Russell Shappy, Jr. & Linda B. Shappy ( 2023 )

United States Tax Court
T.C. Memo. 2023-146CHARLES G. BERWIND TRUST FOR DAVID M. BERWIND, DAVID
M. BERWIND, D. MICHAEL BERWIND, JR.; GAIL B. WARDEN,
LINDA B. SHAPPY AND VALERIE L. PAWSON,
TRUSTEES, ET AL., 1
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket Nos. 26218-08, 26219-08, Filed December 4, 2023.
26220-08, 26221-08,
26222-08.
—————
John William Schmehl, Thomas S. Biemer, Marc Alan Feller, and
Benjamin S. Bolas, for petitioners.
Philip S. Yarberough and John Anthony Guarnieri, for respondent.
CONTENTS
MEMORANDUM FINDINGS OF FACT AND OPINION ..................... 4
FINDINGS OF FACT .............................................................................. 7
1. In 1963, Charles G. Berwind, Sr., established trusts to hold
the stock of Berwind Corporation for his four children. .............. 7
1 Cases of the following petitioners are consolidated herewith: Duncan Warden
and Gail Warden, Docket No. 26219-08; Russell Shappy, Jr., and Linda B. Shappy,
Docket No. 26220-08; David M. Berwind and Jeanne M. Berwind, Docket No. 26221-08;
and D. Michael Berwind, Jr., and Carol R. Berwind, Docket No. 26222-08.
Served 12/04/23
2
[*2]
2. Under the control of Charles G. Berwind, Sr.’s son, Graham
Berwind, Berwind Corporation redeemed all of the shares
of the trusts for daughters Margaret and Emery and half
the shares owned by the trust for son David. .............................. 9
3. In 1978, Berwind Corporation bought Colorcon, Inc. ................ 10
4. In 1983, BPSI was added to the corporate structure above
Colorcon, Inc. ............................................................................... 11
5. In 1985, Berwind Corporation redeemed the remaining
shares owned by the David Berwind Trust. ............................... 15
6. BPSI changed its articles of incorporation to authorize
preference stock and preferential stock...................................... 17
7. The Graham Berwind Trust and the Graham Children
Trusts consolidated their shares of Berwind Corporation
and the common stock of BPSI; BPSI’s articles of
incorporation were corrected to add terms regarding its
preference and preferential stock. .............................................. 17
8. Under Pennsylvania law regarding short-form mergers, a
parent corporation may merge with its 80%-owned
subsidiary without a vote by the subsidiary’s other
shareholders; however, these shareholders have the right
to demand the fair market value of their sares. ........................ 26
9. In December 1999, a short-form merger was formalized
between BPSI and its newly formed parent corporation,
but this merger was challenged by the David Berwind
Trust, which also asserted its right to receive the fair
market value of its BPSI shares. ................................................ 40
OPINION ................................................................................................ 96
I. On December 16, 1999, there was a “sale or exchange” of
the David Berwind Trust’s shares of BPSI common stock
within the meaning of section 483. ............................................. 99
A. The plan of merger between BPSI Acquisition and BPSI
did not violate BCL § 1922(a)(3); even if the plan of
3
[*3] merger did violate that provision, the merger was not
void. ...................................................................................... 102
1. The plan of merger complied with BCL § 1922(a)(3). ... 102
2. Even if the plan of merger violated BCL § 1922(a)(3),
the merger was not void. ................................................ 104
B. The merger of BPSI Acquisition and BPSI did not
violate BPSI’s articles of incorporation. .............................. 107
C. The remedies of the plaintiffs in the Warden litigation
would not have been limited to the dissenters-rights
provisions had the merger been tainted with fraud or
fundamental unfairness. However, petitioners do not
ask us to determine that the merger was so tainted. ......... 108
D. Count XIII of the amended complaint in the Warden
litigation should not be treated as failing to state a
claim on the grounds that the Graham Berwind and
McKenney’s resignations as trustees of the David
Berwind Trust were effective. ............................................. 110
E. Application of the origin-of-the-claim test does not lead
to the conclusion that the sale or exchange occurred on
November 25, 2002. ............................................................. 113
F. Lyeth v. Hoey does not require us to determine the tax
consequences of the payment by BPSI to the David
Berwind Trust for the Trust’s BPSI common stock as if
the plaintiffs in the Warden litigation had successfully
enjoined the merger between BPSI Acquisition and
BPSI. ..................................................................................... 117
G. The 2002 settlement agreement did not provide that the
merger was rescinded or that the merger was void............ 118
H. Merely because the David Berwind Trust’s holding
period of BPSI common stock would have included the
period from December 16, 1999, to November 25, 2002,
for purposes of section 1231 of the Internal Revenue
Code of 1954, does not mean that the sale or exhange of
the trust’s BPSI common stock did not occur on
December 16, 1999, for purposes of section 483. ................ 120
4
[*4]
I. That the sale or exchange of the David Berwind Trust’s
BPSI common stock occurred on December 16, 1999, is
not inconsistent with Megargel v. Commissioner, 3 T.C.
238 (1944), and cases following it. ....................................... 125
J. That the sale or exchange of the David Berwind Trust’s
BPSI common stock occurred on December 16, 1999, is
not inconsistent with Victor E. Gidwitz Family Tr. v.
Commissioner, 61 T.C. 664 (1974). ..................................... 129
K. That the sale or exchange of the BPSI common stock of
the David Berwind Trust occurred on December 16,
1999 is not inconsistent with judicial interpretations of
section 163(a). ...................................................................... 131
II. The plan of merger was the contract for the sale or
exchange of the David Berwind Trust’s BPSI shares. ............. 135
III. The payment from BPSI to the David Berwind Trust for its
BPSI common stock was “under” the plan of merger even if
the David Berwind Trust did not voluntarily contract to
receive the payment as part of the plan of merger. ................. 136
IV. The payment made by BPSI to the David Berwind Trust
for the trust’s BPSI shares was a $191,257,353 payment
that was made on December 31, 2002. ..................................... 138
V. Conclusion ................................................................................. 140
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: Respondent (hereinafter the IRS) mailed a
notice of deficiency to the Charles D. Berwind Trust for David M.
Berwind. We refer to this trust as the “David Berwind Trust”. The
notice of deficiency mailed to the David Berwind Trust reflected a
determination that $31,096,783 of the David Berwind Trust’s income for
the 2002 taxable year constituted imputed interest that had been
improperly reported as capital gain on the trust’s Form 1041, U.S.
Income Tax Return for Estates & Trusts. The notice of deficiency stated
that the deficiency was $5,363,331.
5
[*5] The David Berwind Trust had four beneficiaries, each of whom
filed a joint return for 2002 with their respective spouses. The
beneficiaries and their respective spouses were:
• David McMichael Berwind (David Berwind) and Jeanne M.
Berwind,
• David McMichael Berwind, Jr. (Michael Berwind) and Carol
R. Berwind,
• Duncan Warden and Gail Berwind Warden, and
• Russell Shappy, Jr. and Linda Berwind Shappy.
