Santa Fe Pacific Gold Company and Subsidiaries, By and Through Its Successor in Interest Newmont USA Limited v. Commissioner ( 2009 )

132 T.C. No. 12UNITED STATES TAX COURT
SANTA FE PACIFIC GOLD COMPANY AND SUBSIDIARIES, BY AND THROUGH
ITS SUCCESSOR IN INTEREST NEWMONT USA LIMITED, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22956-06. Filed April 27, 2009.
SF was a wholly owned subsidiary of parent P. P spun
SF off into a stand-alone entity. Two years after being
spun off, SF faced a hostile takeover by competitor N. In
order to avoid being taken over, SF entered into a merger
agreement with white knight HS. The merger agreement
provided for the payment of a termination fee should the
agreement be terminated. Shortly thereafter N increased its
offer. SF’s board accepted the increased offer. SF paid a
$65 million termination fee to HS. SF claimed a deduction
for the amount of the termination fee on its 1997 tax
return, which R disallowed.
Held: SF is entitled to a deduction of $65 million for
the termination fee.
- 2 -
David D. Aughtry, Arnold B. Sidman, and William O.
Grimsinger, for petitioner.
Curt M. Rubin, Matthew I. Root, Michael D. Wilder, and
Jennifer S. McGinty, for respondent.
Contents
FINDINGS OF FACT.........................................3
A. Introduction....................................4
B. Spin-off of Mining Unit.........................5
C. The Mining Industry in General..................5
D. Santa Fe’s First 2 Years........................6
1. Initial Corporate Strategy.................8
2. Becoming Poolable..........................8
E. Initial Contacts................................9
F. Initial Contact With Newmont and Homestake......10
G. November 21, 1996, Santa Fe Board Meeting.......17
H. Newmont Responds to Santa Fe’s Rejection........18
I. December 8, 1996, Santa Fe Board Meeting........19
J. Newmont Reacts to the Santa Fe-Homestake Agreement
................................................22
K. Santa Fe Reacts to Newmont’s Increased Offer....25
L. The March 7-8, 1997, Santa Fe Board Meeting.....29
1. Newmont Offer..............................29
2. Homestake Offer............................29
a. Initial Homestake Offer.............29
b. Attempts To Obtain a Higher Offer.. 30
3. Newmont Wins Out...........................30
M. The Santa Fe-Newmont Agreement..................30
N. Santa Fe Post Merger............................31
OPINION..................................................33
I. Burden of Proof.....................................33
II. Deductibility v. Capitalization.....................33
A. INDOPCO, Inc. v. Commissioner...................36
B. Victory Mkts., Inc. & Subs. v. Commissioner.....37
C. United States v. Federated Dept. Stores, Inc....37
D. Staley I & II...................................38
III. Origin of the Claim Doctrine........................39
- 3 -
IV. Petitioner’s Arguments..............................41
A. Significant Benefit........................41
B. Origin of Claim............................41
C. Petitioner’s Experts.......................43
V. Respondent’s Arguments..............................44
A. Significant Benefit........................44
B. Origin of Claim............................46
C. Respondent’s Expert........................49
VI. Analysis...........................................49
VII. Conclusion.........................................58
VIII. Section 165........................................58
IX. Conclusion.........................................62
GOEKE, Judge: The issue for decision is whether Santa Fe
Pacific Gold Co. (Santa Fe) is entitled to a deduction of $65
million for a payment made to Homestake Mining Co. (Homestake) as
a result of the termination of a merger agreement between Santa
Fe and Homestake (termination fee) for Santa Fe’s 1997 tax year.
For the reasons stated herein, we find that Santa Fe is entitled
to a deduction pursuant to sections 162 and 165.1
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulation
of facts and accompanying exhibits are incorporated herein by
this reference.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
- 4 -
Petitioner’s principal office and place of business was
Denver, Colorado, on the date it filed its petition.
A. Introduction
During the late 1800s the Federal Government hoped to spur
development of cross-country railroads. In order to entice
private companies to develop those railroads, the Federal
Government offered and granted large parcels of land bordering
the railroads to the companies that developed them. The program
was successful, and as a result a checkerboard pattern of land
owned by the railroads spread across the country.
Santa Fe Pacific Corp. was one company that took part in the
Government program, worked to build transcontinental railroads,
and was granted land alongside its rails. Some of this land
contained minerals that could be mined for profit. Santa Fe
Pacific Corp. took no part in the mining of its land. Until the
late 1970s Santa Fe Pacific Corp. leased these mineral rights to
unrelated companies and individuals rather than mine the land
itself.
Santa Fe Industries, successor to Santa Fe Pacific Corp.,
later developed an internal unit to manage the mining of the
parcels of land. The mining unit originally focused on uranium
mining but later switched to coal and then gold mining.
- 5 -
B. Spinoff of the Mining Unit
In the late 1980s Santa Fe Industries became the target of a
hostile takeover attempt. In a move meant to help defeat the
attempted acquisition, the mining unit was put up for sale.
Although the sale was never consummated, the mining unit’s
management realized that they were not considered an integral
part of Santa Fe Industries and began to appreciate the benefits
of the mining unit’s being a stand-alone entity. Management of
the mining unit began to consider the idea of having it separated
from the parent company.
The spinoff of Santa Fe was a two-step process. First,
there was an initial public offering (IPO) of 14.6 percent of
Santa Fe’s common stock on June 23, 1994. In September 1994
Santa Fe’s parent corporation distributed its remaining shares of
Santa Fe stock to Santa Fe’s public shareholders. As a result of
the spinoff, Santa Fe became a publicly traded stand-alone
entity.
Once the spinoff was completed, the newly independent
company’s management appreciated the benefits of being a stand-
alone company and did not want to return to being a subsidiary of
a larger company.
C. The Mining Industry in General
Mining companies are classified by tiers. First-tier mining
companies are the top mining companies in the country. Newmont
- 6 -
USA Limited (Newmont) was a first-tier mining company. Second-
tier mining companies are smaller mines focused on developing
mines and building production. Santa Fe and Homestake were
second-tier mining companies. Third-tier mining companies are
the lowest ranked and consist of junior exploration companies.
During the 1990s the mining industry was in a state of
consolidation. Consolidation was driven by two factors: (1)
Larger companies could lower costs; and (2) larger companies were
viewed as better investments because they had higher multiples on
earnings and cashflow than smaller companies. Second-tier mining
companies traded at lower multiples than first-tier companies.
D. Santa Fe’s First 2 Years
Because Santa Fe could not qualify for “pooling of
interests” accounting treatment,2 Santa Fe was an unattractive
company to other mining companies. Pooling of interests
accounting is preferred because it avoids the creation of
goodwill. If a transaction qualifies for pooling of interests
accounting treatment, the purchaser will generally pick up the
target’s assets, liabilities, and net worth at the book values
those items had on the target’s financial statements, without
regard to the current fair value of those assets or liabilities,
2
Pursuant to the Financial Accounting Standards Board,
Statement of Financial Accounting Standards No. 141, Business
Combinations, pooling of interests accounting is no longer
available to transactions initiated after June 30, 2001.
- 7 -
or the fair value of the consideration the purchaser issued in
exchange for the target’s net assets. See 3 Ginsburg & Levin,
Mergers, Acquisitions, and Buyouts, par. 1703.4. If a
transaction does not qualify for pooling of interests accounting
treatment, purchase accounting rules apply. Goodwill may be
created when purchase accounting rules apply. This purchase
goodwill, considered a new asset, is shown on the acquirer’s
books as the excess of the acquirer’s cost for the target over
the fair market value of the target’s identifiable assets. Id.par. 1703.2.1. Creation of goodwill is undesirable from the
acquirer’s standpoint because the goodwill might have to be
written off. Id. Goodwill is required to be written off to the
extent it becomes impaired. Id. Goodwill is impaired when “‘the
carrying amount of goodwill exceeds its implied fair value.’”
Id. par. 1703.2.1.3 (quoting FASB Statement No. 142, par. 18).
The determination of impairment, if any, is made on a case-by-
case basis pursuant to accounting rules. Id. par. 1703.2.1.3. A
company considering an acquisition would prefer pooling of
interests accounting, thereby avoiding the effects of purchase
accounting.
Pooling of interests accounting treatment was prohibited
with respect to acquisitions of a company within 2 years of the
time that the company was a subsidiary of another company.
Accordingly, for 2 years Santa Fe would not be able to take
- 8 -
advantage of pooling of interests accounting treatment for any
business combination it took part in. Pooling of interests
accounting treatment would be available if Santa Fe were to enter
into a transaction that would otherwise qualify for pooling of
interests accounting treatment after October 1, 1996.
1. Initial Corporate Strategy
On January 1, 1995, Santa Fe’s president, Pat James (Mr.
James), took over as chief executive officer and chairman of
Santa Fe’s board of directors. Santa Fe management had set as
one of its goals reaching first-tier status. In order to do so,
management set an initial production goal of 1 million troy
ounces of gold per year and hoped to reach that goal by 1997.
Santa Fe reached this goal by the end of 1996. Management also
developed a 5-year business plan that was later expanded to a 10-
year business plan. Once Santa Fe had accomplished its goal of 1
million troy ounces per year, the company planned on increasing
production to 2 million troy ounces per year.
2. Becoming Poolable
Towards the end of 1995 Santa Fe began to investigate
possible three-way combinations with TVX Gold, Inc. (TVX), and
Battle Mountain Gold Co. (Battle Mountain). Both TVX and Battle
Mountain were significant companies in the mining industry but
were smaller than Santa Fe. At this time Santa Fe’s management
recognized the value of its large land positions and understood
- 9 -
that this made the company a prime takeover target. The
impossibility of qualifying for pooling of interests accounting
treatment, however, protected Santa Fe from takeover because the
prospect of being forced to account for the transaction under
purchase accounting rules made Santa Fe a less attractive target.
