Diebold Foundation, Inc. v. Commissioner of Internal Revenue

12-3225
Diebold Foundation, Inc. v. Commissioner of Internal Revenue
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
____________________
August Term, 2012
(Argued: April 15, 2013 Decided: November 14, 2013)
Docket No. 12-3225-cv
____________________
DIEBOLD FOUNDATION, INC., TRANSFEREE,
Petitioner-Appellee,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant.
____________________
Before: POOLER, DRONEY, Circuit Judges, SEIBEL,* District Judge.
The Commissioner of Internal Revenue (“Commissioner”) appeals the decision of
the Tax Court (Goeke, J.) holding that the Diebold Foundation, Inc. (“Diebold”), could
not be held liable as a transferee of a transferee under 26 U.S.C. § 6901. As an initial
matter, we conclude that, as required by 26 U.S.C. § 7482, the standard of review for
mixed questions of law and fact in a case on review from the Tax Court is the same as
* The Honorable Cathy Seibel, United States District Court for the Southern
District of New York, sitting by designation.

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that for a case on review after a bench trial from the district court: de novo to the extent
that the alleged error is in the misunderstanding of a legal standard and clear error to the
extent the alleged error is in a factual determination. On the merits, we hold that the two
requirements of 26 U.S.C. § 6901 are separate and independent inquiries, a procedural
one governed by federal law and a substantive one governed by state law. Under the New
York Uniform Fraudulent Conveyance Act, the applicable state statute, the series of
transactions collapses based upon the constructive knowledge of the parties involved.
The case is remanded to the Tax Court to determine in the first instance whether Diebold
is a transferee of a transferee under § 6901 and whether the three-year or six-year statute
of limitations is applicable.
Vacated and remanded.
____________________
ARTHUR T. CATTERALL, Attorney (Kathryn Keneally,
Assistant Attorney General, Tamara W. Ashford, Deputy
Assistant Attorney General, Gilbert S. Rothenberg, Kenneth
L. Greene, Attorneys), Tax Division, United States
Department of Justice, Washington, DC, for
Respondent-Appellant.
A. DUANE WEBBER (Phillip J. Taylor, Summer M. Austin,
Mireille R. Zuckerman, Baker & McKenzie LLP,
Washington, DC, Jaclyn Pampel, Baker & McKenzie LLP,
Chicago, IL, on the brief), Baker & McKenzie LLP,
Washington, DC, for Petitioner-Appellee.
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POOLER, Circuit Judge:
The Commissioner of Internal Revenue (“Commissioner”) appeals the decision of
the United States Tax Court (Joseph Robert Goeke, J.) holding that the Diebold
Foundation, Inc. (“Diebold”), could not be held liable as a transferee of a transferee under
26 U.S.C. § 6901. As an initial matter, we conclude that the standard of review for mixed
questions of law and fact in a case on review from the Tax Court is the same as that for a
case on review after a bench trial from the district court: de novo to the extent that the
alleged error is in the misunderstanding of a legal standard and clear error to the extent
the alleged error is in a factual determination. See 26 U.S.C. § 7482(a). On the merits,
we hold that the two requirements of 26 U.S.C. § 6901—transferee status and
liability—are separate and independent inquiries, one procedural and governed by federal
law, and the other substantive and governed by state law. We further hold that, under the
New York Uniform Fraudulent Conveyance Act, the applicable state statute, the series of
transactions at issue collapse based upon the constructive knowledge of the parties
involved. The case is remanded to the Tax Court to determine in the first instance
whether Diebold is a transferee of a transferee under § 6901 and whether the three-year
statute of limitations of 26 U.S.C. § 6901(c)(2), which applies transferee of transferee
liability, or the six-year statute of limitations of 26 U.S.C. § 6501(e)(1)(A), which applies
to collection when substantial omissions are made from the report of gross income,
governs. We thus vacate the decision of the Tax Court and remand the case for further
proceedings consistent with this opinion.
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BACKGROUND
I.
This case involves shareholders who owned stock in a C Corporation (“C Corp”),
which in turn held appreciated property. Upon the disposition of appreciated property,
taxpayers generally owe tax on the property’s built-in gain—that is, the difference
between the amount realized from the disposition of the property and its adjusted basis.
26 U.S.C. §§ 1(h), 1001, 1221, 1222. A C Corp, a corporation governed by subchapter C
of the Internal Revenue Code, Eisenberg v. Comm’r, 155 F.3d 50, 52 n.3 (2d Cir. 1998),
is treated as a separate legal entity for tax purposes, 26 U.S.C. § 11. C Corps are also
subject to tax on built-in gain. See 26 U.S.C. §§ 11, 1201.
When shareholders who own stock in a C Corp that in turn holds appreciated
property wish to dispose of the C Corp, they can do so through one of two transactions:
an asset sale or a stock sale. In an asset sale, the shareholders cause the C Corp to sell the
appreciated property (triggering the built-in gain tax), and then distribute the remaining
proceeds to the shareholders.1 In a stock sale, the shareholders sell the C Corp stock to a
third party. The C Corp continues to own the appreciated assets and the built-in gain tax
is not triggered. In other words, in an asset sale, because C Corps are treated as separate
legal entities for tax purposes, subject to corporate tax (independent of any capital gain
taxes assessed against the earning shareholders), a C Corp’s sale of its assets imposes an
1 See 26 U.S.C. §§ 302(a), 331, 1001.
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additional tax liability. While the C Corp, and not the shareholders, pays this tax liability,
such payment nonetheless reduces the amount of cash available for distribution to those
shareholders.
In the case of a stock sale, the assets remain owned by the C Corp and the tax on
the built-in gain is not triggered. Buyers would generally prefer to purchase the assets
directly and receive a new basis equal to the purchase price, thus eliminating the built-in
gain. Sellers generally disfavor the sale of assets because of the attendant tax liability and
would prefer to sell the stock and move the tax liability on to the purchaser. However,
the seller’s preferred transaction merely pushes the tax liability down the line; at any
point when the shareholders of the C Corp—including new owners who purchased the
shares in a stock sale—wish to sell the assets, the built-in gain tax will be triggered.
Because of this accompanying tax liability, a stock sale will generally merit a lower sale
price than an asset sale.