(Michael Berwind, Gail Berwind Warden, and Linda Berwind Shappy
are the children of David Berwind.) The IRS also mailed notices of
deficiency to the beneficiaries and their respective spouses, determining
deficiencies in their income taxes for 2002. The notices mailed to the
beneficiaries and their respective spouses determined that, as a result
of the adjustment to the David Berwind Trust’s income reflected in the
notice of deficiency mailed to the David Berwind Trust, each beneficiary
received taxable distributions from the David Berwind Trust during the
2002 tax year in excess of the amounts reported on their respective
Forms 1040, U.S. Individual Income Tax Return. The notices of
deficiency mailed to the beneficiaries and their respective spouses
determined income-tax deficiencies in the following amounts for the
2002 tax year:
Taxpayer Deficiency
Michael Berwind & Carol Berwind $102,783
David Berwind & Jeanne Berwind 12,603
Duncan Warden & Gail Berwind Warden 104,441
Russell Shappy & Linda Berwind Shappy 108,375
On October 28, 2008, a timely Petition was filed as to the notice
of deficiency that had been mailed to the David Berwind Trust. The
Petition was signed by (1) an attorney for the trust and (2) the trustees
of the trust in their capacity as trustees. The Petition named as non-
governmental parties in the caption (1) the David Berwind Trust,
(2) David Berwind (as trustee), (3) Michael Berwind (as trustee), (4) Gail
Berwind Warden (as trustee), (5) Linda Berwind Shappy (as trustee),
and (6) Valerie Pawson (as trustee). The David Berwind Trust’s
principal office was in Massachusetts and its trust situs was in the state
of Pennsylvania by virtue of the state residence of the settlor when the
6
[*6] trust was founded. The states in which the trustees resided were
as follows: David Berwind (Florida), Michael Berwind (Massachusetts),
Gail Berwind Warden (Massachusetts), Linda Berwind Shappy
(Massachusetts), and Pawson (unknown). We do not take a position on
whether the trust is the petitioner or whether instead the trustees of the
trust are the petitioners.
On October 28, 2008, timely petitions were filed by the four
beneficiaries of the David Berwind Trust (and their respective spouses)
as to their four respective notices of deficiency. When Michael and Carol
Berwind filed their Petition, they resided in Massachusetts. When
David and Jeanne Berwind filed their Petition, they resided in Florida.
When Duncan Warden and Gail Berwind Warden filed their Petition,
they resided in Massachusetts. When Russell Shappy and Linda
Berwind Shappy filed their Petition, they resided in Massachusetts.
The Court has jurisdiction under section 6213(a). 2 We assigned
five separate docket numbers to reflect that five separate notices of
deficiency were challenged in the Petitions. The Court later
consolidated the five cases.
The issues in the case concern the tax treatment of a settlement
payment received by the David Berwind Trust to resolve a lawsuit
challenging a squeeze-out merger designed to extinguish its 16.4%
common stock interest in Berwind Pharmaceutical Services, Inc. (BPSI),
a lawsuit that also included an appraisal action to (a) determine the
value of the interest and (b) require BPSI to pay that value to the David
Berwind Trust. The amount of the payment, and the date it was
received by the David Berwind Trust, are matters in dispute in the
present case.
On December 14, 1999, the David Berwind Trust had owned
16.4% of the common stock of BPSI. On December 16, 1999, BPSI filed
with the Pennsylvania Department of State articles of merger providing
that it merged with its majority shareholder, BPSI Acquisition
Corporation (BPSI Acquisition), and that its common stock was
cancelled. On November 25, 2002, BPSI and other defendants agreed to
settle the lawsuit. On November 25, 2002, BPSI transferred
$191,000,000 to an escrow account for the benefit of the David Berwind
2 Unless otherwise indicated, all references to sections are to the Internal
Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references
are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant
times, and Rule references are to the Tax Court Rules of Practice and Procedure.
7
[*7] Trust. On November 26, 2002, $191,007,012.05 was transferred
from the escrow account to an escrow account with PNC. On December
31, 2002, $191,257,353 was released from the PNC escrow account to
the David Berwind Trust. We hold:
I. The sale or exchange of the David Berwind Trust’s shares
of BPSI common stock occurred on December 16, 1999, not
November 25, 2002.
II. The sale or exchange was pursuant to a contract.
III. The payment from BPSI to the David Berwind Trust for its
BPSI common stock was “under” the plan of merger even if
the David Berwind Trust did not voluntarily contract to
receive the payment as part of the plan of merger.
IV. The payment by BPSI to the David Berwind Trust for the
Trust’s shares was a $191,257,353 payment on December
31, 2002, not a $191,000,000 payment on November 25,
2002.
FINDINGS OF FACT
The Court adopts the stipulations of fact entered into by the
parties. Most of these stipulations are stated here. We also state other
findings of fact that are not found in the stipulations.
1. In 1963, Charles G. Berwind, Sr., established trusts to hold the stock
of Berwind Corporation for his four children.
Founded in 1883, Berwind Corporation was a closely held
business that was engaged in coal mining. In the 1960s, Berwind
Corporation began to diversify its holdings by investing in other
industries such as pharmaceutical and health science.
In 1963, Charles G. Berwind, Sr., established four trusts, one for
each of his four children. His children were (1) David Berwind,
(2) Charles G. Berwind, Jr., referred to here as Graham Berwind,
(3) Emery Berwind, and (4) Margaret Berwind. Each child was the
primary beneficiary of the respective trust. Each trust was named for
the respective child beneficiary: the David Berwind Trust, the Graham
Berwind Trust, the Emery Berwind Trust, and the Margaret Berwind
Trust. To each trust, Charles G. Berwind, Sr., transferred shares of
Berwind Corporation. The Graham Berwind Trust received 53,200
8
[*8] shares; each of the other children’s trusts received only 45,600. The
reason for the disparity was that Charles G. Berwind, Sr., intended that
Graham Berwind should be the one among his children who would
eventually run Berwind Corporation. Graham Berwind had already
been working for Berwind Corporation when the children’s trusts were
created. By contrast, David Berwind took a career path outside the
company, becoming the headmaster of a boys’ school.
The table below shows the ownership of Berwind Corporation by
the children’s trusts when the trusts were created:
Shares of Berwind Corp. held by the trusts for the benefit of
the children of Charles G. Berwind, Sr.
Graham David Emery Berwind Margaret
Berwind Trust Berwind Trust Trust Berwind
Trust
53,200 45,600 45,600 45,600
The David Berwind Trust had three trustees when it was created:
(1) David Berwind, (2) Graham Berwind, and (3) a lawyer named Albert
Gilmer. The table below shows these initial trustees:
Trustees of the David Berwind Trust
David Berwind
Graham Berwind
Albert Gilmer, attorney
Paragraph 11.G of the David Berwind Trust’s deed of trust
provides that “[a]ny individual trustee may resign at any time without
court approval, so long as he or she has executed the instrument referred
to in paragraph [11.]A.” Paragraph 11.A provides that “each trustee,
upon assuming office, shall execute a written acceptance of trusteeship
and shall also lodge with the other trustees within a reasonable time an
instrument designating two or more individuals as a succession of
successor trustees, to serve in the event that he or she ceases to act . . . .”
The deed of trust also contains the following provision: “The fact that
any trustees may be interested in Berwind Corporation or any of its
subsidiaries as director, stockholder, manager, agent or employee shall
not constitute an adverse or conflicting interest, and the acts of such
trustee shall be judged as if he had no interest in the Corporation.”
9
[*9] 2. Under the control of Charles G. Berwind, Sr.’s son, Graham
Berwind, Berwind Corporation redeemed all of the shares of the
trusts for daughters Margaret and Emery and half the shares
owned by the trust for son David.
Charles G. Berwind, Sr., died in 1972. Graham Berwind then
assumed day-to-day control of Berwind Corporation. He sought to
consolidate the ownership of Berwind Corporation by directing the
corporation to repurchase its outstanding common stock.