Recognizing that the prohibition against pooling was going to end
soon, however, Santa Fe realized that it would need a new
strategy to avoid takeover. Santa Fe viewed a possible three-way
merger as a defense against a possible hostile takeover.
However, the prospective deals with TVX and Battle Mountain were
unsuccessful.
E. Initial Contacts
On January 19, 1996, Santa Fe’s board of directors (the
Santa Fe board) engaged S.G. Warburg & Co., Inc. (S.G. Warburg),
as the board’s financial advisers. The engagement letter
indicated that S.G. Warburg would act as strategic financial
advisers to Santa Fe, advising the company regarding
acquisitions, mergers of equals, and takeover defenses. Santa
Fe’s management was interested in exploring possible acquisitions
by Santa Fe and was targeting companies both smaller than and
equal in size to Santa Fe. Management’s strategy was that
acquisitions would help to defeat a takeover attempt because any
acquisition would increase Santa Fe’s value, requiring a suitor
to pay a higher price.
- 10 -
F. Initial Contact With Newmont and Homestake
On April 1, 1996, at a meeting of the Gold Institute, a
mining industry association, Ron Cambre (Mr. Cambre), chief
executive officer of Newmont, contacted Mr. James about a
business combination. Mr. James was not surprised. Newmont was
two to three times larger than Santa Fe and was one of the
biggest companies in the mining industry. Mr. Cambre did not
provide a specific proposal but informally mentioned that Newmont
and Santa Fe should be looking at some sort of combination of the
two companies. Newmont’s interest in a combination with Santa Fe
centered on Santa Fe’s land position. At that time Santa Fe had
a larger land position in Nevada than Newmont did. Mr. James
viewed any hypothetical business combination with Newmont as a
takeover of Santa Fe because of their relative sizes. Mr. James
rebuffed Mr. Cambre’s attempts, informing Mr. Cambre that Santa
Fe wanted to continue as an independent firm.
At that time Santa Fe’s management realized that it had to
act before the 2-year prohibition on pooling of interests
accounting expired in order for Santa Fe’s business and long-term
plans to be protected. On July 17, 1996, Mr. Cambre wrote to Mr.
James reiterating his desire to explore a possible business
combination of Newmont and Santa Fe.
At a July 25, 1996, meeting of the Santa Fe board, Mr. James
discussed Santa Fe’s strategic alternatives. S.G. Warburg
- 11 -
provided a more detailed review of these options, while counsel
from the law firm of Skadden, Arps, Slate, Meagher & Flom made a
presentation on the Santa Fe board members’ fiduciary duties in
considering any strategic alternatives.
On July 26, 1996, the Homestake board of directors (the
Homestake board) met. The minutes of that meeting reflected that
during the meeting Homestake’s president and chief executive
officer Jack Thompson (Mr. Thompson) informed the Homestake board
that he had recently spoken with Mr. James regarding Santa Fe’s
interest in a possible business combination with Homestake. The
minutes further indicated that Mr. James told Mr. Thompson that
Santa Fe “would prefer to act on its own at this point”.
Sometime around the beginning of August 1996 Mr. James
informed Mr. Cambre that Santa Fe was not interested in pursuing
a combination with Newmont. On August 8, 1996, Mr. Cambre sent a
letter to Mr. James expressing his disappointment that Santa Fe
had decided to stay the course and not consider a business
combination with Newmont. The letter also stated that with Santa
Fe’s nonpooling period coming to a close, Mr. Cambre knew that
Santa Fe and Santa Fe’s board would “be concerned about hostile
interlopers” who would disrupt Santa Fe’s strategic plans, and
that a combination with Newmont would protect Newmont’s and Santa
Fe’s ability to work towards their strategic goals.
- 12 -
Mr. James and Mr. Batchelder, a Santa Fe director, did not
view Mr. Cambre’s letter as a positive development. Rather, they
viewed Mr. Cambre’s letter as a warning that Santa Fe was
vulnerable to a takeover. Mr. James and Mr. Batchelder viewed
Newmont as one of the companies that could take Santa Fe over if
Santa Fe resisted their friendly overtures. Mr. Batchelder had
experience dealing with mergers and acquisitions and hostile
takeovers in the mining industry before joining Santa Fe as a
director. On August 22, 1996, Mr. James responded to Mr.
Cambre’s August 8, 1996, letter and reiterated Santa Fe’s
position that it was not interested in a business combination
with Newmont at that time.
On September 18, 1996, the Newmont board of directors (the
Newmont board) met. Before the meeting, Mr. Cambre sent the
board members a letter detailing his beliefs that Santa Fe was a
good strategic fit and that Newmont should pursue a transaction
with Santa Fe. It also detailed Mr. Cambre’s discussions with
Mr. James and passed along Mr. James’s message of August 22,
1996, that Santa Fe was not interested in a transaction with
Newmont. Attached to the letter was a presentation prepared by
Goldman, Sachs & Co. (Goldman Sachs) about Project North.3 The
3
Parties to merger or acquisition transactions often refer
to themselves and other entities involved with code words that
begin with the same letter as the name of the entity. Newmont
was referred to as “North”, while Santa Fe was referred to as
(continued...)
- 13 -
presentation listed the positive and negative aspects of doing
either a friendly or hostile deal with Santa Fe. Specifically
listed as a potential negative consequence of an unfriendly deal
was that a negative attempt might “drive South into the hands of
another party”. The presentation also included steps North could
take to “turn up the heat” on South and a review of South’s
structural defenses. The presentation included a slide which
showed the following:
Turning up the Heat
Levels of Unsolicited/Hostile Activity
1. Target CEO Private Conversation
2. Target Board Member Private Conversation
3. Target CEO Private Letter
4. [Acquire Stock Secretly (<5%)]
5. Target Board Member “On the Record” Conversation
6. Non-disclosable Bear-Hug Letter
7. Public Expression of Interest
8. Disclosed Bear-Hug Letter
9. [Acquire Stock Publicly (>5% or announce)]
10. Proxy Fight/Special Meeting/Written Consent
11. Public Tender/Exchange Offer
The steps are ordered in increasing levels of hostility.
Steps 1 through 4 were considered private because they would not
trigger any duty of Santa Fe management or the Santa Fe board
that would require management or the board to announce to Santa
Fe’s shareholders and the public at large that Santa Fe and
Newmont were in discussions. For example, should a Newmont board
member contact a Santa Fe board member, as described in step 3,
3
(...continued)
“South”.
- 14 -
the contact could be structured such that the Santa Fe board was
not required to inform Santa Fe’s shareholders. Likewise, step 6
would be a letter to Santa Fe’s management and board from Newmont
that would not trigger a duty of disclosure to shareholders.
Step 8, however, would be a public letter that would alert Santa
Fe’s shareholders and the public to Newmont’s interests. Steps 9
through 11 would be a clear, public, hostile takeover of Santa Fe
by Newmont.
In the months leading up to Santa Fe’s becoming poolable,
Santa Fe’s management began to consider its strategic options.
At that time Homestake was unable to discuss any combinations
with Santa Fe because Homestake was dealing with a regulatory
issue, and Battle Mountain was currently engaged in finishing a
prior acquisition; this left Newmont. The Santa Fe board
recognized that if they did not reach out to Newmont first,
Newmont was sure to reach out to them. The board and the
management felt that by initiating contact they would be able to
maintain control over any due diligence or meetings between Santa
Fe and Newmont personnel. Also, meeting with Newmont in a
friendly manner might allow Santa Fe to learn more about
Newmont’s thought processes and goals.
On September 26, 1996, the Santa Fe board met again and
instructed Mr. James and Mr. Batchelder to approach Newmont
concerning possible strategic plans. At the time, Santa Fe
- 15 -
management was afraid of having the company put in play because
that would effectively mean the company was for sale to the
highest bidder. Mr. James hoped that if Santa Fe was able to
remain in control during the process, it might be able to delay
Newmont long enough to allow Homestake to become available.
Santa Fe viewed Homestake as a possible “white knight” and hoped
that an agreement with Homestake would prevent Newmont from
acquiring Santa Fe. Also, an agreement and merger with Homestake
would provide benefits to Santa Fe that its management viewed as
absent in any merger with Newmont, including in part: (1) Shared
board control; (2) shared management; (3) greater retention of
Santa Fe employees; and (4) an opportunity to continue Santa Fe’s
business objectives.
Mr. James felt that a merger with Homestake would be much
better for Santa Fe because he viewed it as an opportunity to
merge two undervalued companies. The merger would also result in
more Santa Fe employees keeping their jobs as a result of a
fairer selection process.
Santa Fe management recommended to the Santa Fe board that
the board talk to Newmont but leave their options open in case
Homestake became available. Mr. James and Mr. Batchelder met
with Mr. Cambre on October 1, 1996, at Mr. Cambre’s home in New
Mexico. Also present was Wayne Murdy (Mr. Murdy), who was
serving as Newmont’s chief financial officer at the time.
- 16 -
About 6 weeks later, Santa Fe and Newmont held what appeared
to Newmont to be initial due diligence meetings. During these
meetings Mr. James came to realize further that a deal with
Newmont would not be in the best interests of Santa Fe and its
shareholders because it appeared to him that many Santa Fe
employees would be fired and the work Santa Fe’s management had
done to develop the company would be lost.
While these meetings were ongoing, Santa Fe attempted to get
Newmont to enter into a standstill agreement.4 A standstill
agreement would have prevented Newmont from launching a hostile
bid for Santa Fe if Santa Fe and Newmont were unable to come to
an agreement. Newmont refused to enter into a standstill
agreement for just this reason; it specifically wanted to reserve
its right to launch a hostile bid and go directly to the Santa Fe
shareholders if that was what was necessary to get a deal done.
Mr. James understood Newmont’s refusal of a standstill provision
to be an indicator of Newmont’s reserving its right to begin a
hostile takeover.