“Midco transactions” or “intermediary transactions” are structured to allow the
parties to have it both ways: letting the seller engage in a stock sale and the buyer engage
in an asset purchase. In such a transaction, the selling shareholders sell their C Corp
stock to an intermediary entity (or “Midco”) at a purchase price that does not discount for
the built-in gain tax liability, as a stock sale to the ultimate purchaser would. The Midco
then sells the assets of the C Corp to the buyer, who gets a purchase price basis in the
assets. The Midco keeps the difference between the asset sale price and the stock
purchase price as its fee. The Midco’s willingness to allow both buyer and seller to avoid
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the tax consequences inherent in holding appreciated assets in a C Corp is based on a
claimed tax-exempt status or supposed tax attributes, such as losses, that allow it to
absorb the built-in gain tax liability. See I.R.S. Notice 2001-16, 2001-1 C.B. 730. If
these tax attributes of the Midco prove to be artificial, then the tax liability created by the
built-in gain on the sold assets still needs to be paid. In many instances, the Midco is a
newly formed entity created for the sole purpose of facilitating such a transaction, without
other income or assets and thus likely to be judgment-proof. The IRS must then seek
payment from the other parties involved in the transaction in order to satisfy the tax
liability the transaction was created to avoid.
II.
Double D Ranch, Inc., (“Double D”), a personal holding company, taxed as a C
Corp, 26 U.S.C. § 542, had two shareholders: the Dorothy R. Diebold Marital Trust
(“Marital Trust”) and The Diebold Foundation Inc. (“Diebold New York”) (together, the
“Shareholders”). The trustees of the Marital Trust were the Bessemer Trust Company
N.A. (“Bessemer”), operating primarily through its Senior Vice President, Austin J.
Power, Jr., Dorothy Diebold (“Mrs. Diebold”), and Andrew W. Bisset, Mrs. Diebold’s
attorney and personal advisor. The directors of Diebold New York were Mrs. Diebold,
Bisset, and the three adult Diebold children. Diebold New York held slightly more than
one-third of the shares of Double D; 2 the rest were held by the Marital Trust. Double D
2 On May 28, 1999, the Marital Trust transferred these shares to Diebold New
York. Prior to that time, the Marital Trust held all of the shares of Double D.
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owned assets worth approximately $319 million, including $21.2 million in cash, $6.3
million in real property, and $291.4 million in publicly traded securities. Included in
these securities holdings were approximately $129 million in shares of American Home
Products Corporation (“AHP”) stock; the rest of the portfolio was made up of diversified
holdings. The AHP stock, other securities, and the real property—a farm in
Connecticut—all had substantial built-in gain, such that the sale of the assets would have
triggered a tax liability of approximately $81 million.
By 1999, Mrs. Diebold and her three children were “anxious” for her to begin
making cash gifts to them, but the Marital Trust was insufficiently liquid for her to make
such gifts. The other trustees, Power of Bessemer and Bisset, explained to Mrs. Diebold
that the best way to make such gifts would be to sell the shares of Double D. Power
knew that liquidating the assets of Double D would incur the substantial tax consequences
discussed above because of the low tax basis of the assets. Power discussed with “a
whole network of people, for months,” whether there “were potential purchase[r]s for a
corporation like Double D.” Power engaged senior staff members at Bessemer as well as
lawyers in other trust companies, identifying the illiquidity of the trust and the attendant
tax consequences as “a problem,” and asking, “What’s the possible solution? How do we
sell this?” Among those with whom Power consulted was Richard Leder, an attorney at
Chadbourne & Parke and Bessemer’s “principal outside tax counsel.” Identifying the
steep tax liability inherent in the assets held by Double D, Leder testified, “it was
generally known . . . in that profession that there were . . . some people, who for whatever
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reason, whatever their tax activities are, were able to make very favorable offers to sellers
with stock with appreciated assets . . . with the corporation having appreciated assets.”
Leder directed Power to one of these “people” in the form of Harry Zelnick of River Run
Financial Advisors, LLC (“River Run”). Power also sought out Stephen A. Baxley, a
managing director at Bessemer, who referred him to Craig Hoffman at Fortrend
International LLC (“Fortrend”).
The trustees of the Marital Trust and the Directors of Diebold New York each
decided that their respective entity would sell all of its Double D stock. Power was
primarily responsible for implementing the decision to sell Double D. On May 26, 1999,
Power, Baxley, Leder, and two other attorneys, acting as representatives of the
Shareholders, met with Zelnick of River Run and Ari Bergmann, a principal at Sentinel
Advisors, LLC (“Sentinel”), a small investment banking firm specializing in “structuring
economic transactions to solve specific corporate or estate or accounting issues.” At this
meeting, the Shareholder representatives, Zelnick, and Bergmann discussed methods for
valuing Double D’s AHP stock and alternatives for dealing with the Connecticut farm
property (whether to distribute that asset out of the corporation or to leave it in the
corporation for the buyer to sell). They also discussed the possibility of leaving the
shareholders with an “option to buy” the farm. Sentinel gave the Shareholders a
slideshow presentation of the possibilities for selling and valuing Double D, which
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Bergmann subsequently sent to the Shareholder representatives for their reference.3
Shortly after this meeting, Dudley Diebold, one of Mrs. Diebold’s adult children who was
a Director of Diebold New York, founded Toplands Farm, LLC (“Toplands Farm”) to
purchase the Connecticut farm property from Double-D.
Several days after the meeting with River Run and Sentinel, the Shareholder
representatives met with Craig Hoffman and Howard Teig of Fortrend to discuss the sale
of Double D. According to Leder, tax attorney to the Bessemer Trust, he was familiar
with Fortrend because he “had represented a seller of stock in another transaction where
the buyer had arranged to have [Fortrend] participate in the purchase.” Fortrend provided
Bessemer with a firm profile that detailed its strategy entitled the “Buy Stock/Sell Assets
Transaction.” Identifying the tax liabilities endemic to selling a corporation with
appreciated assets, Fortrend presented its expertise as follows: “We are working with
various clients who may be willing to buy the stock from the seller and then cause the
3 As Appellee rightly points out, many of the documents included with the
stipulated facts were conceded to be hearsay, and it was agreed that such documents
“cannot be admitted for the truth of the matters asserted therein.” In seeking to
discourage reliance on these materials, Appellee argues they are barred as hearsay based
on this stipulation. However, Appellee misapprehends the use to which these documents
were put. The IRS, the lower court, and this Court do not rely on these documents to
conclude that it is true, for example, that Fortrend actually had clients with “certain tax
attributes that enable them to absorb the tax gain inherent in the assets,” which would be a
use of the documents to prove the truth of the matter asserted. Rather, these documents
demonstrated the surrounding circumstances of which the parties were aware. If not
offered to prove the truth of the matter, the attendant hearsay rules have no applicability.
Fed. R. Evid. 801.
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target corporation to sell its net assets to the ultimate buyer. These clients have certain
tax attributes that enable them to absorb the tax gain inherent in the assets.”