In 1972, Berwind Corporation redeemed the shares of its common
stock owned by the Margaret Berwind Trust and the Emery Berwind
Trust, which by that time were the only owners of Berwind Corporation
common stock other than the Graham Berwind Trust and the David
Berwind Trust. After these 1972 redemptions, the ownership of
Berwind Corporation common stock was as follows:
Ownership of Berwind Corp. common stock
Graham Berwind Trust David Berwind Trust
53,200 45,600
In 1976, Berwind Corporation redeemed half of the shares of
common stock owned by the David Berwind Trust. After this 1976
redemption, the ownership of Berwind Corporation common stock was
as follows:
Ownership of Berwind Corp. common stock
Graham Berwind Trust David Berwind Trust
53,200 22,800
From this point until 1985, there is no information in the record
about changes in the ownership of the common stock shares of Berwind
Corporation held by the Graham Berwind Trust, the David Berwind
Trust, and other owners. 3
3 As explained infra FINDINGS OF FACT, Part 5, in 1985 Berwind
Corporation redeemed all of the shares of its common stock owned by the David
Berwind Trust (which by then totaled 21,132). At the time of this redemption, the
Graham Berwind Trust and the Graham Children Trusts (terms which are defined
infra FINDINGS OF FACT, Part 4) owned 104,078 shares.
10
[*10] 3. In 1978, Berwind Corporation bought Colorcon, Inc.
In 1978, Berwind Corporation bought all the shares of Colorcon,
Inc. Colorcon, Inc., was in the business of applying color coatings to
pharmaceutical tablets. The corporate structure thus became:
Figure 1
Corporate structure after Berwind Corporation bought Colorcon, Inc., in 1978
Graham Berwind Trust David Berwind Trust
common common
Berwind
Corporation
100%
Colorcon, Inc.
In December 1979, Gilmer resigned as a trustee of the David
Berwind Trust. He appointed Thomas Morris, Jr., a partner at the law
firm of Dechert, Price, and Rhoads LLP, as his successor trustee. Thus,
the trustees were:
Trustees of the David Berwind Trust
David Berwind
Graham Berwind
Thomas Morris, Jr., attorney
11
[*11] 4. In 1983, BPSI was added to the corporate structure above
Colorcon, Inc.
In 1983, BPSI was formed. 4 BPSI issued 16.4% of its common
stock (6,500 shares) to the David Berwind Trust. It issued the
remaining 83.6% of its common stock (33,440 shares) to four new trusts
that Graham had established for the benefit of his children. The four
new trusts are referred to here as the “Graham Children Trusts”.
When BPSI was formed, it was also authorized to issue (but did
not immediately issue) shares of preferred stock with par value of $50
per share. BPSI’s articles of incorporation contained the following
provisions governing the redemption of preferred stock:
The Company [BPSI], by action of its Board of
Directors, subject to the terms and conditions upon which
shares of any particular series are subject to redemption,
may redeem the whole or any part of . . . the [p]referred
[s]tock, at any time or from time to time, by paying in cash
the redemption price for the shares . . . fixed therefor as
herein provided, together with accrued but unpaid
dividends to the date fixed for such redemption. Notice of
every such redemption (pursuant to a sinking fund
requirement or otherwise) shall be given at least thirty (30)
days and not more than ninety (90) days prior to the date
fixed for such redemption by hand delivery or first class
mail, to the holders of record of the shares of the [p]referred
[s]tock so to be redeemed, at their respective addresses as
the same shall appear on the books of the Company. . . .
The Board of Directors shall have full power and authority,
subject to the limitations and provisions herein contained,
to prescribe the manner in which and the terms and
conditions upon which the shares of the [p]referred [s]tock
shall be redeemed from time to time. If such notice of
redemption shall have been duly given and if on or before
the redemption date specified in such notice all funds
necessary for such redemption shall have been set aside by
the Company, separate and apart from its other funds, in
trust for the account of the holders of the shares of
[p]referred [s]tock to be redeemed, so as to be and continue
4 The corporation was initially named Pharmaceutical Specialties Corporation,
but in 1985 its name was changed to Berwind Pharmaceutical Services, Inc.
12
[*12] to be available therefor, then, notwithstanding that any
certificate for shares of [p]referred [s]tock so called for
redemption shall not have been surrendered for
cancellation, from and after the date fixed for such
redemption, the shares represented thereby shall no longer
be deemed outstanding, the right to receive dividends
thereon shall cease to accrue and all rights with respect to
such shares so called for redemption shall forthwith on
such redemption date cease and terminate, except only the
right of the holders thereof to receive, out of the funds so
set aside in trust, the amount payable upon the redemption
thereof, without interest.
BPSI’s articles of incorporation also contained the following
provision requiring consent of the majority of the preferred stockholders
to a merger:
So long as any shares of the [p]referred [s]tock are
outstanding:
....
(B) the [c]ompany [i.e., BPSI] shall not,
without the consent (given by vote at a meeting called for
that purpose) of the holders of at least a majority of the
total number of shares of the [p]referred [s]tock . . . then
outstanding, merge . . . with any other corporation unless:
(a)(i) the agreement of merger . . . shall
provide that all authorized shares and all outstanding
shares of the [p]referred [s]tock shall continue,
respectively, to be authorized and outstanding after such
merger . . . and (ii) the corporation resulting from such
merger . . . would not have after such merger . . . any
authorized class of shares ranking prior to or on a parity
with the [p]referred [s]tock as to either assets or dividends,
except the same number of shares of the same par value (or
shares having the same aggregate par value, or an
aggregate stated value equal to the aggregate of the par
value) with the same rights and preferences as the
authorized shares of the [c]ompany immediately preceding
such merger . . . ; or
13
[*13] (b)(i) the agreement of merger . . . shall
provide for the conversion of all shares of the [p]referred
[s]tock into an equal number of shares of a class of capital
stock (hereinafter called the “[c]onversion [s]tock”) of the
resulting corporation of the same par value (or shares
having the same aggregate par value, or an aggregate
stated value equal to the aggregate of the par value) and
having comparable rights and preferences (allowing for
differences of form and minor substance) as the shares of
the . . . resulting corporation would not have after such
merger . . . any authorized class of shares prior to or on a
parity with the [c]onversion [s]tock as to either assets or
dividends, except the same number of shares of the same
par value (or shares having the same aggregate par value,
or an aggregate stated value equal to the aggregate of the
par value) with the same rights and preferences as the
authorized shares of the [c]ompany immediately preceding
such merger . . . .
In 1983, Berwind Corporation sold the common stock of Colorcon,
Inc., to BPSI. In exchange for the Colorcon, Inc. stock, BPSI transferred
to Berwind Corporation 120,000 shares of BPSI preferred stock and a
note. The corporate structure thus became:
14
[*14] Figure 2
Corporate structure after interposition of BPSI between Berwind Corporation and
Colorcon, Inc., in 1983
Graham Berwind Trust
and Graham Children David Berwind Trust
Trusts
common common
Berwind
33,440 common Corporation 6,500 common
(83.6%) (16.4%)
120,000
preferred
plus note
BPSI
100 % common
Colorcon, Inc.
15
[*15] 5. In 1985, Berwind Corporation redeemed the remaining shares
owned by the David Berwind Trust.
In 1985, Berwind Corporation redeemed the remaining 21,132
shares of its common stock owned by the David Berwind Trust. This did
not affect the ownership of BPSI stock. 5 The corporate structure thus
was:
5 Immediately before this redemption, the David Berwind Trust owned 21,132
shares. The Graham Berwind Trust and the Graham Children Trusts owned 109,078
shares.