Shortly thereafter Mr. James learned that Homestake’s
regulatory issue had been resolved. Mr. James called Mr.
Thompson and set up a lunch in the hope of convincing Homestake
4
A standstill agreement is defined as “Any agreement to
refrain from taking further action; esp., an agreement by which a
party agrees to refrain from further attempts to take over a
corporation (as by making no tender offer) for a specified
period”. Blacks Law Dictionary (8th ed. 2004).
- 17 -
to enter into a merger with Santa Fe. Santa Fe’s management
hoped that a combination with Homestake would derail Newmont’s
acquisition attempt. On November 6, 1996, Mr. Thompson sent a
letter to Mr. James indicating his belief that a merger between
Santa Fe and Homestake would be good for their investors. The
letter further stated that Mr. Thompson was prepared to recommend
to the Homestake board that Homestake and Santa Fe merge on the
basis of a “‘pooling of interests,’ combining our management and
shareholders as partners.”
Mr. James and Mr. Thompson met shortly thereafter. Mr.
Thompson was interested in quickly pursuing due diligence, which
began the following week. Santa Fe and Homestake moved quickly
to investigate a possible merger.
G. November 21, 1996, Santa Fe Board Meeting
On November 21, 1996, Newmont submitted its offer to the
Santa Fe board. The next day Homestake submitted its offer. At
the time both Homestake and Newmont had suspicions that other
parties were involved in negotiations with Santa Fe, but neither
knew for sure nor knew the identities of any other possible
bidders.
Santa Fe’s management recommended the Santa Fe-Homestake
deal to the Santa Fe board. The Santa Fe board discussed the
pending offers and chose to proceed with Homestake. Mr. James
and Mr. Batchelder called Mr. Cambre to inform him that Newmont’s
- 18 -
offer had been rejected. Mr. James did not ask for a higher
offer nor tell Mr. Cambre about Santa Fe’s and Homestake’s
agreement when the two spoke. After that call ended, Mr. Cambre
spoke with Mr. Murdy and expressed his displeasure at being
rejected and not having a chance to discuss a higher offer. The
two also came to the conclusion that Newmont would have to, in
Mr. Murdy’s words, “turn up the heat” on Santa Fe.
H. Newmont Responds to Santa Fe’s Rejection
The Santa Fe board met on December 5, 1996. Along with its
normal duties the Santa Fe board discussed the pending Santa Fe-
Homestake merger. During the meeting Newmont sent a fax to Santa
Fe’s offices. The fax stated that at 10 a.m. that morning
Newmont was going to issue a press release detailing the offer
that Newmont had submitted and Santa Fe had rejected. The press
release provided details on the offer.5 The offer described in
the press release, although similar to the previous offer, was
not identical. Because the offer contained in the press release
was so similar to Newmont’s earlier offer, the Santa Fe board did
not feel that it triggered any fiduciary duty to investigate and
consider the offer any more than they had already. Accordingly,
the Santa Fe board was able to, and did, reject it outright.
5
This is a type of public bear hug letter, as described in
step 8 of the Goldman Sachs presentation discussed supra.
- 19 -
Mr. James and the other members of Santa Fe’s management and
board viewed this press release sent directly to its shareholders
as a hostile tactic. Newmont had not increased its offer, did
not take into account whether there were any third parties
involved, and did not make any attempt, until 15 minutes before
the press release was issued, to contact Santa Fe about the press
release. Newmont could have kept the offer private, rather than
issue it publicly. Had it been kept private, Santa Fe’s
management and board would have had the option of keeping it
private or announcing it to the public. However, because the
press release was sent directly to the Santa Fe shareholders,
Newmont’s interest in Santa Fe, and Santa Fe’s rejection of
Newmont, were both made public. At that time Santa Fe and
Homestake had not yet executed a merger agreement.
The next day as word of Newmont’s offer spread several
lawsuits were filed against the Santa Fe board for allegedly
violating its fiduciary duties to the Santa Fe shareholders. The
lawsuits alleged that Santa Fe’s directors had abused their
fiduciary duties by thwarting Newmont’s attempts to acquire Santa
Fe and by attempting to entrench themselves in their positions.
I. December 8, 1996, Santa Fe Board Meeting
Over the next week Santa Fe and Homestake continued to work
out a merger agreement. On December 8, 1996, the Santa Fe board
met again to consider the Santa Fe-Homestake merger. After
- 20 -
discussions the Santa Fe board unanimously approved the proposed
agreement. As the basis for this approval the Santa Fe board
resolved that an agreement between Santa Fe and Homestake was
fair to and in the best interests of Santa Fe and its
shareholders. The Homestake board also met that day to discuss
and consider the Santa Fe-Homestake proposal. After discussions,
the Homestake board decided to enter into the merger transaction
with Santa Fe, finding that it was both fair and in the best
interests of the corporation and its shareholders.
Santa Fe and Homestake executed a merger agreement which
contained a termination fee clause. The clause provided for a
payment should the agreement be terminated by either party. The
termination fee clause provided in pertinent part that should
Santa Fe receive an offer from a third party, and should the
Santa Fe-Homestake agreement be breached because of that third
party offer, then Santa Fe would be required to pay Homestake $65
million.
Termination fees are included in merger agreements for a
variety of reasons, some of which may benefit the target, the
acquirer, or both. From the bidder’s (Homestake’s) perspective,
a termination fee could serve a number of purposes, including:
(1) To test the seriousness of the potential target; (2) to serve
as insurance for the bidder and compensate the bidder for
information provided to the target and lost opportunity costs if
- 21 -
its bid is rejected or a rival bidder emerges and wins a contest
for the target; and (3) to serve to deter a competing bidder who
might not be willing or able to pay the additional expense of the
termination fee in order to win the contested merger. See Swett,
“Merger Terminations After Bell Atlantic: Applying A Liquidated
Damages Analysis to Termination Fee Provisions”, 70 U. Colo. L.
Rev. 341, 356 (1999). A target may benefit by the inclusion of a
termination fee because the fee may: (1) Be necessary to attract
a serious bidder by showing the target’s willingness to enter
into due diligence and negotiations; (2) allow the target’s board
to preserve its fiduciary duties at a known cost; and (3) protect
the target by requiring a reciprocal termination fee in case the
acquirer terminates the agreement. Id. at 356-357.
The Santa Fe-Homestake merger agreement also contained what
is known as a fiduciary-out clause. A fiduciary-out clause is a
contract clause that would allow a party to the agreement to
consider superior offers if not doing so would cause it to
violate its fiduciary duties to its shareholders.
On December 9, 1996, Mr. James held a press conference to
announce the Santa Fe-Homestake merger agreement. The assembled
reporters asked Mr. James a number of questions, including some
relating to the termination fee and whether the termination fee
was included in the merger agreement in order to keep Santa Fe’s
management and board in place.
- 22 -
In the days after this announcement a number of lawsuits
were filed in the State of Delaware, alleging that the Santa Fe
board violated its fiduciary duties to Santa Fe’s shareholders
and that individual board members had abused their positions by
accepting the Homestake offer rather than negotiate with Newmont.
The suits alleged that the merger agreement with Homestake was
entered into in order to entrench Santa Fe’s management.
J. Newmont Reacts to the Santa Fe-Homestake Agreement
On December 18, 1996, Mr. Cambre circulated a memorandum to
Newmont’s board discussing the prospects of a Newmont-Santa Fe
business combination in the light of the Santa Fe-Homestake
agreement. The memorandum provided that Newmont’s original
valuation of Santa Fe was based upon Newmont’s belief that Santa
Fe’s board and management were in agreement on a merger with
Newmont. The memorandum goes on to note that, instead of
supporting a Newmont-Santa Fe merger, Santa Fe was talking to
other parties and decided to enter into a transaction with
Homestake.
Mr. Cambre also speculated that the Santa Fe board was more
inclined to support a merger with Homestake because any
combination with Homestake would result in a more favorable
treatment of the Santa Fe board and management, rather than a
deal with Newmont in which Santa Fe was effectively being
acquired. On the basis of this speculation, Mr. Cambre stated
- 23 -
that the Newmont board should recognize that any action taken by
Newmont would probably be opposed by the Santa Fe board because
the Santa Fe board would stand to benefit more from a Santa Fe-
Homestake merger than a Santa Fe-Newmont combination. Lastly,
Mr. Cambre discussed the Santa Fe-Homestake termination fee. Mr.
Cambre pointed out that when adding the cost of a proxy fight to
the $65 million termination fee, Newmont would be facing an
incremental cost of $85 million to “fight and win this battle.”
On January 3, 1997, the Newmont board met to discuss the
Santa Fe situation. At the meeting, Goldman Sachs presented
reports on Newmont’s initial offer, the market’s reaction to that
offer, and Newmont’s options going forward, including: (1) Doing
nothing; (2) renewing the offer at its current price level; (3)
matching Homestake’s offer; or (4) making an offer higher than
Homestake’s. After discussion, the Newmont board resolved to
increase Newmont’s offer to the Santa Fe shareholders to 0.40
share of Newmont common stock for each share of Santa Fe stock.
Between December 31, 1996, and January 6, 1997, a wholly
owned subsidiary of Newmont, Midtown One Corp., privately
acquired about 4,800 shares of Santa Fe stock. These
acquisitions allowed Newmont to demand a shareholder list from
Santa Fe, which was provided to Newmont on January 6, 1997.
On January 7, 1997, Mr. Cambre sent a letter on behalf of
the Newmont board to the Santa Fe board. This was the second
- 24 -
“bear hug letter” Newmont had sent Santa Fe and was one of the
steps described in the Goldman Sachs presentation as a tool that
could be used to “turn up the heat” on Santa Fe. The letter
informed the Santa Fe board of Newmont’s increased offer and
stated that if Santa Fe did not terminate its proposed merger
with Homestake, Newmont would solicit proxies against the
Homestake merger proposal pursuant to proxy solicitation
materials filed with the Securities and Exchange Commission
(SEC). Also on January 7, 1997, Newmont filed a registration
statement with the SEC along with a preliminary proxy statement
and assorted materials attempting to persuade Santa Fe
shareholders to vote against the Santa Fe-Homestake merger
agreement. In addition, Newmont directly contacted Santa Fe
shareholders in an attempt to convince them to vote against the
merger agreement.