The Shareholder representatives chose to pursue the transaction with Sentinel
instead of with Fortrend, and Sentinel sent them an initial term sheet, laying out the
preliminary details of the transaction, on June 8, 1999. Sentinel intended to use a newly
formed entity, Shap Acquisition Corporation II (“Shap II”), specifically created to carry
out the transaction. Power informed the Shareholders that Sentinel would purchase all of
the shares of Double D, from both the Marital Trust and from Diebold New York, for a
price that “works out to 97% of the market value of the Corporation’s assets.” Had the
Shareholders sold the assets directly, the tax liability would have caused the Shareholders
to realize an amount that worked out to approximately 74.5% of the assets’ market value,
a clear reduction from that negotiated with Shap II. On June 10, 1999, Mrs. Diebold
approved of the sale and directed Power to go forward with it. On June 17, 1999, Shap II
and the Shareholders executed a letter of intent and term sheet specifying that Shap II
would purchase all issued and outstanding Double D Stock for cash in an amount equal to
the value of Double D’s assets minus a discount of 4.5% of the built-in gain.4
4 To state this as a formula:
Purchase Price = Value of Assets - 4.5% Built-In Gain
In a stock sale, one would expect the discount rate to be the amount of the tax liability,
which would be the tax rate times the built-in gain. Assuming a flat tax rate of 35%,
which was the highest marginal corporate tax rate in 1999, the formula would be:
Purchase Price = Value of Assets - 35% Built-In Gain.
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Sentinel intended to purchase the Double D stock through Shap II with financing
from Rabobank. Even prior to taking ownership of the Double D stock, Sentinel planned
on having Shap II immediately sell Double D’s securities portfolio, as it intended to use
the proceeds of that sale to repay the loan from Rabobank. Rabobank provided financing
on the condition that Shap II enter into a fixed price contract to sell the securities, with the
purchase price to be paid directly to Rabobank, pursuant to an irrevocable payment
instruction. Rabobank understood that the loan would be outstanding for “not more” than
five business days, as that was the “longest settlement period” for the securities to be
liquidated. Sentinel determined that the securities would be sold to Morgan Stanley.
While it is not clear that the Shareholders knew the details behind Sentinel’s
financing plan, the Shareholder representatives did indeed have notice that Shap II
planned to sell Double D’s securities to Morgan Stanley, based upon the draft of the stock
purchase agreement drawn up to execute the stock sale between the Marital Trust and
Diebold New York, on the one hand, and Shap II, on the other, which (1) indicated that
certain limitations within the agreement would not apply to sale arrangements Shap II
already had with Morgan Stanley, (2) held the selling shareholders liable for any costs
incurred upon termination in “connection with arrangements for the sale of the Securities
by [Double D] following the Closing,” and (3) indicated that the agreement’s prohibition
on assignments of rights would not apply to Shap II assigning its rights “to Morgan
Stanley as collateral security for [Shap II’s] obligation to deliver the Securities to Morgan
Stanley following the closing for purposes of resale.” These specific provisions were
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altered by the Shareholders’ attorneys from Chadbourne to make them far more general
and to delete the references to Morgan Stanley. In their review of the purchasing
agreement, the Chadbourne lawyers also added further detailed provisions dealing with
“Tax Matters.” These alterations included changing the responsibility of the selling
Shareholders for all taxes “with respect to any tax period ending on or before the Closing
Date,” to making Shap II, the purchaser, liable for all taxes related to sale of Double D’s
assets, regardless of the date of the taxable period. The added tax-related provisions also
made Shap II liable to the selling Shareholders for related tax refunds and specified that
“any sale or other disposition of assets by [Double D] that is consummated after the
acquisition of the Shares by [Shap II] shall be treated as occurring after the period ending
on the closing date.”
After these negotiations, Shap II and the Shareholders executed their stock
purchase agreement on June 25, 1999, setting a closing date of July 1, 1999. The
agreement also required Shap II to cause Double D to execute an option agreement on the
Connecticut farm “immediately” after the closing. This agreement was structured as one
between Double D and Toplands Farm, Dudley Diebold’s entity, giving Toplands the
option to purchase the farm for $6.3 million. Also on June 25, Shap II and Morgan
Stanley entered into a contract wherein Shap II agreed to sell the securities held by
Double D to Morgan Stanley after the closing date. This agreement mandated the use of
the exact same valuation method for the securities as did the agreement between Shap II
and the selling Shareholders. The agreement between Morgan Stanley and Shap II was
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slated to be executed on July 1, 1999—the same day for which the closing between Shap
II and the shareholders was originally scheduled.
On June 30, 1999, Dudley Diebold, acting as manager of Toplands Farm, executed
the option agreement to purchase Double D’s Connecticut real estate. The agreement,
which was to then be executed by Double D “immediately” after the closing, gave
Toplands Farm the right to purchase through July 31, 1999. At the same time, Dudley
Diebold executed an occupancy agreement that set forth terms allowing Toplands Farm to
take possession of the property on July 1, 1999, including requirements that it maintain
liability insurance and take responsibility for all utilities and taxes beginning on that date.
The closing between Shap II and Double D was delayed from July 1, 1999, to July
2, 1999. As the closing did not occur as originally scheduled, Shap II could not transfer
the securities to Morgan Stanley on July 1, as mandated by the agreement between Shap
II and Morgan Stanley. By its terms, Shap II’s agreement with Morgan Stanley obligated
Shap II to deliver equivalent securities or their cash equivalent to Morgan Stanley in the
event the Double D transaction did not occur on July 1, 1999. As it turned out, however,
Morgan Stanley did not require this from Shap II. Power contacted Tim Morris, the head
of Bessemer’s investment department, who contacted John Mack, a very senior officer at
Morgan Stanley. Following Morris’s call to Mack, Morgan Stanley “backed off” from
demanding securities or their cash equivalent from Shap II. Shap II and Double D then
closed, a day delayed from the originally set date. Morgan Stanley “backed off” by
agreeing to change its settlement date with Shap II to July 6, 1999, the first business day
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after the July 2, 1999 closing date. Thus, the two agreements—one between Double D
and Shap II and the other between Shap II and Morgan Stanley—were both amended to
change their closing dates and the date on which the price for all non-AHP shares would
be set from July 1 to July 2, while keeping the average pricing mechanism for the AHP
shares the same as it had been in the original agreements.
On July 2, 1999, both parties to the stock sale of Double D took steps to carry out
the transaction. The selling Shareholders opened an account at Rabobank for the receipt
of Double D’s cash holdings. The Marital Trust, Diebold New York, and Bessemer
executed an agreement with Rabobank in which the bank agreed to waive any of its
possible set-off rights against the account. Under such an agreement, Rabobank could not
apply any of the money from that account to satisfy Shap II’s obligation to pay its loan to
the bank. Also on July 2, in executing the closing, Rabobank credited over $297 million
to Shap II’s account per the loan agreement, and Shap II paid $297 million to the
Shareholders, with further adjustments to be paid shortly thereafter. The Shareholders
transferred their stock shares to Shap II, and Bessemer wired Double D’s cash holdings
from the account at Bessemer to the newly created account at Rabobank.