16
[*16] Figure 3
Corporate structure after Berwind Corporation's redemption of the David Berwind
Trust's shares in 1985
Graham Berwind Trust
and Graham Children David Berwind Trust
Trusts
100% common
33,440 common 6,500 common
(83.6%) (16.4%)
Berwind
Corporation
120,000
preferred
plus note
BPSI
100% common
Colorcon, Inc.
17
[*17] 6. BPSI changed its articles of incorporation to authorize
preference stock and preferential stock.
On October 31, 1989, BPSI amended its articles of incorporation
to authorize 3,480,000 shares of preference stock with a $1.00 par value
and 600,000 shares of preferential stock with a $1.00 par value. 6
7. The Graham Berwind Trust and the Graham Children Trusts
consolidated their shares of Berwind Corporation and the common
stock of BPSI; BPSI’s articles of incorporation were corrected to add
terms regarding its preference and preferential stock.
In 1990, the Graham Berwind Trust and the Graham Children
Trusts contributed their BPSI common stock to Berwind Group
Partners, a general partnership that was owned by these trusts. The
Graham Berwind Trust held a 47.528% interest in the partnership; each
of the four Graham Children Trusts held a 13.118% interest. Following
the contributions, Berwind Group Partners owned 83.6% of BPSI’s
common stock.
The Graham Berwind Trust and the Graham Children Trusts
also transferred their shares in Berwind Corporation to Berwind Group
Partners. The date of this transfer is not clear from the record. For
purposes of discussion, we assume the transfer took place in 1990. After
the transfer, the corporate structure thus was:
6 The record does not contain information about who owned these shares
during the period from October 31, 1989, to December 14, 1999. By December 14, 1999,
all shares of BPSI preference stock would be owned by Berwind Corporation. By
December 14, 1999, the shares of BPSI preferential stock would be owned by the David
Berwind Trust (13.12%), Graham Berwind (2%), Berwind Group Partners (66.88%),
and Berwind Corporation (18%).
18
[*18] Figure 4
Corporate structure after interposition of Berwind Group Partners
Graham Berwind Graham Children
Trust Trusts
47.528% 52.472%
David Berwind
Trust
Berwind Group
Berwind Group
Partners
Partners
100% common 16.4% common
Berwind
Corporation
83.6% common
120,000
preferred
plus note
BPSI
100% common
Colorcon, Inc.
19
[*19] In 1993, Graham Berwind, on behalf of Berwind Group Partners,
offered to buy the David Berwind Trust’s stock in BPSI for $29 million.
The David Berwind Trust did not accept the offer.
In 1994, three of David Berwind’s children—Michael Berwind,
Linda Berwind Shappy, and Gail Berwind Warden—were approved as
additional trustees of the David Berwind Trust. This brought the total
number of trustees of that trust to six. The trustees at this point were:
Trustees of the David Berwind Trust
David Berwind
Graham Berwind
Tom Morris, Jr., attorney
Michael Berwind
Linda Berwind Shappy
Gail Berwind Warden
In 1996, Berwind Group Partners formed ZYAC Holding
Corporation (ZYAC Holding) to acquire from a third party all the
outstanding shares of Zymark Corporation (Zymark), a company which
performed pharmaceutical testing. To finance ZYAC Holding’s purchase
of Zymark stock, BPSI loaned $20 million to ZYAC Holding in exchange
for a note that bore interest at the prime rate. Sometime in 1996, ZYAC
Holding succeeded in acquiring a 100% interest in Zymark from the
third party. In September 1996, in connection with ZYAC Holding’s
acquisition of Zymark, BPSI acquired 1,000 shares of ZYAC Holding
Series A 8.75% noncumulative preferred stock for $10 million. 7 BPSI
never acquired any of the ZYAC Holding common stock. At all times,
the common stock of ZYAC Holding was owned by Berwind Group
Partners. Zymark continued as an operating business after its
acquisition by ZYAC Holding. The corporate structure at this point was
as follows:
7 The record does not reveal if BPSI acquired the preferred stock from ZYAC
Holding or from Zymark.
20
[*20] Figure 5
Corporate structure after creation of ZYAC Holding and its purchase of Zymark in
1996
Graham Graham
Berwind Children
Trust Trusts
47.528% 52.472%
David Berwind
Trust
Berwind Group
Partners
100% common 83.6% common 100% common 16.4% common
Berwind
Corporation
100%
preferred
plus note
• 1,000 Series A BPSI
8.75% noncumulative
preferred (bought for
$10 million)
• $20 million note
100% common
ZYAC Holding
Colorcon, Inc.
100% interest
Zymark
21
[*21] In the summer of 1997, Graham Berwind, on behalf of Berwind
Group Partners, offered $53.5 million for the David Berwind Trust’s
shares of BPSI. The David Berwind Trust made a counterproposal to
sell its shares at a significantly higher price, but Berwind Group
Partners did not respond favorably to this proposal.
On June 26, 1997, Graham Berwind signed a document entitled
“Designation of Successor Trustee” stating: “I hereby designate . . .
Bruce J. McKenney . . . to succeed me as trustee [of the David Berwind
Trust].” On the same day, Graham Berwind and McKenney signed a
document in which Graham Berwind stated that he “resigns as a
trustee” of the David Berwind Trust “effective only upon acceptance of
trusteeship by the successor trustee previously designated” and
McKenney stated that he “hereby accepts appointment as a successor
trustee” of the David Berwind Trust. On the same day, McKenney
signed another document, entitled “Designation of Successor Trustee,”
stating: “I hereby designate . . . [Graham Berwind] to succeed me as
trustee” of the David Berwind Trust.
On October 28, 1997, the semiannual meeting of the trustees of
the David Berwind Trust was held in Philadelphia. The meeting
minutes stated that “[d]uring the summer, a decision was made to move
the administration of the trust” from (a) Berwind Corporation in
Philadelphia to (b) Boston. The meeting minutes stated: “As part of this,
[Graham Berwind] resigned as trustee . . . .” The minutes stated that
Russell Shappy and Gail Berwind Warden would take over the
accounting function and handle it in Massachusetts.
On December 30, 1997, McKenney signed a document entitled
“Resignation as Trustee” stating that he “resigns as a trustee” of the
David Berwind Trust “effective immediately.”
On December 2, 1998, Michael Berwind sent a memorandum to
David Berwind, Linda Berwind Shappy, and Gail Berwind Warden. The
memorandum, entitled “BPSI Valuation”, stated that “Berwind”
(probably meaning Berwind Corporation or Berwind Group Partners)
had made various offers to buy the BPSI stock owned by the David
Berwind Trust. The memorandum explained that the David Berwind
Trust was in the process of supplying data to Merrill Lynch to “obtain
an independent valuation” (of the BPSI stock). The memorandum also
explained that “our stated objective” is “to gain liquidity by selling our
shares in BPSI at a price on the lower end of fair.”
22
[*22] On July 27, 1999, Merrill Lynch prepared a report to the David
Berwind Trust stating that the value of the trust’s 16.4% interest in
BPSI was in the range of $68.2 to $93.3 million.
On August 11, 1999, Edward Kosnik, the President and Chief
Operating Officer of Berwind Corporation and a member of BPSI’s board
of directors, sent a letter to the David Berwind Trust. The letter stated
that over the last few years BPSI had been negotiating with the David
Berwind Trust for BPSI to redeem the trust’s shares in BPSI. The letter
stated that the redemption would be in the interests of the trust by
allowing it to “diversify its holdings and liquefy a deep minority equity
investment.” The letter further stated:
We very much would like to negotiate a mutually
satisfactory purchase/sale, but we are prepared to start a
process that will result in our ownership of 100% of BPSI
at a price to be determined by us and our financial advisors.