On January 7, 1997, Homestake was advised of Newmont’s
increased offer as required by the Homestake-Santa Fe merger
agreement. Mr. Thompson responded to this notification by
requesting an opportunity to address the Santa Fe board at such
time as it would be considering the increased Newmont offer. Mr.
Thompson’s letter indicated his belief that the Santa Fe-
Homestake merger remained superior to the increased Newmont offer
and provided greater value to the Santa Fe shareholders; the
letter reiterated that the Newmont offer should be rejected.
- 25 -
K. Santa Fe Reacts to Newmont’s Increased Offer
On January 12, 1997, the Santa Fe board met to discuss the
increased Newmont offer. The Santa Fe board heard presentations
from Santa Fe’s legal and financial advisers and discussed the
implications of Newmont’s increased offer. The Santa Fe board
then determined that a decision not to investigate the Newmont
offer would be a breach of the board’s fiduciary duties to Santa
Fe’s shareholders. This determination satisfied the fiduciary-
out clause, section 4.02(a)(ii)(A), of the Homestake-Santa Fe
merger agreement.
Before Santa Fe began considering the Newmont and Homestake
offers, the makeup of Santa Fe’s investor base began to shift.
Over the preceding year Santa Fe’s long-term shareholders and
investors had slowly been replaced by larger institutional
shareholders and investors. These new investors brought their
own distinct views as to what Santa Fe should do when deciding
between the Homestake and Newmont offers. This change in
shareholder makeup was going to have an effect on Santa Fe’s
decision regarding the two offers.
On January 17, 1997, Mr. Cambre sent a letter to Newmont’s
board apprising the board of the Santa Fe situation. Mr. Cambre
noted that Newmont was getting good responses from large
institutional shareholders who preferred Newmont stock to
Homestake. Mr. Cambre also informed Newmont’s board that he had
- 26 -
requested an opportunity to speak with the Santa Fe board during
its meetings on January 22 and 23, 1997, when it was anticipated
that the Santa Fe board would be considering Newmont’s offer.
While the Santa Fe board was considering its next steps,
there arose a question of whether the $65 million termination fee
would, pursuant to accounting rules, prevent a combination with
Newmont from being accounted for as a pooling of interests.
Newmont contacted the SEC, hoping to obtain assurances that
payment of the termination fee would not prevent a takeover of
Santa Fe by Newmont from qualifying for pooling of interests
accounting treatment.
On January 23, 1997, the Santa Fe board met. Mr. James and
Mr. Batchelder discussed the upcoming negotiations with Newmont,
the major questions to ask of Newmont, and a strategy for Santa
Fe to follow in investigating the Newmont offer while fulfilling
its obligations to Homestake under the merger agreement. Mr.
James and Mr. Batchelder hoped to complete their investigation
and prepare a comparison of the two options by February 12, 1997,
which would then be presented to the full Santa Fe board.
On January 29, 1997, the Newmont board met for a regular
meeting and was updated on the attempt to acquire Santa Fe. The
Newmont board was also given a presentation by Goldman Sachs
which included market reaction to Newmont’s offer and a time line
of Newmont’s next steps. The next day Mr. Cambre sent Mr. James
- 27 -
a letter confirming the teams assigned to various due diligence
issues concerning Newmont and Santa Fe before the meeting of the
Santa Fe board to consider the Newmont and Homestake offers.
On February 4, 1997, Mr. James wrote to Mr. Thompson. The
letter confirmed to Mr. Thompson that Homestake would have an
opportunity to present its case to the Santa Fe board in February
1997. The letter also requested that the merger agreement be
amended such that any termination fee would not be paid until
another business combination had been consummated and that the
termination fee would not be paid at all to the extent that it
prevented Santa Fe from engaging in a pooling of interests
merger. The letter went on to state that the Santa Fe board
would consider Homestake’s refusal of the above requests as a
negative factor when evaluating Homestake’s offer. Mr. James
sent a similar letter to Mr. Cambre on February 4, 1997,
confirming that Newmont would be presenting its offer to the
Santa Fe board as well. The letter also requested that Newmont
pay the Santa Fe-Homestake termination fee if Santa Fe’s board
chose Newmont’s offer. Newmont refused, as Mr. Cambre viewed the
termination fee as Santa Fe’s obligation and not Newmont’s.
On February 7, 1997, Homestake wrote to Wayne Jarke (Mr.
Jarke), Santa Fe’s general counsel, requesting that the Santa Fe
board reaffirm its recommendation of the Homestake offer in
accordance with the Santa Fe-Homestake merger agreement.
- 28 -
On February 13, 1997, Mr. Cambre wrote to the Newmont board
to inform the board of the results of Newmont’s due diligence.
Due diligence was more productive than it had been when performed
for the meetings conducted in October and November of 1996
because Santa Fe’s management had to engage in legitimate due
diligence regarding the pending offers of Homestake and Newmont
in order to allow the Santa Fe board members to make an informed
decision and satisfy their fiduciary duties. Mr. Cambre
described the synergies to be taken advantage of in the event of
a combination and discussed the upcoming Santa Fe board meeting.
On February 20, 1997, the Santa Fe board met to consider
Homestake’s requested reaffirmation as to the Homestake offer.
The Santa Fe board decided to reaffirm its commitment to the
Homestake offer even though Newmont had increased its offer.
Notice that Homestake’s offer had been reaffirmed was sent on
February 20, 1997.
While preparations for the presentations were ongoing, Santa
Fe and Newmont were still facing the prospect that payment of the
termination fee to Homestake would prevent Newmont from
qualifying for pooling of interests accounting treatment. On or
about February 26, 1997, the SEC advised Newmont that payment of
the termination fee would not prevent a Santa Fe-Newmont
combination from qualifying for pooling of interests accounting
treatment.
- 29 -
L. The March 7-8, 1997, Santa Fe Board Meeting
1. Newmont Offer
The Santa Fe board met in Albuquerque, New Mexico, on March
7 and 8, 1997, to discuss the competing business proposals. The
board held four sessions over 2 days. Newmont made the first
presentation. When it was finished, a Santa Fe director informed
Mr. Cambre that the Santa Fe board was going to listen to
Homestake’s presentation but that during that time Newmont should
prepare its best and final offer. In response to this request,
Mr. Cambre made an offer of .43 share of Newmont stock for each
share of Santa Fe stock. The Newmont board held a special
meeting to discuss this increased offer and approved the .43-
share offer. Mr. Cambre reported to the Santa Fe board that the
Newmont board had approved this higher offer.
2. Homestake Offer
a. Initial Homestake Offer
Homestake raised its offer before the presentation to the
Santa Fe board. Mr. Thompson informed Mr. James by letter that
the Homestake board had approved an increased offer of 1.25
shares of Homestake common stock for each share of Santa Fe
common stock. Newmont’s .43-share offer, however, provided a
higher value to Santa Fe than Homestake’s 1.25-share offer.
- 30 -
b. Attempts To Obtain a Higher Offer
After Newmont increased its offer to .43 share, Santa Fe
held out hope that Homestake would be able to raise its offer
further. Mr. James visited Mr. Thompson, informed him that
Newmont had raised its offer, and asked if Homestake could beat
it. Mr. Thompson informed Mr. James that Homestake was unable to
raise its offer again. At this point it became clear to Santa Fe
that its agreement with Homestake would not prevent Newmont’s
acquisition. Delaware fiduciary duties laws required Santa Fe’s
board to obtain the highest value for the company’s shareholders.
3. Newmont Wins Out
The Santa Fe board decided that Newmont’s offer was superior
in value to Homestake’s offer. In order to fulfill the fiduciary
duties imposed on directors by Delaware State law, the Santa Fe
board was required to accept the offer. Accordingly, the Santa
Fe board unanimously resolved to accept Newmont’s offer.
M. The Santa Fe-Newmont Agreement
On March 10, 1997, the Santa Fe board met again. That same
day Mr. James formally notified Homestake that Santa Fe would be
terminating the Santa Fe-Homestake agreement and would be paying
the termination fee. Santa Fe paid $65 million to Homestake by
wire transfer on March 10, 1997. Santa Fe would not receive a
refund if the Newmont merger was rejected by its shareholders.
Nor would Newmont reimburse Santa Fe for the termination fee if
- 31 -
the combination was rejected. On March 10, 1997, Mr. Cambre
advised the Newmont board by letter that Newmont and Santa Fe had
executed a merger agreement.
On April 4, 1997, the Santa Fe shareholders received an
invitation to a meeting on May 5, 1997. At that meeting the
Santa Fe shareholders voted to approve the merger with Newmont.
N. Santa Fe Post Merger
After the Santa Fe-Newmont agreement was executed, Newmont
attempted to capitalize on the synergies of the two companies
that formed the impetus for Newmont’s approaching Santa Fe.
Although described by Mr. Cambre as shared synergies between
Santa Fe and Newmont, the synergy in reality came from Newmont’s
ability to mine Santa Fe’s land without need of Santa Fe’s
executives and management. For the most part synergy was
effected by cutting Santa Fe staff, shuttering all Santa Fe
offices since they duplicated Newmont offices, and putting any
remaining Santa Fe employees under the control of Newmont
employees. Almost all of the employees terminated were employees
and managers who came to Newmont from Santa Fe. All of Santa
Fe’s board members resigned on or before May 5, 1997. Santa Fe’s
headquarters was closed shortly thereafter in August 1997.
Newmont also abandoned Santa Fe’s 5- and 10-year plans.