On the same day, Double D instructed Bank of New York to transfer the securities
in Double D’s account to Morgan Stanley on July 6, 1999. This was an irrevocable
transfer agreement—between Bessemer, Double D, and Shap II—to transfer custody of
Double D’s assets to Shap II’s Morgan Stanley account and “to not honor any other
request or instruction which would cause Bessemer to be unable to make such a transfer.”
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Shap II also directed Morgan Stanley to transfer over $258 million into its loan account
at Rabobank on July 6 and irrevocably instructed Rabobank to pre-pay its loan obligation
with any amounts transferred into that account.
On July 6, 1999, Bessemer and Bank of New York delivered the securities in
Double D’s accounts to Shap II’s Morgan Stanley accounts. As to these transferred
securities, which represented approximately 97% of the total value of Double D’s
securities, Morgan Stanley recorded a trade date of July 2, 1999, and, with the exception
of one security, a settlement date of July 6, 1999. Also on July 6, Morgan Stanley wired
over $297 million from Shap II’s Morgan Stanley account to Shap II’s loan account at
Rabobank, and Bessemer wired the funds transferred by Shap II pursuant to the closing to
the Marital Trust and Diebold New York, in proportion to the amount of stock in Double
D each owned. On July 9 and 12, 1999, Shap II paid the Shareholders the additional
purchase price adjustments, bringing the total amount paid by Shap II to approximately
$309 million. Bessemer distributed these funds to the Marital Trust and Diebold New
York on July 12. Bessemer made an additional distribution of $15.7 million to the selling
Shareholders on November 8, 1999.
Also pursuant to the closing on July 2, the option agreement regarding the sale of
the Connecticut real estate was executed. Toplands Farm paid $1,000 for the option to
purchase. Subsequently, Toplands Farm made a down payment to Shap II for the farm on
July 28, 1999, and paid the purchase price in full on August 27, 1999.
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The transaction described above had the form of a Midco transaction with Shap II
in the role of the Midco. The Shareholders sold the Double D stock for approximately
$309 million in cash. Morgan Stanley and Toplands Farm purchased, respectively,
Double D’s securities and real property. Shap II received approximately $319 million
from the asset sale. Because it claimed losses sufficient to offset the built-in gain, it did
not pay any tax on this amount. After paying back its loan to Rabobank, it retained a
profit of approximately $10 million.
Pursuant to a dissolution, effective on January 29, 2001, Diebold New York
distributed all of its assets in equal shares to three foundations, each one headed by one of
the adult Diebold children: the Diebold Foundation (“Diebold”), Appellee in the instant
case, the Salus Mundi Foundation, and the Ceres Foundation. These transfers, of
approximately $33 million each, were not made in exchange for any property or to satisfy
an existing debt. On March 26 and April 15, 2004, Bessemer distributed an additional
$5.6 million from the escrow account used for the sale of Double D to the Marital Trust
and to each of the successor foundations of Diebold New York.
III.
The parties to this Midco transaction all filed tax returns. The Shareholders filed
timely returns reflecting their sale of Double D stock. Double D filed a corporate return
for a short taxable year, beginning July 1, 1999, and ending July 2, 1999, and dissolved.
Double D’s asset sales were not included in this return. On its tax return for the taxable
year ending June 30, 2000, Shap II filed a consolidated return with Double D, on which it
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reported all of Double D’s built-in gain from its asset sales. On this return, Shap II
claimed sufficient losses to offset the gain, resulting in no net tax liability.5
On March 10, 2006, the IRS issued a notice of deficiency against Double D,
determining a deficiency of income tax, penalties, and interest of approximately $100
million for its July 2, 1999 taxable year. The deficiency resulted from the IRS’s
determination that the Shareholders sale of Double D stock was, in substance, actually an
asset sale followed by a liquidating distribution to the Shareholders. Double D did not
contest this assessment, but the IRS was unable to find any Double D assets from which
to collect the liability.
Deciding that any additional efforts to collect from Double D would be futile, the
Commissioner attempted to collect from the Shareholders as transferees of Double D.
Section 6901 of the Internal Revenue Code authorizes the assessment of liability against
both (a) transferees of a taxpayer who owes income tax and (b) transferees of transferees.
26 U.S.C. § 6901(a)(1)(A)(I), (c)(2). On August 7, 2007, the IRS issued a notice of
transferee liability against Mrs. Diebold as a transferee of Double D. The Tax Court
determined that she was not liable because the Marital Trust was the actual Double D
shareholder, and the court saw no reason to ignore its separate existence. Diebold v.
5 The Tax Court concluded that Shap II’s losses were artificial losses from a
Son-of-BOSS transaction. A Son-of-BOSS transaction is a type of tax shelter that creates
artificial tax losses. See Kligfield Holdings v. Comm’r, 128 T.C. 192, 194 (2007). The
name refers to the fact that the tax shelter “is a variation of a slightly older alleged tax
shelter known as BOSS, an acronym for ‘bond and options sales strategy.’” Id.
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Comm’r, 100 T.C.M. (CCH) 370, at *8 (2010). On July 11, 2008, the IRS issued separate
notices of transferee liability against each Foundation for the approximately $33 million
each received from Diebold New York.6 The Commissioner asserted that Diebold New
York was a transferee of Double D and that the three successor Foundations were, in turn,
transferees of Diebold New York. The Foundations contested the notices of deficiency
before the Tax Court, who consolidated their petitions for briefing and decision. The
parties agreed to use the same evidence, including trial testimony, that was used in the
earlier Diebold v. Comm’r, 100 T.C.M. (CCH) 370 (2010). The Tax Court found in favor
of the petitioners, holding in a memorandum opinion that Diebold New York was not
liable as a transferee of Double D, and thus that Diebold and the other successor
Foundations were not liable as transferees of a transferee. Following its memorandum
opinion, the Tax Court entered separate decisions in favor of each Foundation. The IRS
now appeals.
DISCUSSION
I.
In an appeal from the Tax Court, it is without dispute in this Circuit that we review
legal conclusions de novo and findings of fact for clear error. Robinson Knife Mfg. Co. v.
Comm’r, 600 F.3d 121, 124 (2d Cir. 2010). While we have previously held the standard
6 In that case, as noted by the Tax Court, the IRS failed to raise the argument that
Mrs. Diebold was a transferee of a transferee. Id. at *10. The IRS chose not to appeal the
decision.
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of review for mixed questions of law and fact to be one for clear error, see Wright v.