This will be a costly, time-consuming and legalistic process
that we would prefer to avoid, but one that we are prepared
to undertake, if necessary. . . . [I]f we don’t hear from you
by September 7, 1999, we will start down our path with the
intention of completing a transaction by year end.
On August 30, 1999, as part of its internal discussions of the value
of the David Berwind Trust’s interest in BPSI stock, BPSI sent to its
counsel, Howard Meyers of Morgan Lewis & Bockius, three possible
valuations of the interest. These valuations were:
Source of valuation Valuation method Value
1999 budget 15 times net income from $78,767,000
operations
1998 actual 15 times net income from $66,504,000
operations
1997 March forecast 20 times net income from $51,534,000
operations minus 25%
minority discount
The parties in the present case do not take a position on how
exactly these valuations take into account (1) the value of BPSI’s
preferred stock interest in ZYAC Holding, (2) the value of the note issued
by ZYAC Holding to BPSI, or (3) the earnings of Zymark.
23
[*23] By October 27, 1999, the David Berwind Trust had retained
Justin Klein of the Ballard Spahr law firm to represent it with respect
to the acquisition by BPSI of the trust’s shares of BPSI.
On October 27, 1999, Michael Berwind wrote a memorandum to
Klein, Russell Shappy, and Pawson stating that for the “David Berwind
Family” the “current minimum acceptable base value” of “BPSI” was
$135 million before any “[a]djustment[ ]” for “Zyac Holding Company.”
The $135 million amount was purportedly based on a “[m]ultiple of
earnings” of “27.5.”
On November 5, 1999, BPSI filed with the Pennsylvania
Department of State a statement of correction to its articles of
incorporation. The statement of correction added provisions governing
the redemption of preference stock. The added provisions were similar
to the provisions governing the redemption of preferred stock in the
articles of incorporation of BPSI, quoted in FINDINGS OF FACT, Part
4, supra. The provisions in the statement of correction were:
The Company [BPSI], by action of its Board of Directors,
subject to the terms and conditions upon which shares of
any particular series are subject to redemption, may
redeem the whole or any part of . . . the [p]reference [s]tock,
at any time or from time to time, by paying in cash the
redemption price for the shares . . . fixed therefor as herein
provided, together with accrued but unpaid dividends to
the date fixed for such redemption. Notice of every such
redemption shall be given at least thirty (30) days and not
more than ninety (90) days prior to the date fixed for such
redemption by hand delivery or first class mail, to the
holders of record of the shares of the [p]reference [s]tock so
to be redeemed, at their respective addresses as the same
shall appear on the books of the Company . . . The Board of
Directors shall have full power and authority, subject to
the limitations and provisions herein contained, to
prescribe the manner in which and the terms and
conditions upon which the shares of the [p]reference [s]tock
shall be redeemed from time to time. If such notice of
redemption shall have been duly given and if on or before
the redemption date specified in such notice all funds
necessary for such redemption shall have been set aside by
the Company, separate and apart from its other funds, in
trust for the account of the holders of the shares of
24
[*24] [p]reference [s]tock to be redeemed, so as to be and
continue to be available therefor, then, notwithstanding
that any certificate for shares of [p]reference [s]tock so
called for redemption shall not have been surrendered for
cancellation, from and after the date fixed for such
redemption, the shares represented thereby shall no longer
be deemed outstanding, the right to receive dividends
thereon shall cease to accrue and all rights with respect to
such shares so called for redemption shall forthwith on
such redemption date cease and terminate, except only the
right of the holders thereof to receive, out of the funds so
set aside in trust, the amount payable upon the redemption
thereof, without interest.
On November 5, 1999, BPSI filed with the Pennsylvania
Department of State a statement of correction to its articles of
incorporation. The statement of correction added provisions governing
the redemption of preferential stock. The added provisions were similar
to the provisions governing the redemption of preferred stock in the
articles of incorporation of BPSI quoted in FINDINGS OF FACT, Part 4,
supra. The provisions in the statement of correction were:
The Company [BPSI], by action of its Board of Directors,
subject to the terms and conditions upon which shares of
any particular series are subject to redemption, may
redeem the whole or any part of . . . the [p]referential
[s]tock, at any time or from time to time, by paying in cash
the redemption price for the shares . . . fixed therefor as
herein provided, together with accrued but unpaid
dividends to the date fixed for such redemption. Notice of
every such redemption shall be given at least thirty (30)
days and not more than ninety (90) days prior to the date
fixed for such redemption by hand delivery or first class
mail, to the holders of record of the shares of the
[p]referential [s]tock so to be redeemed, at their respective
addresses as the same shall appear on the books of the
Company . . . The Board of Directors shall have full power
and authority, subject to the limitations and provisions
herein contained, to prescribe the manner in which and the
terms and conditions upon which the shares of the
[p]referential [s]tock shall be redeemed from time to time.
If such notice of redemption shall have been duly given and
if on or before the redemption date specified in such notice
25
[*25] all funds necessary for such redemption shall have been set
aside by the Company, separate and apart from its other
funds, in trust for the account of the holders of the shares
of [p]referential [s]tock to be redeemed, so as to be and
continue to be available therefor, then, notwithstanding
that any certificate for shares of [p]referential [s]tock so
called for redemption shall not have been surrendered for
cancellation, from and after the date fixed for such
redemption, the shares represented thereby shall no longer
be deemed outstanding, the right to receive dividends
thereon shall cease to accrue and all rights with respect to
such shares so called for redemption shall forthwith on
such redemption date cease and terminate, except only the
right of the holders thereof to receive, out of the funds so
set aside in trust, the amount payable upon the redemption
thereof, without interest.
On November 18, 1999, Klein (counsel to the David Berwind
Trust) sent a letter to Meyers (counsel to BPSI) transmitting proposed
confidentiality agreements under which the David Berwind Trust’s
advisors would be prohibited from disclosing financial information about
BPSI. The purpose of the confidentiality agreements was to facilitate
the disclosure of BPSI financial information to the David Berwind
Trust’s advisors so the trust could negotiate the sale of its shares of
BPSI. Klein’s letter enclosed a “draft time table for this transaction.”
Klein’s letter stated that the draft timetable was based on a November
15, 1999 telephone conversation between Klein and Meyers. 8 The letter
stated: “We would also reiterate our request that you agree that BPSI
will not take action to consummate a merger prior to January 31, 2000
and to notify our clients at least ten days in advance of such merger. We
would, of course agree that during the time prior to such notice, our
clients would not initiate any legal process.” The letter stated that
enclosed with the letter was “an agreement embodying these terms.”
However, the record does not contain a copy of the agreement. Nor does
the record contain a copy of the proposed confidentiality agreements or
the draft timetable.
On November 19, 1999, Meyers responded to Klein’s letter.
Meyers enclosed “a letter agreement that I have been authorized to
execute on behalf of Berwind Group Partners and Berwind
8 Besides the November 18, 1999 letter from Klein, there is little in the record
about the November 15, 1999 telephone conversation.
26
[*26] Pharmaceutical Services, Inc.” Meyers stated that the proposed
confidentiality agreements that Klein had enclosed with his letter were
unacceptable but asked Klein to call him promptly to discuss the “proper
form” of the confidentiality agreements. The proposed agreement
attached to Meyers’ letter provided that BPSI would not take any action
to institute a merger until January 31, 2000. The proposed agreement
would bar the David Berwind Trust from instituting any legal
proceeding prior to January 31, 2000. The proposed agreement stated
that Berwind Group Partners and BPSI desired to work with the David
Berwind Trust to strike a “mutually acceptable agreement for the
acquisition of the [BPSI] stock owned by the Trust.” The proposed
agreement contained a time schedule for negotiating the acquisition
agreement. Under the time schedule, a final agreement would be
executed on or before January 31, 2000. The proposed agreement
contained a signature line that permitted Klein to accept it on behalf of
the David Berwind Trust. The proposed agreement was never executed.
