that no handicap at all was needed, since the extra years actually gave Ray the advantage of “more time to train.” After briefs and oral argument, the handicap was set at 1 hour 15 minutes. Betting was brisk, but Ray’s attempts to bet on Scott were deemed non-sporting. Despite the veritable flood of pre-race complaints of ailments lodged by the runners, both did show for the race and both performed admirably. Ray might have been sandbagging a bit, since his time (3:39) minus the handicap would have required Scott to turn in a 2:24 for a push. Scott actually might have pulled that off. He was on pace and in the top 20 when the wheels came off around Mile 18. Effects of a lingering cold and dehydration forced Scott to the pits. Terms of a rematch are being negotiated. A handicap adjustment is likely.
| 