Comm’r, 571 F.3d 215, 219 (2d Cir. 2009), all Courts of Appeals are to “review the
decisions of the Tax Court . . . in the same manner and to the same extent as decisions of
the district courts in civil actions tried without a jury.” 26 U.S.C. § 7482(a)(1). Our case
law enunciating the standard of review for mixed questions of law and fact in an appeal
from the Tax Court is in direct tension with this statutory mandate. Following a civil
bench trial, we review a district court’s findings of fact for clear error, and its conclusions
of law de novo; resolutions of mixed questions of fact and law are reviewed de novo to
the extent that the alleged error is based on the misunderstanding of a legal standard, and
for clear error to the extent that the alleged error is based on a factual determination.
MacWade v. Kelly, 460 F.3d 260, 267 (2d Cir. 2006). Two recent panels of our Court
have recognized this contradiction between our case law and 26 U.S.C. § 7482(a)(1) but
did not resolve the tension, as they determined that under either standard of review the
outcome in the particular case would be the same. Scheidelman v. Comm’r, 682 F.3d
189, 193 (2d Cir. 2012); Robinson Knife, 600 F.3d at 124. In the instant case, the
standard of review affects the outcome, so our Court can avoid the question no longer.
The standard that mixed questions of law and fact are reviewed under a clearly
erroneous standard when we review a decision of the Tax Court was established in this
Circuit’s jurisprudence in Bausch & Lomb Inc. v. Comm’r, 933 F.2d 1084, 1088 (2d Cir.
1991). Bausch & Lomb imported the standard from the Seventh Circuit, which, in Eli
Lilly & Co. v. Comm’r, 856 F.2d 855, 861 (7th Cir. 1988), held the clearly erroneous
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standard to be applicable. Eli Lilly in turn relied upon another Seventh Circuit case,
Standard Office Bldg. Corp. v. United States, 819 F.2d 1371, 1374 (7th Cir. 1987), a tax
case on review from the district court. None of these decisions mention 26 U.S.C.
§ 7482(a)(1), which has been a part of the Internal Revenue Code since 1954. In
Standard Office Building, the Seventh Circuit indicated that one of the open questions in
the appeal was “the kind of ‘mixed’ question of fact and law . . . that, in this circuit at
least, is governed by the clearly-erroneous standard.” Id. (emphasis added). That court
then cited a handful of cases from their circuit that stated this standard from cases
reviewing the decision of a district court. 819 F.2d at 1374 (citing Mucha v. King, 792
F.2d 602, 605 (7th Cir. 1986) (review from the Northern District of Illinois noting that
“[i]n particular, the Second Circuit had long adhered to the view that [the mixed question
of law and fact at issue in the particular case] is not subject to the clearly-erroneous
standard”) and Wright v. United States, 809 F.2d 425, 428 (7th Cir. 1987) (review from
the Central District of Illinois)). The Seventh Circuit uses the clearly erroneous standard
of review for mixed questions of law and fact when reviewing both decisions of the Tax
Court and those of the district courts. Its standard is thus not in tension with 26 U.S.C.
§ 7482(a)(1), unlike this Court’s.
Quoting Eli Lilly approvingly, in Bausch & Lomb, this Court indicated, “‘We are
unaware of any decision discussing the standard that governs appellate review of a Tax
Court’s [determination].’” Bausch & Lomb, 933 F.2d at 1088 (quoting Eli Lilly, 856 F.2d
at 860-61). It was certainly the case that no decision at that time discussed the standard
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for such appellate review, but the statute which governs our Court’s review of Tax Court
decisions set out a mandatory standard, tied to the level of review in appeals on review
from a district court. 26 U.S.C. § 7482(a)(1). Once imported from the Seventh Circuit,
this standard for mixed questions of law and fact, which stands at odds with our standard
for such review of district court decisions, was propagated again in Merrill Lynch & Co.
v. Comm’r, 386 F.3d 464, 469 (2d Cir. 2004) (citing Bausch & Lomb, 933 F.2d at 1088),
and again in Wright, 571 F.3d at 219 (2d Cir. 2009) (citing Merrill Lynch, 386 F.3d at
469; Bausch & Lomb, 933 F.2d at 1088). These three cases make up the bulk, if not the
entirety, of the citations for this standard in subsequent decisions of this Court. See
Wilmington Partners L.P. v. Comm’r, 495 F. App’x 173, 174 (2d Cir. 2012) (summary
order) (citing Wright); Scheidelman, 682 F.3d at 193-94 (citing Wright, Merrill Lynch,
and Bausch & Lomb); Robinson Knife, 600 F.3d at 124 (same); Wright, 571 F.3d at 219
(citing Merrill Lynch and Bausch & Lomb).
We now conclude that this standard of review was adopted in error. 7 As all Article
III courts, with the exception of the Supreme Court, are solely creatures of statute, see
U.S. Const. art. III; 28 U.S.C. §§ 1-463, the statute must be determinative in this case.
7 “We readily acknowledge that a panel of our Court is bound by the decisions of
prior panels until such time as they are overruled either by an en banc panel of our Court
or by the Supreme Court, and thus that it would ordinarily be neither appropriate nor
possible for us to reverse an existing Circuit precedent.” Shipping Corp. of India Ltd. v.
Jaldhi Overseas Pte Ltd., 585 F.3d 58, 67 (2d Cir. 2009) (internal quotation marks and
citation omitted). “In this case, however, we have circulated this opinion to all active
members of this Court prior to filing and have received no objection,” a process we refer
to “as a mini-en banc.” Id. at 67 & n.9.
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Moreover, there is no reason to review the Tax Court under a different standard than a
district court, as “its relationship to us [is] that of a district court to a court of appeals.”
Scheidelman, 682 F.3d at 193 (internal quotation marks omitted). We hold that the Tax
Court’s findings of fact are reviewed for clear error, but that mixed questions of law and
fact are reviewed de novo, to the extent that the alleged error is in the misunderstanding
of a legal standard. See 26 U.S.C. § 7482(a)(1); MacWade, 460 F.3d at 267. Having
clarified the standard of review applicable to decisions of the Tax Court, we now turn to
the merits of the instant case.
II.
Title 26, Section 6901 of the United States Code provides that the IRS may assess
tax against the transferee of assets of a taxpayer who owes income tax. 26 U.S.C.
§ 6901(a)(1)(A)(I). The section provides that the tax liability will “be assessed, paid, and
collected in the same manner and subject to the same provisions and limitations as in the
case of the taxes with respect to which the liabilities were incurred” and allows for the
collection of “[t]he liability, at law or in equity, of a transferee of property . . . of a
taxpayer.” Id. A “transferee” includes a “donee, heir, legatee, devisee, [or] distributee.”
Id. § 6901(h).
The Supreme Court has long held that this section “neither creates nor defines a
substantive liability but provides merely a new procedure by which the Government may
collect taxes.” Comm’r v. Stern, 357 U.S. 39, 42 (1958) (discussing the predecessor
transferee liability statute under the Internal Revenue Code of 1939, 26 U.S.C. § 311).