8. Under Pennsylvania law regarding short-form mergers, a parent
corporation may merge with its 80%-owned subsidiary without a vote
by the subsidiary’s other shareholders; however, these shareholders
have the right to demand the fair market value of their shares.
The David Berwind Trust correctly anticipated that BPSI would
attempt to eliminate its BPSI shares through a short-form merger.
The mechanics of a short-form merger under Pennsylvania law,
and the remedies available to a dissenting shareholder, are discussed
below.
The provisions governing a short-form merger are in the
Pennsylvania Business Corporation Law of 1988. Hereafter we refer to
the Pennsylvania Business Corporation Law of 1988 as the BCL. The
BCL consists of §§ 1101 to 4162 of title 15 of Pennsylvania’s
Consolidated Statutes. 15 Pa. Cons. Stat. § 1101 (West 1995). When we
cite to a provision of the BCL we give the particular section of title 15 of
Pennsylvania’s Consolidated Statutes to which the provision
corresponds. The provisions of the BCL to which we refer are in the
version of the BCL enacted by the General Association Act of 1988, 1988
Pa. Laws 1444, as amended by the GAA Amendments Act of 1990, 1990
Pa. Laws 834, and as amended by the GAA Amendments Act of 1992,
1992 Pa. Laws 1333, but before any amendments by the GAA
Amendments Act of 2001, 2001 Pa. Laws 418, and before subsequent
amendments. One notable set of subsequent amendments was made by
27
[*27] the Association of Transactions Act, 2014 Pa. Laws 2640. The act
repealed, reorganized, and modified the provisions in BCL §§ 1921–1966
and codified them in the BCL with new section numbers. See BCL
§ 1101(a). BCL § 1921(a) provides that two corporations may, “in the
manner provided” in subchapter C of the BCL (i.e., §§ 1921 to 1932 of
the BCL), be merged into one of the corporations, which is referred to as
the “surviving corporation”. BCL § 1921(a). The provisions in
subchapter C of the BCL set forth five steps for effecting a merger
between two corporations:
BCL § 1922(a) A plan of merger must be prepared.
BCL § 1922(c) The plan of merger must be approved by each
corporation’s board of directors and submitted
to the shareholders of each corporation for a
shareholder vote.
BCL § 1924 The plan of merger must be adopted by the
shareholders of each corporation by a
majority vote.
BCL § 1926 Articles of merger must be executed by each
corporation.
BCL § 1927 The articles of merger must be filed.
We now discuss these steps in detail.
BCL § 1922(a) requires that “[a] plan of merger . . . shall be
prepared” (in the event of a merger). The plan of merger must set forth
the terms and conditions of the merger. BCL § 1922(a)(1). The plan of
the merger also must set forth the changes, if any, that would be made
in the articles of incorporation of the surviving corporation. BCL
§ 1922(a)(2)(i). The plan of the merger also must set forth
[t]he manner and basis of converting the shares of each
corporation into shares or other securities or obligations of
the surviving . . . corporation, as the case may be, and, if
any of the shares of any of the corporations that are parties
to the merger . . . are not to be converted solely into shares
or other securities or obligations of the surviving . . .
corporation, the shares or other securities or obligations of
any other person or cash, property or rights that the
28
[*28] holders of such shares are to receive in exchange for, or
upon conversion of, such shares . . . .
BCL § 1922(a)(3).
BCL § 1922(c) provides that “[e]very merger . . . shall be proposed
in the case of each . . . corporation by the adoption by the board of
directors of a resolution approving the plan of merger.” The same
subsection further provides that “the board of directors shall direct that
the plan [of merger] be submitted to a vote of the shareholders entitled
to vote” unless approval of the shareholders is unnecessary under
subchapter C of the BCL (i.e., §§ 1921 to 1932 of the BCL).
BCL § 1924(a) and (b) requires a plan of merger be adopted by
each merging corporation and specifies how the plan of merger is
adopted:
(a) General rule.—The plan of merger . . . shall be
adopted upon receiving . . . a majority of the votes cast by
all shareholders entitled to vote thereon of each . . .
corporation[] that is a party to the merger . . . and, if any
class or series of shares is entitled to vote thereon as a class
. . . a majority of the votes cast in each class vote . . . . A
proposed plan of merger . . . shall not be deemed to have
been adopted by the corporation unless it has also been
approved by the board of directors, regardless of the fact
that the board has directed or suffered the submission of
the plan to the shareholders for action.
(b) Adoption by board of directors.—
(1) Unless otherwise required by its bylaws, a
plan of merger . . . shall not require the approval of the
shareholders of a . . . corporation if:
....
(ii) immediately prior to the adoption of
the plan and at all times thereafter prior to its
effective date, another corporation that is a party to
the merger . . . owns directly or indirectly 80% or
more of the outstanding shares of each class of the
corporation; or . . .
....
(3) If a merger . . . of a subsidiary corporation
with a parent corporation is effected pursuant to
paragraph (1)(ii), the plan of merger . . . shall be deemed
adopted by the subsidiary corporation when it has been
29
[*29] adopted by the board of the parent corporation and
execution of articles of merger . . . by the subsidiary
corporation shall not be necessary.
The exception found in BCL § 1924(b)(1)(ii) applies if the parent
corporation owns 80% of each class of shares of the subsidiary. When
BCL § 1924(b)(1)(ii) was originally enacted by the General Association
Act of 1988, Act No. 1988-177, the relevant percentage was 90%. 1988
Pa. Laws 1444, at 1566. The percentage was changed to 80% by the
GAA Amendments Act of 1992, 1992 Pa. Laws 1333, at 1343, 1372,
effective 60 days after December 18, 1992. It is this percentage
threshold that governs the short-form merger by BPSI.
The effect of BCL § 1924(b)(1)(ii) is that for a parent to merge with
its 80%-owned subsidiary, there is no requirement that the merger be
approved by the shareholders of the subsidiary absent such a
requirement in the subsidiary’s bylaws. Furthermore, BCL
§ 1924(b)(1)(ii) and (iii) has been interpreted by some commentators to
mean that such a merger need not be approved by (1) the board of
directors of the subsidiary or (2) the shareholders of the parent. Rafael
A. Porrata-Dorias, Jr., The Proposed Pennsylvania Business
Corporation Law: A Horse Designed By Committee, 59 Temple L.Q. 437,
449 (1986) (“Finally, the New BCL provides that a parent corporation
that owns ninety percent or more of the stock of a subsidiary, directly or
indirectly, may merge with the subsidiary without the approval either
of the shareholders of the parent corporation, or of the board of directors
or shareholders of the subsidiary. [fn: New BCL Section
1924(b)(1)(ii).]”); Vincent F. Garrity, Jr. & Sandra A. Ballard, What the
General Practitioner Should Know About Pennsylvania’s New Business
Corporation Law, 61 Pa. Bar Ass’n Q. 23, 24 (Jan. 1990) (“SHORT
FORM MERGERS. The 1988 BCL authorizes a parent corporation’s
board to effect a merger with a 90%-owned subsidiary without obtaining
the approval of the subsidiary’s board or the parent’s shareholders,
similar to current Delaware law (§ 1924(b)).”) 9 Cautious practitioners
9 The parties have stipulated that under a short-form merger a “shareholder
vote” is not required, but it is unclear whether the stipulation is referring to a vote of
the shareholders of the subsidiary or a vote of the shareholders of both the parent and
the subsidiary. Here is the text of the stipulation:
The BCL provided that, generally, a corporate merger was to be
adopted by the affirmative vote of a majority of the shareholders
entitled to such a vote. See BCL section 1924(a). However, the BCL
also provided a procedure often referred to as a “short-form-merger,”
30
[*30] might have advised their clients to secure both types of approvals
anyway. 10
A merger governed by BCL § 1924(b)(1)(ii) is referred to as a
“short-form merger.” Warden v. McLelland, 288 F.3d 105, 116 (3d Cir.