On January 15, 1998, Santa Fe timely filed its Form 1120,
U.S. Corporation Income Tax Return, for the short period January
- 32 -
1 to May 5, 1997. Santa Fe claimed a deduction of $68,660,812,
of which $65 million was the termination fee paid pursuant to the
merger agreement between Santa Fe and Homestake.
On August 15, 2005, respondent issued to Newmont USA Limited
(petitioner), as Santa Fe’s successor in interest, a statutory
notice of deficiency which determined in relevant part that
petitioner was not entitled to a deduction for the termination
fee. The notice stated in pertinent part:
7.a.3 Abandonments (Termination Fee)
It is determined that are allowed $-0- as a deduction
for abandonments under section 165 of the Internal Revenue
Code rather than the $65,000,000 shown on your return for
the tax year ended May 5, 1997. The amount of $65,000,000
is not allowed as a deduction because it was a capital
expenditure under section 263 of the Internal Revenue Code.
Therefore, your taxable income for the tax year ended May 5,
1997 is increased $65,000,000.
On November 9, 2006, petitioner filed a petition with this
Court, alleging in part that respondent erred in disallowing the
claimed deduction for $65 million. A trial was held from
December 10 to 14, 2007, during a special session of the Court in
Atlanta, Georgia. Petitioner presented a number of fact
witnesses, and both petitioner and respondent presented expert
testimony. Petitioner argues that Santa Fe is entitled to deduct
the $65 million paid to Homestake. Respondent argues that Santa
Fe is required to capitalize the $65 million.
- 33 -
OPINION
I. Burden of Proof
We must decide whether Santa Fe may deduct the termination
fee or must capitalize it as an expenditure to be deducted in
later years. The Commissioner’s determinations in the notice of
deficiency are presumed correct, and the taxpayer bears the
burden of proving,6 by a preponderance of the evidence, that
these determinations are incorrect. Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933).
II. Deductibility vs. Capitalization
For Federal income tax purposes the principal difference
between classifying a payment as a deductible expense or a
capital expenditure concerns the timing of the taxpayer’s
recovery of the cost. As the Supreme Court observed in INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 83-84 (1992):
The primary effect of characterizing a payment as
either a business expense or a capital expenditure
concerns the timing of the taxpayer’s cost recovery:
While business expenses are currently deductible, a
capital expenditure usually is amortized and
depreciated over the life of the relevant asset, or
where no specific asset or useful life can be
ascertained, is deducted upon dissolution of the
6
Petitioner argues that respondent should bear the burden of
proving that the termination fee should be capitalized because
the notice of deficiency did not adequately describe the basis
for disallowance under Shea v. Commissioner, 112 T.C. 183 (1999).
We decline to address petitioner’s argument. Petitioner
presented its case as if it bore the burden of proof, and the
record supports our decision regardless of whether the burden is
on petitioner or respondent.
- 34 -
enterprise. * * * Through provisions such as these, the
Code endeavors to match expenses with the revenues of
the taxable period to which they are properly
attributable, thereby resulting in a more accurate
calculation of net income for tax purposes. * * *
Section 162(a) allows as a deduction “all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business”. To qualify for a deduction,
“an item must (1) be ‘paid or incurred during the taxable year,’
(2) be for ‘carrying on any trade or business,’ (3) be an
‘expense,’ (4) be a ‘necessary’ expense, and (5) be an ‘ordinary’
expense.” Commissioner v. Lincoln Sav. & Loan Association, 403
U.S. 345, 352 (1971). Section 165(a) allows as a deduction “any
loss sustained during the taxable year and not compensated for by
insurance or otherwise.”
An expense may be ordinary even if it rarely occurs or
occurs only once within the lifetime of the taxpayer. Welch v.
Helvering, supra at 114. Although the transaction may be unique
to the individual taxpayer, the question is whether the
transaction is ordinary in the “life of the group, the community,
of which * * * [the taxpayer] is a part.” Id. An expense is
necessary if it meets “the minimal requirement that the expense
be ‘appropriate and helpful’ for ‘the development of the
[taxpayer’s] business.’” Commissioner v. Tellier, 383 U.S. 687,
689 (1966) (quoting Welch v. Helvering, supra at 113). A
deduction is generally allowed for expenses incurred in defending
- 35 -
a business and its policies from attack. INDOPCO, Inc. v.
Commissioner, supra at 83; Commissioner v. Tellier, supra;Commissioner v. Heininger, 320 U.S. 467 (1943); see also Locke
Manufacturing Cos. v. United States, 237 F. Supp. 80 (D. Conn.
1964) (permitting corporation to deduct expenses incurred in
successful defense to proxy fight). The underlying reasoning in
this line of cases is that the expenses were incurred to protect
corporate policy and structure, not to acquire a new asset. See,
e.g., United States v. Federated Dept. Stores, Inc., 171 Bankr.
603, 610 (S.D. Ohio 1994), affg. In re Federated Dept. Stores,
Inc., 135 Bankr. 950 (Bankr. S.D. Ohio 1992).
Section 263(a)(1) generally provides that a deduction is not
allowed for “Any amount paid out for new buildings or for
permanent improvements or betterments made to increase the value
of any property or estate.”
The determination of whether an expenditure is deductible
under section 162(a) or must be capitalized under section
263(a)(1) is a factual determination. When an expense creates a
separate and distinct asset, it usually must be capitalized.
See, e.g., Commissioner v. Lincoln Sav. & Loan Association,
supra. When an expense does not create such an asset, the most
critical factors to consider in passing on the question of
deductibility are the period over which the taxpayer will derive
a benefit from the expense and the significance of that benefit.
- 36 -
See INDOPCO, Inc. v. Commissioner, supra at 87-88; United States
v. Miss. Chem. Corp., 405 U.S. 298, 310 (1972); FMR Corp. & Subs.
v. Commissioner, 110 T.C. 402, 417 (1998); Conn. Mut. Life Ins.
Co. v. Commissioner, 106 T.C. 445, 453 (1996). Expenses must
generally be capitalized when they either: (1) Create or enhance
a separate and distinct asset, or (2) otherwise generate
significant benefits for the taxpayer extending beyond the end of
the taxable year. Metrocorp, Inc. v. Commissioner, 116 T.C. 211,
222 (2001). Under the required test, capitalization is not
always required when an incidental future benefit is generated by
an expense. INDOPCO, Inc. v. Commissioner, supra at 87.
“Whether a benefit is significant to the taxpayer who incurs the
underlying expense rests on the duration and extent of the
benefit, and a future benefit that flows incidentally from an
expense may not be significant.” Metrocorp, Inc. v.
Commissioner, supra at 222.
A. INDOPCO, Inc. v. Commissioner
The Supreme Court considered fees incurred during a friendly
business combination in INDOPCO, Inc. v. Commissioner, supra.
The focus of the Supreme Court’s opinion was the taxpayer’s
argument that the fees at issue were deductible because no
separate and distinct asset was created. The taxpayer attempted
to argue that under the Court’s opinion in Commissioner v.
Lincoln Sav. & Loan Association, supra, only fees that led to the
- 37 -
creation of a separate and distinct asset were subject to
capitalization. The Court rejected the taxpayer’s argument.
INDOPCO, Inc. v. Commissioner, supra at 86-87. The Court held
that the fees at issue were to be capitalized because they
provided for benefits extending past the tax year at issue.
B. Victory Mkts., Inc. & Subs. v. Commissioner
In Victory Mkts., Inc. & Subs. v. Commissioner, 99 T.C. 648(1992), we were confronted with facts similar to those of
INDOPCO, Inc. v. Commissioner, supra. The taxpayer argued that
it incurred professional service fees in connection with the
acquisition of its stock by an acquirer and claimed that it was
entitled to deduct those expenses because, unlike the taxpayers
in INDOPCO, Inc., it was acquired in a hostile takeover. We
declined to decide whether INDOPCO, Inc., required capitalization
of expenses incurred incident to a hostile takeover, however,
because we concluded that the nature of the takeover in Victory
Mkts. was not hostile and that the facts were generally
indistinguishable from those in INDOPCO, Inc.
C. United States v. Federated Dept. Stores, Inc.
United States v. Federated Dept. Stores, Inc., supra,
addressed breakup fees paid to “white knights” in the aftermath
of failed merger attempts undertaken to avoid undesired corporate
takeovers. The District Court sustained the bankruptcy court’s
holdings that deductions were allowable under either section 162
- 38 -
or section 165. The District Court relied on the bankruptcy
court’s findings that no benefit accrued beyond the year in which
the expenditures were made and, on that basis, distinguished
INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). The
bankruptcy judge had found explicitly that the provisions for the
payment of the breakup fees did not enhance the amounts that the
debtors’ shareholders actually received in the takeover
transactions. The District Court also agreed with the bankruptcy
court that the failed merger transactions with white knights were
separate transactions from the successful takeovers and thus
could be treated as abandoned transactions eligible for a loss
deduction under section 165.
D. Staley I & II
In A.E. Staley Manufacturing Co. & Subs. v. Commissioner,
105 T.C. 166 (1995) (Staley I), revd. 119 F.3d 482 (7th Cir.
1997) (Staley II), we were again faced with a situation similar
to that of INDOPCO, Inc. and Victory Mkts. In Staley I, we were
asked to consider the proper characterization of fees paid by a
corporation to investment bankers shortly before the corporation
was acquired. We held that the fees be capitalized rather than
deducted under section 162 or 165. We disallowed the deductions
on the basis of the Supreme Court’s opinion in INDOPCO, Inc. We
also held that the taxpayer was not allowed to deduct the costs
as an abandonment loss. We distinguished the situation in Staley
- 39 -
I from that of Federated Dept. Stores because unlike the
situation in Federated Dept. Stores, there was no white knight
transaction present in Staley I.
The U.S. Court of Appeals for the Seventh Circuit reversed.