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Although the provision with respect to transferees is not expansive in its terms, the IRS
may assess transferee liability under § 6901 against a party only if two distinct prongs are
met: (1) the party must be a transferee under § 6901; and (2) the party must be subject to
liability at law or in equity. Rowen v. Comm’r, 215 F.2d 641, 643 (2d Cir. 1954)
(discussing predecessor statute, 26 U.S.C. § 311). Under the first prong of § 6901, we
look to federal tax law to determine whether the party in question is a transferee. Id. at
644. The second prong, whether the party is liable at law or in equity, is determined by
the applicable state law, Stern, 357 U.S. at 45, here, the New York Uniform Fraudulent
Conveyance Act (“NYUFCA”), N.Y. Debt. & Cred. Law §§ 270-281. Specifically,
Section 273 of the NYUFCA establishes liability for a transferee if the transferor (1)
makes a conveyance, (2) without fair consideration, (3) that renders the transferor
insolvent. See N.Y. Debt. & Cred. Law § 273; United States v. McCombs, 30 F.3d 310,
323 (2d Cir. 1994). The parties do not dispute the application of this two-pronged test,
but contest the relationship between the two prongs and their application to this particular
case.
The Commissioner urges that these two prongs are not independent—that a court
must first make a determination as to whether the party in question is a transferee, looking
to the federal tax law doctrine of “substance over form” to recharacterize the transaction,
and that if a court recharacterizes the transaction, when it proceeds to the second prong to
make the determination of state law liability, it must assess liability with respect to the
recharacterized transaction. Under this formulation, the order in which the two prongs
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are assessed is critical to the determination of the case. In contrast, Diebold argues that
the two prongs of § 6901 are independent: even if the court uses federal law to
recharacterize the transaction under the first prong and determines the party in question is
a transferee, it must look separately to state law under the second prong to determine
whether to recharacterize the transaction when analyzing liability. Under this
formulation, if a court has determined that one of the two prongs does not apply to the
party at issue—whether they are a transferee or whether they are liable—it need not
consider the other prong of § 6901.
The Tax Court accepted Diebold’s understanding of the two-prong framework and
stated that “[t]he law of the State where the transfer occurred . . . controls the
characterization of the transaction.” Under the NYUFCA, a party seeking to
recharacterize a transaction must show that the transferee had “actual or constructive
knowledge of the entire scheme that renders [its] exchange with the debtor fraudulent.”
HBE Leasing Corp. v. Frank, 48 F.3d 623, 635 (2d Cir. 1995). Applying HBE Leasing,
the Tax Court found that the Shareholders did not have actual or constructive knowledge
of the entire series of transactions. Therefore, it respected the form of the transaction
between the Shareholders and Shap II as a stock sale. According to the Tax Court,
because there was no conveyance from Double D to Diebold New York under § 273 of
the NYUFCA, Diebold New York was under no liability in law or equity, and thus the
successor foundations were not liable as transferees of a transferee. In making this
determination, the Tax Court did not address federal law, but concluded that because
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there was no state law liability, it was immaterial to the outcome of the case if Diebold
was a transferee under the terms of § 6901.
A.
The First and the Fourth Circuits have both recently addressed the relationship
between the transferee prong and the liability prong of § 6901. See Frank Sawyer Trust
of May 1992 v. Comm’r, 712 F.3d 597, 605 (1st Cir. 2013); Starnes v. Comm’r, 680 F.3d
417, 428 (4th Cir. 2012). Both of these circuits concluded that the two prongs of § 6901
are independent and that the Tax Court did not err by only addressing the liability prong.
Frank Sawyer, 712 F.3d at 605; Starnes, 680 F.3d at 428. We now join the First and
Fourth Circuits in their interpretations of § 6901.
In Stern, the Supreme Court recognized that the predecessor statute to § 6901
“neither creates nor defines a substantive liability but provides merely a new procedure
by which the Government may collect taxes.” Stern, 357 U.S. at 42. The statute was
enacted in order to do away with the procedural differences between collecting taxes from
one who was originally liable and from someone who received property from the original
tax ower. Id. at 43. The procedures in place prior to the enactment of § 6901’s
predecessor statute depended upon state statutory or case law and “proved unduly
cumbersome.” Id. The statute was not enacted to expand the government’s reach as
creditor in collecting taxes. Rather, “[t]he Government’s substantive rights in this case
are precisely those which other creditors would have under [state] law.” Id. at 47. As
such, § 6901 does not place the government in a better position than any other creditor
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under state law. This symmetry of rights contemplated under the statute must lead to the
conclusion that the requirements of § 6901 are indeed independent. If we accepted the
Commissioner’s argument that state law liability is assessed based upon the transaction as
recharacterized by federal tax law, we would be placing the IRS in a substantially
different position than “ordinary creditors under state law.” Starnes, 680 F.3d at 429.
Under the interpretation urged by the Commissioner, the IRS would be able to collapse
the transaction based upon federal law, thus transforming it into a conveyance under the
applicable state statute, while an ordinary creditor would be required to collapse the
transaction under state law—which may require, as it does in this case, a different
showing—in order to collect from a transferee. This distinction demonstrates that the
position urged by the IRS imports federal law into the substantive determination of
liability, in contravention of long settled law that § 6901 is only a procedural statute,
creating no new liability. Stern, 357 U.S. at 42.
In the instant case, if there was not a “conveyance” under the NYUFCA, a
determination that is necessarily made under state law, id. at 45, then it is of no moment
whether or not the selling Shareholders were “transferees” as defined by federal
law—namely, 26 U.S.C. § 6901(h). As the First Circuit recently noted in Frank Sawyer,
“if the Trust was not a ‘transferee’ of the companies for purposes of Massachusetts
fraudulent transfer law, then whether or not it was a ‘transferee’ for purposes of § 6901 is
irrelevant.” Frank Sawyer, 712 F.3d at 605. The same formulation is true in the instant
case: if Diebold New York did not receive a conveyance from Double D for purposes of
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the NYUFCA, “then whether or not it was a ‘transferee’ for purposes of § 6901 is
irrelevant.” Id. Having determined that the two prongs of § 6901 are “ independent
requirements, one procedural and governed by federal law, the other substantive and
governed by state law,” Starnes, 680 F.3d at 427, we now turn to the Tax Court’s
assessment of liability under New York state law.
B.
The NYUFCA defines a “conveyance” as “every payment of money, assignment,
release, transfer, lease, mortgage or pledge of tangible or intangible property, and also the
creation of any lien or incumbrance.” N.Y. Debt. & Cred. Law § 270. It further
establishes liability for a transferee if the transferor, without regard to his actual intent, (1)
makes a conveyance, (2) without fair consideration, (3) that renders the transferor
insolvent. See N.Y. Debt. & Cred. Law § 273; McCombs, 30 F.3d at 323. If Double D
had sold its assets and liquidated the proceeds to its shareholders without retaining
sufficient funds to pay the tax liability on the assets’ built-in gains, this would be a clear
case of a fraudulent conveyance under § 273. However, due to the Midco form of this
transaction, Double D did not actually make a conveyance to the Shareholders. If the
form of the transaction is respected, § 273 is inapplicable.