2002).
BCL § 1926 provides that “[u]pon the adoption of the plan of
merger . . . by the corporations desiring to merge”, each corporation must
execute articles of merger except as provided in BCL § 1924(b)(3). The
articles of merger must set forth (1) the plan of merger, (2) the effective
date of the plan of merger (if the plan of merger is to be effective on a
specified date), and (3) certain other information. Id.
BCL § 1928 provides that “[u]pon the filing of the articles of
merger . . . in the Department of State or upon the effective date
specified in the plan of merger . . ., whichever is later, the merger . . .
shall be effective.”
BCL § 1929 provides that “[u]pon the merger . . . becoming
effective”, the two corporations that are parties to the merger will be a
single corporation that is the corporation designated in the plan of
merger as the surviving corporation and the existence of the other
corporation shall cease.
Figure 6 illustrates the steps necessary to effectuate a merger of
corporations A and B when neither corporation owns 80% of the shares
of the other.
by which the board of directors of a parent corporation owning 80
percent or more of the outstanding shares of each class of stock of a
corporation (the “merging corporation”) could adopt a plan of merger
and potentially eliminate a minority shareholders’ interest in the
merging corporation without a shareholder vote. See BCL section
1924(b).
10 In 2001, BCL § 1924(b)(3) was amended to expressly provide that if a merger
is effected pursuant to BCL § 1924(b)(1)(ii), “approval of the plan by the board of
directors of the subsidiary corporation . . . shall not be necessary.” GAA Amendments
Act of 2001, P.L. 418, No. 34, § 3. The amendment was effective 60 days after June 22,
2001.
31
[*31] Figure 6
Steps required for merger of corporations A and B
Plan of merger prepared
(BCL § 1922)
Board A approves plan of Board B approves plan of
merger (BCL § 1922(c)) merger (BCL § 1922(c))
Board A submits plan of Board B submits plan of
merger to shareholders for merger to shareholders for
vote (BCL § 1922(c)) vote (BCL § 1922(c))
Shareholders of A approve Shareholders of B approve
plan of merger by vote plan of merger by vote
(BCL § 1924(a)) (BCL § 1924(a))
Plan of merger considered Plan of merger considered
adopted by A adopted by B
(BCL § 1924(a)) (BCL § 1924(a))
Articles of merger executed Articles of merger executed
by A (BCL § 1926) by B (BCL § 1926)
Articles of merger filed with Secretary
of State (BCL § 1927)
Merger is effective on date specified in
plan of merger
(BCL § 1928)
32
[*32] When A owns 80% of the shares of B, a merger of the two
corporations is a short-form merger governed by BCL § 1924(b)(1)(ii).
Figure 7 illustrates the steps necessary to effectuate a merger of A and
B when A owns 80% of the shares of B.
33
[*33] Figure 7
Steps required for merger of corporations A and B (where A owns ≥ 80% of B)
Plan of merger prepared
(BCL § 1922)
Board A approves plan of Board B approves plan of
merger (BCL § 1922(c)) merger (BCL § 1922(c))
Board A submits plan of Submission to B’s shareholders
merger to shareholders for not required unless required by
vote (BCL § 1922(c)) bylaws (BCL § 1922(c))
Shareholders of A approve Approval by B’s shareholders
plan of merger by vote not required unless required by
(BCL § 1924(a)) bylaws
(BCL § 1924(b)(1)(ii))
Plan of merger considered Plan of merger considered
adopted by A adopted by B (BCL §1924(a))
(BCL § 1924(a))
Articles of merger executed Execution of articles of merger
by A (BCL § 1926) by B not required
(BCL § 1924(b)(3))
Articles of merger filed with
Secretary of State (BCL § 1927)
Merger is effective on date specified
in plan of merger
(BCL § 1928)
34
[*34] Figure 7 assumes that the plan of merger must be approved by the
board of directors of B and by the shareholders of A. However, as
discussed earlier, some commentators believe that approvals by the
board of directors of the subsidiary and by the shareholders of the parent
are unnecessary. Because both such approvals were made of the merger
at issue in the present case, we need not decide if they were necessary.
On a parallel track with the procedures for merging two
corporations discussed so far, there are provisions for dissenters rights
set forth in BCL §§ 1571 through 1580.
BCL § 1571(a) provides that “any shareholder of a . . . corporation
shall have the right to dissent from, and to obtain payment of the fair
value of his shares in the event of, any corporate action, or to otherwise
obtain fair value for his shares, where this part [BCL §§ 1101–4162]
expressly provides that a shareholder shall have the rights and remedies
provided in this subchapter [BCL §§ 1571–1580].” One of the provisions
of “this part” (BCL §§ 1101–4162) is BCL § 1930(a).
BCL § 1930(a) provides that “[i]f any shareholder of a . . .
corporation that is to be a party to a merger . . . objects to the plan of
merger . . . and complies with the provisions of Subchapter D of Chapter
15 [§§ 1571–1580 of the BCL] (relating to dissenters rights), the
shareholder shall be entitled to the rights and remedies of dissenting
shareholders therein provided, if any.” See also BCL § 1571(a) (second
sentence) (giving 13 examples from “this part” (15 Pa. Stat. and Cons.
Stat. Ann. §§ 501–7701 (West 1995 & 2012 Cum. Ann. Pocket Pt.)) of
provisions granting a shareholder the rights and remedies provided in
subchapter D of chapter 15 of the BCL (BCL §§ 1571–1580); one of the
13 examples is BCL § 1930). Therefore, a shareholder of a corporation
that merges with another corporation has the rights and remedies set
forth in §§ 1571–1580 of the BCL. BCL §§ 1571–1580, which we
summarize in relevant part here, employ the term “dissenter” to mean
a “shareholder . . . who is entitled to and does assert dissenters rights
under this subchapter [BCL §§ 1571–1580] and who has performed
every act required up to the time involved for the assertion of those
rights.”
BCL § 1574 provides that if the proposed corporate action of the
type that must be approved by a vote at a shareholder meeting (such as
a long-form merger), the shareholder wishing to receive payment for
shares must (1) before the vote, file with the corporation a written notice
of intention to demand payment of the fair value of shares if the
35
[*35] proposed action is effectuated and (2) refrain from voting in favor
of the proposed corporate action. The corporation must send a notice to
demand payment to all shareholders who filed the notice of intention to
demand payment and who refrained from voting in favor of the proposed
corporation action. BCL § 1575(a). BCL § 1575(a) provides that if the
proposed corporate action is to be taken without a vote of the
shareholders (such as a plan of merger governed by the short-form-
merger provision of BCL § 1924(b)(1)(ii) as to the subsidiary’s
shareholders), the corporation must send the notice to demand payment
(which must be accompanied by a notice that the corporation action was
adopted) to “all shareholders who are entitled to dissent and demand
payment of the fair market value of their shares.”