The Court of Appeals discussed the law concerning the
deductibility of expenses to resist changes in corporate control
before INDOPCO, Inc., then stated that INDOPCO, Inc. neither
abrogated nor even discussed those cases. The Court of Appeals
then stated that the issue for decision in determining the
deductibility of the fees was “whether the costs incurred * * *
are more properly viewed as costs associated with defending a
business or as costs associated with facilitating a capital
transaction.” Staley II, 119 F.3d at 489. The court allowed a
deduction in part, remanding to this Court to allocate the costs
between those that were incurred to prevent the takeover and
those that facilitated the takeover.
III. Origin of the Claim Doctrine
The issue of whether expenses are deductible or must be
capitalized may be resolved by the origin of the claim test.
Woodward v. Commissioner, 397 U.S. 572 (1970); United States v.
Gilmore, 372 U.S. 39 (1963). Under this test, the substance of
the underlying claim or transaction out of which the expenditure
in controversy arose governs whether the item is a deductible
expense or a capital expenditure, regardless of the motives of
- 40 -
the payor or the consequences that may result from the failure to
defeat the claim. See Woodward v. Commissioner, supra at 578;
Newark Morning Ledger Co. v. United States, 539 F.2d 929, 935 (3d
Cir. 1976); Clark Oil & Ref. Corp. v. United States, 473 F.2d
1217, 1220 (7th Cir. 1973); Anchor Coupling Co. v. United States,
427 F.2d 429, 433 (7th Cir. 1970). The origin of the claim test
does not involve a “mechanical search for the first in the chain
of events” but requires consideration of the issues involved, the
nature and objectives of the litigation, the defenses asserted,
the purpose for which the amounts claimed as deductions were
expended, and all other facts relating to the litigation. Boagni
v. Commissioner, 59 T.C. 708, 713 (1973). The Supreme Court, in
adopting the origin of the claim test, chose in favor of
the view that the origin and character of the claim
with respect to which an expense was incurred, rather
than its potential consequences upon the fortunes of
the taxpayer, is the controlling basic test of whether
the expense was “business” or “personal” and hence
whether it is deductible or not under § 23(a)(2). * * *
United States v. Gilmore, supra at 49.
The origin of the claim doctrine can help determine whether
the termination fee should be deducted or capitalized by
determining whether it is more closely tied to the Santa Fe-
Homestake deal or the Santa Fe-Newmont deal.
- 41 -
IV. Petitioner’s Arguments
A. Significant Benefit
Petitioner argues that Santa Fe did not receive a
significant benefit from payment of the termination fee. First,
petitioner argues that payment of the fee reduced Santa Fe’s net
worth by $65 million. Second, petitioner focuses on the effects
of the Santa Fe-Newmont merger on Santa Fe. Petitioner points to
the removal of Santa Fe’s management team, the removal of Santa
Fe’s board of directors, the abandonment of Santa Fe’s 5- and 10-
year plans, and the termination of more than half of Santa Fe’s
employees. Lastly, petitioner argues that Newmont closed a
disproportionate number of Santa Fe facilities after the merger
was consummated.
B. Origin of the Claim
Petitioner argues that the origin of the claim doctrine
requires us to find that the origin of the termination fee lies
with the Santa Fe-Homestake agreement, and not the Santa Fe-
Newmont combination. Petitioner points to the fee’s origin in
the Santa Fe-Homestake agreement and to the fact that the Santa
Fe-Newmont agreement also included its own separate termination
fee. Petitioner also points to the fact that the obligation to
pay the termination fee arose before Santa Fe’s later agreement
with Newmont.
- 42 -
Petitioner attempts to rely on 12701 Shaker Blvd Co. v.
Commissioner, 36 T.C. 255 (1961), affd. 312 F.2d 749 (6th Cir.
1963), in support of its argument. In that case the Court
determined the deductibility of fees paid by a corporation to
retire bonds before issuing new bonds. In rejecting the
taxpayer’s argument that the fee should be tied to the new bond
issue, we stated that the new financing was not so closely tied
to the paying off of the old indebtedness that the two
transactions cannot properly be deemed as separate and
independent transactions. Id. at 258. Petitioner analogizes the
issue in Shaker Blvd. Co. to the present issue.
Petitioner next contends that under Wells Fargo Co. & Subs.
v. Commissioner, 224 F.3d 874 (8th Cir. 2000), affg. in part and
revg. in part Norwest Corp. & Subs. v. Commissioner, 112 T.C. 89(1999), the termination fee is more directly related to the Santa
Fe-Homestake agreement than the Santa Fe-Newmont agreement.
Therefore, because the fee is only indirectly related to the
Santa Fe-Newmont deal, capitalization is not required under the
origin of the claim doctrine and the termination fee is
deductible.
Petitioner further argues that a finding that Newmont acted
in a hostile manner supports its position. Petitioner points to
language in Staley II and United States v. Federated Dept.
Stores, Inc., 171 Bankr. 603 (S.D. Ohio 1994), where the courts
- 43 -
stated that costs incurred to defend a business from attack are
deductible. Petitioner contends that these cases, along with
respondent’s concession that costs incurred to defend a business
are deductible, resolve the instant proceeding in favor of
deductibility.
Lastly, petitioner argues that the termination fee should be
deducted because it served to frustrate, rather than facilitate,
the merger between Santa Fe and Newmont. In petitioner’s view,
this finding–-that the fee frustrated Newmont’s attempts--brings
the facts of the present case out of the INDOPCO, Inc. line of
cases and into the Staley II and Federated Dept. Store cases.
C. Petitioner’s Experts
Petitioner put forth two experts. Petitioner’s first
expert, W. Eugene Seago (Mr. Seago), has worked in the accounting
field for more than 30 years and is a professor of accounting at
Virginia Polytechnic Institute and State University. Mr. Seago’s
expert report focused on the termination fee as it related to
public accounting principles, including whether inclusion of the
fee in Santa Fe’s income would fairly represent Santa Fe’s income
for 1997.
Petitioner’s second expert, Gilbert E. Matthews (Mr.
Matthews), has more than 45 years of experience in investment
banking. Mr. Matthews’s report made the following conclusions:
(1) That the termination fee frustrated Newmont’s attempts to
- 44 -
acquire Santa Fe; (2) that Newmont, although first acting
friendly, was clearly attempting a hostile takeover; (3) that
Santa Fe as an entity did not benefit from the Newmont takeover;
and (4) that although short-term shareholders benefited from
Newmont’s takeover, that benefit did not last for more than a
year (i.e., the takeover did not benefit long-term holders of
Santa Fe stock).
V. Respondent’s Arguments
A. Significant Benefit
It is respondent’s position that the termination fee should
be capitalized under section 263(a) and not deducted under
section 162(a). Respondent argues that petitioner paid the
termination fee in order to enter into the Newmont offer.
Respondent argues that Santa Fe was not facing a hostile takeover
but instead wanted to overhaul its capital structure. Respondent
further argues that Santa Fe’s entering into an agreement with
Homestake was merely a negotiating tactic aimed at convincing
Newmont to increase its offer. Respondent points to Santa Fe’s
contacting Newmont in September 1996 as the beginning of Santa
Fe’s search for a business combination. Respondent’s expert
argues that at that time Santa Fe was “in play” and any action
taken afterwards was done to secure the highest possible value
for Santa Fe’s shareholders.
- 45 -
As evidence of this significant benefit, respondent points
to the March 28, 1996, report prepared by S.G. Warburg that
advised Santa Fe that Santa Fe would not become a first-tier gold
company without “strategic acquisitions, mergers or alliances.”
Respondent also points to the Santa Fe board’s decision of
September 26, 1996, to investigate a possible merger with
Newmont. In respondent’s view this statement is indicative of a
decision by Santa Fe to proceed with a merger or sale of the
company. Respondent also points to statements by the Santa Fe
board contained in the March 10, 1997, board minutes and in the
April 4, 1997, SEC Form S-4, Joint Proxy Statement. Both
documents indicated that the Santa Fe board viewed the merger
with Newmont as fair and in the best interests of Santa Fe
stockholders:
In the Form S-4, the board of directors indicates that
it unanimously concluded that the merger is fair and in
the best interests of the Santa Fe shareholders, and
accordingly, unanimously approved the merger agreement
and unanimously resolve to recommend that the Santa Fe
shareholders approve and adopt the merger agreement.
Respondent also points to press releases issued by Santa Fe and
Newmont at the time of the merger generally touting the perceived
benefits of the merger.
In respondent’s view the termination fee was paid in order
to enter into an agreement with Newmont and thus led to any
benefits gained by entering into the agreement with Newmont.
- 46 -
Therefore, the presence of these benefits requires that the
termination fee be capitalized under section 263.
B. Origin of the Claim
Respondent argues that the origin of the claim doctrine
requires the capitalization of the termination fee. Respondent
argues that Santa Fe’s payment of the termination fee was
directly related to the merger with Newmont. Respondent
maintains that Santa Fe was actively seeking a business merger.
Respondent points to Acer Realty Co. v. Commissioner, 132
F.2d 512, 513 (8th Cir. 1942), affg. 45 B.T.A. 333 (1941), and
similar cases. In Acer Realty Co., the Court of Appeals had to
determine the deductibility of large salary payments related to a
capital transaction. The court found that because the large
salaries were directly related to a capital transaction, the
salaries were required to be capitalized as part of that
transaction. In Wells Fargo Co. & Subs. v. Commissioner, 224
F.3d 874 (8th Cir. 2000), however, the Court of Appeals found
that salaries paid to employees who worked on a restructuring of
the corporation were deductible because they were not
extraordinary like the salaries in Acer Realty Co. Respondent
distinguishes Wells Fargo on the grounds that while the salaries
in Wells Fargo would have been paid whether the subject
transactions were entered into or not, the termination fee at
issue in the instant case would not have been paid unless Santa
- 47 -
Fe entered into a transaction with Newmont. Respondent points to
the fact that payment of the termination fee was conditioned on a
“Company Takeover Proposal” and argues that this proposal is
extraordinary and thus like the salaries in Acer Realty Co.