“It is well established that multilateral transactions may under appropriate
circumstances be ‘collapsed’ and treated as phases of a single transaction for analysis
under the UFCA.” HBE Leasing, 48 F.3d at 635 (citing Orr v. Kinderhill Corp., 991 F.2d
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31, 35-36 (2d Cir.1993)). HBE Leasing describes a “paradigmatic scheme” under this
collapsing doctrine as one in which
one transferee gives fair value to the debtor in exchange for the debtor’s property,
and the debtor then gratuitously transfers the proceeds of the first exchange to a
second transferee. The first transferee thereby receives the debtor’s property, and
the second transferee receives the consideration, while the debtor retains nothing.
Id. Such a transaction can be collapsed if two elements are met. “First, in accordance
with the foregoing paradigm, the consideration received from the first transferee must be
reconveyed by the [party owing the liability] for less than fair consideration or with an
actual intent to defraud creditors.” Id. “Second, . . . the transferee in the leg of the
transaction sought to be voided must have actual or constructive knowledge of the entire
scheme that renders her exchange with the debtor fraudulent.” Id.8 Here, it is clear that
the first element is met. Though the transaction in the instant case has an additional
wrinkle—namely, an additional party who serves as the conduit for the transfers, Shap
II—it is still the case that one transferee received Double D’s property, another
transferee—the Shareholders—received the consideration for these assets, and Double D
was left with nothing, neither its assets nor the value of them. Therefore, in order for
there to be liability against the selling Shareholders (and their successor entities), the
Shareholders “must have actual or constructive knowledge of the entire scheme that
renders [the] exchange with [Double D] fraudulent.” Id.
8 The Commissioner bears the burden of proof with regard to demonstrating that the
parties in question had constructive knowledge of the entire scheme. See HBE Leasing, 48 F.3d
at 636 n.9.
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While under an application of § 273 to a single transaction, the intent of the parties
is irrelevant, the knowledge and intent of the parties becomes relevant when a court is
urged to treat multiple business deals as a single transaction. Id. at 635-36; In re
Corcoran, 246 B.R. 152, 158-59 (E.D.N.Y. 2000) (Raggi, J.). Here, the Commissioner
urges the Court to consider the sale of Double D stock to Shap II, the sale of Double D
assets by Shap II to Morgan Stanley and Toplands Farm, and the distribution of funds to
the selling Double D Shareholders as a single transaction such that a conveyance occurred
for purposes of § 273. If the transactions are collapsed, they will be treated as though
Double D sold all of its assets and made a liquidating distribution to the Shareholders.
Under this collapsed transaction, Double D will have transferred all of its assets to the
Marital Trust and Diebold New York receiving nothing, much less fair consideration, in
exchange.
Therefore, we must now assess whether the Shareholders had actual or
constructive knowledge of the entire scheme. The Tax Court concluded they did not.
This assessment is a mixed question of law and fact, assessing whether based upon the
facts as determined by the Tax Court, the Shareholders had constructive or actual
knowledge as a matter of law. Therefore, we review de novo the Tax Court’s
determination that the Shareholders did not have constructive knowledge, but review for
clear error the factual findings that underpin the determination.
Concluding that a party had constructive knowledge does not require a showing
that the party had actual knowledge of a scheme; rather, it is sufficient if, based upon the
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surrounding circumstances, they “should have known” about the entire scheme. HBE
Leasing, 48 F.3d at 636 (internal quotation marks omitted). Constructive knowledge in
this context also includes “inquiry knowledge”—that is, where transferees “were aware of
circumstances that should have led them to inquire further into the circumstances of the
transaction, but . . . failed to make such inquiry.” Id. As we noted in HBE Leasing,
“[t]here is some ambiguity as to the precise test for constructive knowledge,” id. at 636,
in that some cases require “the knowledge that ordinary diligence would have elicited,”
see United States v. Orozco-Prada, 636 F. Supp. 1537, 1543 (S.D.N.Y. 1986), aff’d, 847
F.2d 836 (table) (2d Cir. 1988), and other cases have required a “more active avoidance
of the truth.” HBE Leasing, 48 F.3d at 636 (citing Schmitt v. Morgan, 471 N.Y.S.2d 365,
367 (3d Dep’t 1983)). However, even as we acknowledge this ambiguity in New York
law, we need not reach the issue of which test to apply, because the facts here
demonstrate both a failure of ordinary diligence and active avoidance of the truth.
The facts in this case rested upon a substantial number of stipulated facts and
submissions which together evince constructive knowledge under either standard. As
correctly recognized by the Tax Court, assessing whether constructive knowledge existed
in this case requires examining all of the circumstances to conclude whether inquiry was
required. Constructive knowledge can also be found if, based on all of the facts and
circumstances, the party “should have known” about the entire fraudulent scheme. Id.
The Tax Court concluded that the circumstances in this case did not require the
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Shareholder representatives “to make further inquiry into the circumstances of the
transaction” between Double D and Shap II. We conclude this was error.
The Tax Court did not sufficiently address the totality of the circumstances from
all of the facts, which that court had already laid out itself. The constructive knowledge
inquiry does not begin, in this instance, solely with the agreement between Shap II and
Double D. Rather, it is of great import that the Shareholders recognized the “problem” of
the tax liability arising from the built-in gains on the assets held by Double D. The
Shareholders specifically sought out parties that could help them avoid the tax liability
inherent in a C Corp holding appreciated assets. They viewed slideshow and other
presentations from three different firms—River Run, Sentinel, and Fortrend—that
purported to deal with such problems. While the Tax Court is correct in noting that IRS
Notice 2001-16 was not yet issued at the time of the instant transactions, this is not
determinative on the question of constructive knowledge. The parties to this transaction
were extremely sophisticated actors, deploying a stable of tax attorneys from two
different firms in order to limit their tax liabilities. One of these attorneys testified,
identifying the steep tax liability inherent in the assets held by Double D, that “it was
generally known . . . in that profession that there were . . . some people, who for whatever
reason, whatever their tax activities are, were able to make very favorable offers to sellers
with stock with appreciated assets . . . with the corporation having appreciated assets.”
While not every taxpayer in the country could have been presumed to have knowledge
about the existence of such Midco transactions prior to the IRS issuance of Notice 2001-
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16, it is plain from the facts found by the Tax Court that these particular actors did.