Respondent also argues that petitioner’s application of the
origin of the claim doctrine is improper because petitioner is
simply applying the doctrine in a mechanical way according to
which agreement was entered into first. Respondent argues that
we have previously rejected this application of the doctrine in
Boagni v. Commissioner, 59 T.C. at 713. Respondent argues that
the Santa Fe-Newmont agreement triggered the termination fee and
that the termination fee was paid so Santa Fe could enter into an
agreement with Newmont. Therefore, the termination fee was
directly associated with and facilitated the merger, unlike the
salary expenses in Wells Fargo.
Respondent also disputes petitioner’s claimed reliance on
Staley II and United States v. Federated Dept. Stores, Inc., 171
Bankr. 603 (S.D. Ohio 1994). Regarding Staley II, respondent
frames the issue in the present case as whether the termination
fee facilitated the merger that took place and argues that Staley
II in fact requires capitalization of the termination fee.
Respondent argues that Santa Fe faced one decision in March 1997:
to proceed with Homestake and not pay a fee or proceed with
Newmont and pay a fee. Under respondent’s view, Santa Fe’s
- 48 -
decision to proceed with Newmont means that the termination fee
became a cost to Santa Fe of fulfilling its overall objective of
combining with another large mining company. Therefore, the
termination fee “facilitated” the Santa Fe-Newmont merger and
should be capitalized.
Respondent argues that Federated Dept. Stores is
distinguishable. In Federated Dept. Stores, the District Court
based its holding on the fact that “the subject hostile takeovers
could not, and did not provide Federated or Allied with the type
of synergy found in INDOPCO.” United States v. Federated Dept.
Stores, Inc., supra at 609. Respondent argues that in the
present case, the synergies found in INDOPCO, Inc. are present;
therefore, Federated Dept. Stores does not apply. Respondent
also argues that Federated Dept. Stores is distinguishable
because there the targets engaged in defensive tactics that
respondent argues are not present here. The District Court
stated that “The bankruptcy court specifically found that the
‘[d]ebtors engaged in protracted and strenuous defensive tactics
when faced, involuntarily, with the threat of Campeau’s hostile
acquisition.’” United States v. Federated Dept. Stores, Inc.,
supra at 610 (quoting In re Federated Dept. Stores, 135 Bankr. at
961). Respondent argues that Santa Fe did not engage in any
hostile defenses, even though there were a number of possible
- 49 -
defensive tactics at its disposal (such as poison pills or
shareholder rights plans).
C. Respondent’s Expert
Respondent produced one expert witness, William H. Purcell
(Mr. Purcell), a senior director at a Washington, D.C. investment
banking firm. Mr. Purcell has over 40 years of experience in the
investment banking business.
Mr. Purcell made a number of findings in support of
respondent’s arguments, including: (1) That the Santa Fe-Newmont
transaction was not hostile; (2) that Santa Fe put itself into
play as of October 1, 1996; and (3) that Santa Fe used the
termination fee as a tool to maximize value for Santa Fe’s
shareholders. In Mr. Purcell’s view, Santa Fe entered into an
agreement with Homestake because Santa Fe wanted to send a
message to Newmont that Newmont would have to raise its bid in
order to acquire Santa Fe.
VI. Analysis
As discussed above, we must determine whether payment of the
termination fee “[generated] significant benefits for * * *
[Santa Fe] extending beyond the end of the taxable year.”
Metrocorp. Inc. v. Commissioner, 116 T.C. at 222. As we stated
in Metrocorp: “Expenses must generally be capitalized when they
either: (1) Create or enhance a separate and distinct asset or
(2) otherwise generate significant benefits for the taxpayer
- 50 -
extending beyond the end of the taxable year.” Id. at 221-222.
However, we must take care not to interpret every benefit
received after payment of the termination fee as being caused by
or related to the termination fee.
We note at the outset that this was clearly a hostile
takeover of Santa Fe by Newmont. The management, board of
directors, and investment bankers of Santa Fe considered Newmont
hostile. Although initial contacts between the two entities were
informal, Newmont went directly to Santa Fe’s shareholders once
it learned that Santa Fe and Homestake had entered into an
agreement. The presentations Goldman Sachs made to Newmont
executives clearly foresaw a hostile takeover. Mr. Cambre’s
letters to the Newmont board anticipated a fight and warned the
board that this would lead to higher costs.
Executives of Santa Fe, Newmont, and Homestake all testified
credibly that this was a hostile takeover. Further, we find
credible petitioner’s expert Mr. Matthews’s conclusion that this
was a hostile takeover. Respondent’s expert’s contention that
this was a friendly transaction is at odds with the record as a
whole and is not credible.
Although the merger was described in terms of “shared
synergies”, the only synergy found in the transaction benefited
Newmont. By acquiring Santa Fe, Newmont was able to obtain Santa
Fe’s land while disregarding most of Santa Fe’s annual expenses.
- 51 -
The record makes clear that Newmont was primarily interested in
obtaining Santa Fe’s land position, and the only way for Newmont
to acquire Santa Fe’s land was to purchase the entire company.
Because Newmont was primarily interested in Santa Fe’s land, it
quickly terminated Santa Fe’s employees and discarded the
business plans of Santa Fe’s management. Although Santa Fe the
entity continued to exist on paper, it was nothing more than a
shell owning valuable land.
Santa Fe did not reap the types of benefits present in
INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). After the
merger was completed, Newmont shut down Santa Fe’s headquarters
and let go most of its management. The Supreme Court’s decision
in INDOPCO, Inc. to require capitalization of the fees at issue
therein relied on findings of this Court and the Court of Appeals
for the Second Circuit that the expenditures at issue benefited
the operations of the taxpayer incurring the fees. Santa Fe’s
operations did not benefit from payment of the termination fee.
Santa Fe’s executives testified credibly that Santa Fe did
not have as a strategic goal a business merger with any other
mining company. Newmont was a hostile acquirer. In attempting
to avoid Newmont’s overtures, Santa Fe sought a white knight:
Homestake. Santa Fe was defending against an unwanted
acquisition in an effort to maintain and protect its growing
business. The termination fee was contracted for in an attempt
- 52 -
to salvage its business plan and employees through a white knight
combination. See United States v. Federated Dept. Stores, Inc.,
171 Bankr. at 610.
The termination fee was intended to protect the Santa Fe-
Homestake agreement, to deter competing bids, and to reimburse
Homestake for its time and effort in the event that the deal was
terminated. Although Santa Fe had structural defenses in place,
its major defensive strategy was to engage in a capital
transaction with a third party that would prevent Newmont’s
acquisition. This attempt failed. The record does not support a
finding, and we do not find, that paying the termination fee
produced any long-term benefit. See id. Respondent argues that
Federated Dept. Stores is distinguishable on the facts because
Santa Fe allegedly did not engage in defensive measures; however,
the District Court in Federated Dept. Stores stated that the
targets “engaged in defensive measures--the white knight
proposals with DeBartolo and Macy respectively.” Id. The white
knight transactions in Federated Dept. Stores were in fact viewed
by the court as defensive measures meant to prevent the
respective takeovers. The Santa Fe-Homestake agreement was a
defensive measure meant to prevent Newmont’s takeover of Santa
Fe. The termination fee was a part of the Santa Fe-Homestake
agreement and served as a defense against Newmont. Any benefit
as a result of incurring the termination fee died along with the
- 53 -
Santa Fe-Homestake agreement. Had Santa Fe’s shareholders
rejected the Santa Fe-Newmont agreement, or had some exigent
circumstance arisen that required termination of the Santa Fe-
Newmont agreement, Santa Fe would not have recovered the $65
million.
Although the fact that National Starch became a subsidiary
as a result of its merger was viewed as a benefit supporting
capitalization in INDOPCO, Inc., we do not find Santa Fe’s
becoming a subsidiary to be a significant benefit. In INDOPCO,
Inc., National Starch’s management viewed becoming a subsidiary
as a positive aspect of the acquisition because it relieved
National Starch of its shareholder responsibilities. The Supreme
Court relied on this change of ownership in support of its
decision to require capitalization precisely because the change
in ownership structure served to benefit National Starch’s
operations. In the instant case, Santa Fe did not become a
subsidiary which functioned much as Santa Fe had before the
merger. Santa Fe no longer functioned as an autonomous business
after the merger. Santa Fe viewed Homestake as a potential white
knight to avoid just this result. Santa Fe management sought an
agreement with Homestake to avoid being absorbed by Newmont, but
the results of the Newmont merger confirm the accuracy of their
concerns that Santa Fe would lose its operating identity in a
merger with Newmont.
- 54 -
As stated above, the record does not support a finding that
Santa Fe had as an overarching goal a business combination. The
fact that the Santa Fe board had hired investment advisers and
knew the state of the industry before initiating contact with
Newmont does not mean that Santa Fe had decided on a corporate
restructuring. Santa Fe executives testified credibly that Santa
Fe’s first contact with Newmont was meant to be preventative and
meant to enable Santa Fe to remain in control of any
investigation and agreement. The Santa Fe-Newmont agreement was
not a modified form of the Santa Fe-Homestake agreement. Payment
of the termination fee and subsequent signing of the Santa Fe-
Newmont agreement was not, in substance, a continuation of the
Santa Fe-Homestake agreement in some modified form. The two
transactions were separate: (1) A white knight transaction; and
(2) a hostile takeover. See United States v. Federated Dept.
Stores Inc., supra at 611.