Considering their sophistication, their negotiations with multiple partners to structure the
deal, their recognition of the fact that the amount of money they would ultimately receive
for an asset or stock sale would be reduced based on the need to pay the C Corp tax
liability, and the huge amount of money involved, among other things, it is obvious that
the parties knew, or at least should have known but for active avoidance, that the entire
scheme was fraudulent and would have left Double D unable to pay its tax liability.
The Shareholder representatives also had a sophisticated understanding of the
structure of the entire transaction, a fact that courts consider when determining whether to
collapse a transaction and impose liability on an entity. See HBE Leasing, 48 F.3d at 635-
36 (“The case law has been aptly summarized in the following terms: “In deciding
whether to collapse the transaction and impose liability on particular defendants, the
courts have looked frequently to the knowledge of the defendants of the structure of the
entire transaction and to whether its components were part of a single scheme.” (quoting
In re Best Products Co., 168 B.R. 35, 57-58 (Bankr. S.D.N.Y. 1994))) (emphasis added).
The Shareholder representatives plainly knew that Shap II was a brand new entity that
was created for the sole purpose of purchasing Double D stock. They further had notice,
by means of the draft stock purchase agreement, that Shap II intended to sell Double D’s
securities to Morgan Stanley, and by means of the option agreement, Shap II intended to
sell the Connecticut real estate to Toplands Farm. The Shareholder representatives knew
that Morgan Stanley was going to purchase the securities out of Double D immediately
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upon closing, and that the specific language referencing Morgan Stanley was stricken at
the behest of the Shareholder representatives further suggests that the Shareholders did
not want to know, or reveal that they knew, the details of Shap II’s plans to immediately
sell Double D’s assets.
The delay of the original closing date by one day, and the Shareholders’
representatives’ corresponding intervention between Shap II and Morgan Stanley, make
the conclusion of their “active avoidance of the truth” inescapable. By asking Morgan
Stanley to “back off” and give Shap II extra time to provide the Double D securities so
that the transactions would not be upended, the Shareholders demonstrated not only their
knowledge of the structure of the entire transaction, but their understanding that Shap II
did not have the assets to meet its obligation to buy equivalent shares on the open market
for delivery to Morgan Stanley or pay Morgan Stanley an equivalent sum in cash. This
understanding, combined with the Shareholders’ knowledge that Shap II had just come
into existence for the purposes of the transaction, was more than sufficient to demonstrate
an awareness that Shap II was a shell that did not have legitimate offsetting losses or
deductions to cancel out the huge built-in gain it would incur upon the sale of the Double
D securities.
Taken together, these circumstances should have caused the Shareholder
representatives to inquire further into the supposed tax attributes that allegedly would
have allowed Shap II to absorb the tax liability of which the Shareholders had intimate
knowledge and which indeed was the very reason they structured this deal in the first
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instance. To conclude that these circumstances did not constitute constructive knowledge
would do away with the distinction between actual and constructive knowledge, and, at
times, the Tax Court’s opinion seems to directly make this mistake. The facts in this case
strongly suggest that the parties actually knew that tax liability would be illegitimately
avoided, and in any event, as a matter of law, plainly demonstrate that the parties “should
have known” that this was a fraudulent scheme, designed to let both buyer of the assets
and seller of the stock avoid the tax liability inherent in a C Corp holding appreciated
assets and leave the former shell of the corporation, now held by a Midco, without assets
to satisfy that liability.
Based on the myriad circumstances discussed above of which they were aware, the
Shareholders had a duty to inquire further into the circumstances of the transaction. HBE
Leasing, 48 F.3d at 636. The term in the stock purchase agreement allocating liability for
the taxes to Shap II and Double D is insufficient to relieve the Shareholders of their duty
to inquire. This is because the knowledge requirement for collapsing a transaction was
designed to “protect[] innocent creditors or purchasers for value.” Id. It was not
designed to allow parties to shield themselves, when having knowledge of the scheme, by
simply using a stock agreement to disclaim any responsibility. To accept this rule would
be to undermine the very concept of constructive knowledge, as it would allow an
incantation of assignment of tax liability to magically relieve the parties of their duty to
inquire based on all of the circumstances which they were aware. To relieve parties of
this duty, when the surrounding circumstances indicate that they should further inquire,
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would be to bless the willful blindness the constructive knowledge test was designed to
root out. Moreover, we note that when entering into a particular transaction for the
express purpose of limiting—or altogether avoiding—tax liability, parties are all the more
likely to have this duty to inquire. In such cases, the surrounding circumstances always
include a deliberate effort to avoid liability, and it would be the very rare case indeed
where a purchasing party would assume such liability without an appropriate discount in
the sale price.9 In such scenarios, being aware that this is the case, parties have a duty “to
inquire further into the circumstances of the transaction.” Id.
As we have concluded that the Shareholders’ conduct evinces constructive
knowledge in this case, we collapse the series of transactions and find that there was a
conveyance under the NYUFCA. In collapsing the transactions, we conclude that, in
substance, Double D sold its assets and made a liquidating distribution to its
Shareholders, which left Double D insolvent—that is, “the present fair salable value of
[its] assets [wa]s less than the amount . . . required to pay [its] probable liability on [its]
existing debts as they bec[a]me absolute and matured.” N.Y. Debt. & Cred. Law § 271.
With the liquidating distribution, Double D did not receive anything from the
Shareholders in exchange, and thus it is plain that Double D certainly did not receive fair
consideration. As such, all three prongs of § 273 have been met: Double D (1) made a
9 We recognize that some tax avoidance strategies are perfectly permissible. Here, we
hold only that whether a transaction arose out of a taxpayer’s tax-avoidance motive is simply one
factor, among many, that may be considered in determining whether that transaction should be
collapsed under state law.
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conveyance, (2) without fair consideration, (3) that rendered Double D insolvent. See
N.Y. Debt. & Cred. Law § 273; McCombs, 30 F.3d at 323. As we have determined that
there is state law liability in the instant case, at issue is whether Diebold New York is a
transferee under 26 U.S.C. § 6901, and subsequently, whether Diebold, the Appellee here,
is a transferee of a transferee under the same statute.
III.
Because the Tax Court determined that there was no state law liability, it did not
consider the other questions determinative to the outcome here. We thus remand to the
Tax Court to determine in the first instance: (1) whether Diebold New York is a
transferee under 26 U.S.C. § 6901, relying upon the federal law principles that govern the
question of transferee status; (2) whether Diebold, the Appellee in the instant case, is a
transferee of a transferee—that is, a transferee of Diebold New York; and (3) which
statute of limitations—the three-year statute of limitations laid out in 26 U.S.C.
§ 6901(c)(2), the six-year statute of limitations laid out in 26 U.S.C. § 6501(e)(1)(A), or
some other statute of limitations—applies.
CONCLUSION
For the reasons stated above, the judgment of the Tax Court is hereby VACATED,
and the case is REMANDED to the Tax Court for further proceedings consistent with this
opinion.
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