Santa Fe viewed Newmont’s overtures as hostile; and in an
attempt to defeat Newmont’s takeover, Santa Fe sought out
Homestake as a white knight. Because Newmont’s offer was higher
than Homestake’s, the Santa Fe board believed that in order to
fulfill its fiduciary duties the board had to terminate its
agreement with Homestake and accept Newmont’s higher offer. The
facts do not support respondent’s contention that the termination
fee was paid to restructure Santa Fe in hopes of some future
- 55 -
benefit. See id. The termination fee was paid to Homestake to
compensate it for whatever expenses it incurred. See id. As the
District Court concluded in Federated Department Stores: “in the
instant case, the white knight mergers were abandoned. Any
effect that this merger had on the later merger with Campeau is
irrelevant.” Id. at 611-612.
This Court’s holdings in Staley I and Norwest Corp. & Subs.
v. Commissioner, 112 T.C. 89 (1999), are distinguishable.
In Norwest Corp. & Subs. v. Commissioner, supra at 102, we
required the taxpayer to capitalize salaries paid to bank
executives for work performed in relation to a friendly merger
that provided the bank with significant long-term benefits.
Because of a change in State banking law, the taxpayer, a small
local bank, sought out a merger with a larger national bank. The
taxpayer merged with Norwest because doing so would allow the
bank to continue operating competitively. After the transaction,
the bank remained in operation and offered a wider array of
services than the bank had offered previously. Id. at 95.
Relying on INDOPCO, Inc., we required capitalization because
the disputed expenses “enabled * * * [the taxpayer] to achieve
the long-term benefit that it desired from the transaction”.
Norwest Corp. & Subs. v. Commissioner, supra at 100. Although
the expenses were not directly related to the benefit, we
- 56 -
required capitalization because “the costs were essential to the
achievement of that benefit.” Id. at 102.
In Staley I, as discussed above, we required the taxpayer to
capitalize fees paid to investment bankers incident to a
takeover. The taxpayer was a producer of food sweeteners and
faced a takeover. The taxpayer hired and paid advisers who
counseled the taxpayer before the takeover. Ultimately, the
board of the taxpayer decided to accept the acquirer’s offer. We
held that the expenses had to be capitalized because they were
incurred incident to the taxpayer’s change of ownership, from
which it derived significant long-term benefits.
Unlike Staley I, the present case features a white knight--
Homestake. Further, the acquirer in Staley I had long-term plans
for the target corporation. Although the acquirer’s plans
diverged from those of the target’s management, they were plans
that nonetheless involved the target’s operation as an ongoing
company. After the takeover, the taxpayer existed and operated
as a business. In the present case, Newmont did not have any
plans for Santa Fe’s continued operation, and Santa Fe did not
operate post takeover.
In contrast to Norwest Corp. & Subs., the instant
transaction was not friendly. Newmont proceeded in a hostile
manner once its initial contacts were rebuffed. Newmont’s board
and management planned for and effected a hostile takeover.
- 57 -
Secondly, Santa Fe did not reap the type of benefits present in
Norwest Corp. & Subs. Santa Fe was not able to operate in an
improved manner once the transaction was completed. Santa Fe did
not have access to wider services as a result of the merger, and
Santa Fe was not able to operate competitively once taken over.
Santa Fe, unlike the taxpayer in Norwest Corp. & Subs.,
effectively ceased to exist.
Both Norwest Corp. & Subs. and Staley I focused on
corporations whose operations benefited from the respective
payments at issue. In the present case, Santa Fe’s operations
did not improve as a result of payment of the termination fee.
As a result of the combination Santa Fe ceased operation.
Although the merger was described in terms of synergies between
the two companies, the result of the transaction was that Newmont
was able to mine Santa Fe’s land while cutting any duplicate
costs. In INDOPCO, Inc. the taxpayer’s operations improved
because it gained access to National Starch’s large distribution
network. In Norwest Corp. & Subs., the taxpayer benefited
because it was both able to remain in competition in a much more
competitive market and able to offer a wider range of services
than it had before. In Staley I, the taxpayer benefited because
as a result of its combination it moved away from recent
strategic expansions into new industries back to its core
business lines.
- 58 -
Payment of the termination fee did not lead to significant
benefits for Santa Fe extending past the year at issue.
Accordingly, petitioner is entitled to deduct the amount of the
termination fee pursuant to section 162. In the light of our
reasoning as stated above, we do not reach petitioner’s argument
concerning the origin of the claim doctrine.
VII. Conclusion
On the basis of the foregoing, petitioner is entitled to
deduct the termination fee pursuant to section 162.
VIII. Section 165
Section 165 allows current deductions of any “loss sustained
during the taxable year and not compensated for by insurance or
otherwise.” Section 165 allows a current deduction for costs
associated with an abandoned capital transaction. Sibley,
Lindsay & Curr Co. v. Commissioner, 15 T.C. 106 (1950). These
principles have been applied even though the abandoned
transaction, if consummated, would be a capital transaction and
the associated costs would have to be capitalized. See
Doernbecher Manufacturing Co. v. Commissioner, 30 B.T.A. 973(1934), affd. on other grounds 80 F.2d 573 (9th Cir. 1935). The
question is whether the subject transaction was actually
abandoned. United States v. Federated Dept. Stores, Inc., 171
Bankr. at 611. The loss must be evidenced by a closed and
completed transaction, fixed by identifiable events. Sec. 1.165-
- 59 -
1(b), (d), Income Tax Regs. The regulations also provide that
the loss must be bona fide and that substance, not mere form,
shall govern in determining a deductible loss. Sec. 1.165-1(b),
Income Tax Regs. In Sibley, Lindsay & Curr Co. v. Commissioner,
supra, the taxpayer’s bankers prepared three separate
restructuring plans. The taxpayers chose one of the three and
attempted to deduct the cost of the other two. This Court
allowed a deduction for the cost of the other two restructuring
plans because they were separate plans distinct from the
restructuring that was carried out. Id. at 110.
The District Court in United States v. Federated Dept.
Stores, Inc., 171 Bankr. 603 (S.D. Ohio 1994), also found that
the taxpayers were entitled to deduct the termination fees
pursuant to section 165. The District Court stated that both
targets were presented with two mutually exclusive capital
transactions: Mergers with the white knights, or mergers with
the hostile acquirer. Id. at 611. The District Court reasoned
that each transaction “must be viewed separately” and went on to
state that “Just because a failed capital transaction has some
effect on a later successful capital transaction does not prevent
a deduction for a loss sustained in the failed transaction.” Id.
Respondent argues that petitioner is not entitled to claim a
deduction for an abandonment loss. As stated above, respondent
argues that beginning in October 1996 Santa Fe had as a goal a
- 60 -
corporate restructuring. Respondent views the potential Newmont
and Homestake deals as two mutually exclusive alternatives, each
a part of this goal. Because Santa Fe could merge with only one,
and because Santa Fe had to terminate the Santa Fe-Homestake
agreement to merge with Newmont, the termination fee should not
be allowed as a deduction under section 165 because Santa Fe
never abandoned its goal of a combination and in fact satisfied
it by merging with Newmont. Respondent argues Santa Fe’s goal
was a business merger, not that the Homestake and Newmont mergers
were two separate transactions. Therefore, because (1) Santa Fe
combined with Newmont, (2) the termination fee was paid to
facilitate that merger, and (3) because no transaction was
abandoned, there was no closed transaction with Homestake.
Respondent argues that caselaw requires the capitalization
of fees paid to extricate a party from one contract in order to
enter into a more favorable contract as part of an integrated
plan or overall objective. Respondent points to a line of cases
where costs related to mutually exclusive alternatives that were
part of an integrated plan were not allowed as abandonment
losses. Respondent further argues that Santa Fe made a voluntary
and well-thought-out decision to terminate the Homestake
agreement, pay the termination fee, and merge with Newmont.
Petitioner argues that Santa Fe was faced with two separate
transactions: (1) A hostile takeover by Newmont; and (2) a white
- 61 -
knight transaction with Homestake. Santa Fe management, in
petitioner’s view, was not engaged in one overarching plan to
restructure the company’s capital structure. Santa Fe attempted
to avoid Newmont’s overtures by entering into a deal with
Homestake. When Newmont increased its offer, the Santa Fe board
had no choice but to abandon the Homestake deal. Therefore,
petitioner argues, the termination fee paid to Homestake was part
of an abandoned transaction and petitioner is allowed to deduct
the termination fee under section 165.
Petitioner again analogizes the current case to Federated
Dept. Stores. Respondent argues that Federated Dept. Stores does
not apply and argues that the key fact underlying the Federated
Dept. Stores decision–-that neither of the targets in that case
had voluntarily terminated their merger agreements in order to
engage in a more favorable merger–-is not present here.
We agree with petitioner. The facts in this case do not
show that Santa Fe pursued a corporate restructuring. It is
clear that the board and management of Santa Fe did not want to
be taken over by a large competitor so shortly after the company
was spun off from its former parent. Santa Fe viewed Newmont as
hostile and entered into a white knight agreement with Homestake
in order to prevent Newmont’s acquisition. Later, Santa Fe was
forced to abandon its agreement with Homestake when it became
clear that Newmont’s offer had to be accepted. When Newmont
- 62 -
raised its bid above that of Homestake and Homestake refused to
match it, Santa Fe had no choice. Delaware law required that the
board members choose the highest value for their shareholders.
This forced Santa Fe to breach the Santa Fe-Homestake agreement
and pay the termination fee. At that time, the Santa Fe-
Homestake merger was abandoned. The termination fee was paid as
a result of that abandonment and was therefore a cost of the
abandoned merger with Homestake.
Accordingly, Santa Fe is alternatively entitled to a
deduction under section 165. Santa Fe viewed the possible
transactions with Homestake and Newmont as separate and distinct.
The two possible combinations were not part of an overall plan by
Santa Fe to change its capital structure. The Santa Fe-Homestake
agreement was a closed and completed transaction that Santa Fe
later abandoned when it entered into the Santa Fe-Newmont
agreement.
IX. Conclusion
On the basis of the foregoing, petitioner is entitled to a
deduction of $65 million pursuant to sections 162 and 165 for the
termination fee paid to Homestake.
Accordingly,
Decision will be entered
under Rule 155.