For both types of proposed actions (i.e., those that require a vote
of the shareholders and those that don’t) the notice to demand payment
must “[s]tate where and when a demand for payment must be sent and
certificates for certificated shares must be deposited in order to obtain
payment.” BCL § 1575(a). The deadline for demanding payment and
depositing shares set forth in the notice to demand payment must be 30
days or more after the mailing date of the notice to demand payment.
BCL § 1575(b). BCL § 1576(a) provides that a “shareholder who fails to
timely demand payment, or fails . . . to timely deposit certificates, as
required by a notice pursuant to section 1575 (relating to notice to
demand payment) shall not have any right under this subchapter [BCL
§§ 1571–1580] to receive payment of the fair value of his shares.” 11
BCL § 1577(c) provides that “[p]romptly after effectuation of the
proposed corporate action [such as a merger, see BCL § 1571(a), 1930(a)]
or upon timely receipt of demand for payment if the corporate action has
already been effectuated, the corporation shall either remit to dissenters
who have made demand and . . . have deposited their [share] certificates
the amount that the corporation estimates to be the fair value of the
shares, or give written notice that no remittance under this section will
be made.” 12 Under BCL § 1577(c)(1), (2), and (3), respectively, the
remittance, or the notice of no remittance, as the case may be, must be
accompanied by (1) the corporation’s latest financial statements, (2) a
11 Such a shareholder “shall retain all other rights of a shareholder until those
rights are modified by effectuation of the proposed corporate action.” BCL § 1576(c).
12 BCL § 1577(a) provides that if the corporation fails to effectuate the
“proposed corporate action” (such as a merger) within 60 days from the deadline for
demanding payment and depositing shares, then it must return the deposited shares
to the dissenting shareholder.
36
[*36] statement of the corporation’s estimate of the value of the
shares, 13 and (3) a notice of the right of the dissenter to demand
supplemental payment. Additionally, if the corporation notifies the
dissenting shareholders that it will not make a remittance, it (1) must
return the deposited shares and (2) “may make a notation” on the share
certificate that the shareholder had demanded payment. BCL § 1577(d).
BCL § 1578(a) provides that if the corporation remits payment of its
estimate of the value of the dissenter’s shares, or if the corporation
notifies the dissenting shareholder it will not remit payment and states
its estimate of the value of the shares, and the dissenting shareholder
believes the amount estimated or remitted is less than the value of the
shares, the dissenting shareholder may send to the corporation his or
her own estimate of the value of the shares, “which shall be deemed a
demand for payment of the amount or the deficiency.” If the dissenting
shareholder does not send the corporation such a dissenters estimate,
he or she is entitled only to the corporation’s remittance or estimate of
value. BCL § 1578(b). 14 BCL § 1579(a) provides that, within 60 days of
the later of (1) effectuation of the proposed corporate action, (2) timely
receipt of any demands for payment, or (3) the timely receipt of any
dissenter’s estimates pursuant to BCL § 1578(a), if the demand for
payment remained unsettled, the corporation may file an application for
relief in the Pennsylvania Court of Common Pleas requesting “in the
name of the corporation” that the fair value of the shares be determined
by the court. In such an appraisal proceeding, the Pennsylvania Court
of Common Pleas may appoint an appraiser to take evidence and to
13 When, under BCL § 1577(c), the corporation remits payment to the
shareholders, the amount of that remittance is to be equal to the corporation’s estimate
of the fair value of the shares. Thus, in those instances in which the corporation
chooses to remit to dissenters the amount the corporation estimates to be the fair value
of the shares, BCL § 1577(c)(2) somewhat redundantly requires the corporation to
include with the remittance a statement of the corporation’s estimate of the fair value
of the shares.
14 The legislative history explains the process as follows:
A dissenter to whom the corporation has made payment (or who has
been offered payment) must make his supplemental demand within 30
days after receipt of the payment (or offer of payment) in order to
permit the corporation to make an early decision on initiating
appraisal proceedings. If he fails to do so, he loses the right to demand
additional payment.
Amended Committee Comment—1990, as printed in 15 Pa. Cons. Stat. Ann. § 1578
(1995).
37
[*37] recommend a value. BCL § 1579(c). The dissenting shareholder 15
is entitled to “recover the amount by which the fair value of his shares
is found to exceed the amount, if any, previously remitted, plus interest.”
BCL § 1579(d). For this purpose, “interest” is defined in BCL § 1572 as
follows:
Interest from the effective date of the corporate action until
the date of payment at such rate as is fair and equitable
under all the circumstances, taking into account all
relevant factors, including the average rate currently paid
by the corporation on its principal bank loans.
If the corporation fails to file an application for relief within the 60-day
period specified by BCL § 1579(a), any dissenting shareholder who had
made an as-yet-unsettled demand for payment for shares may file an
application for relief on behalf of the corporation within 30 days after
the expiration of the 60-day period. BCL § 1579(e). BCL § 1579(e)
provides: “If a dissenter does not file an application within the 30-day
period, each dissenter entitled to file an application shall be paid the
corporation’s estimate of the fair value of the shares and no more, and
may bring an action to recover any amount not previously remitted.”
BCL § 1105 limits the rights of a minority shareholder whose
shares are or would be eliminated by a merger. It provides:
A shareholder of a business corporation shall not have any
right to obtain, in the absence of fraud or fundamental
unfairness, an injunction against any proposed plan . . .
authorized under any provision of this subpart [BCL §§
1101–4162], nor any right to claim the right to valuation
and payment of the fair value of his shares because of the
plan . . . except that he may dissent and claim such
payment if and to the extent provided in Subchapter D of
Chapter 15 (relating to dissenters rights) [BCL §§ 1571–
1580] where this subpart [BCL §§ 1101–4162] expressly
provides that dissenting shareholders shall have the rights
and remedies provided in that subchapter. Absent fraud
or fundamental unfairness, the rights and remedies so
provided shall be exclusive. Structuring a plan or
transaction for the purpose or with the effect of eliminating
15 All dissenters whose demands had not been settled are joined to the
proceeding. BCL § 1579(b).
38
[*38] or avoiding the application of dissenters rights is not fraud
or fundamental unfairness within the meaning of this
section.
BCL § 1105 refers to a “proposed plan . . . authorized under any provision
of this subpart.” This term includes a plan of merger. This is because
the provisions of “this subpart”, i.e., BCL §§ 1101–4162, include (1) BCL
§ 1921(a), which authorizes the merger of two corporations, and (2) BCL
§ 1922, which requires a plan of merger to be prepared. Thus BCL
§ 1105 limits the rights of a minority shareholder in a merger.
The dissenters-rights procedure for a corporation that has
adopted a plan of merger without the requirement of a shareholder vote
is illustrated as follows:
39
[*39] Figure 8
Dissenters-rights procedures for shareholders of a corporation that has adopted a
plan of merger without a shareholder vote
Corporation sends shareholder
notice of adoption of plan of
merger with deadline for
depositing shares and demanding
payment (BCL § 1575(a))
Shareholder deposits Shareholder does not respond.
shares and demands Shareholder forfeits right to receive
payment for shares payment for shares (BCL § 1576(a))
(BCL § 1575(a), (b))
Corporation remits to Corporation notifies shareholder
shareholder its estimate of its share value; returns shares;
of value of shares may make notation on returned
(BCL § 1577(c)) shares (BCL § 1577(d))
Shareholder may send If shareholder does Shareholder may send If shareholder does not
higher estimate to not send higher higher estimate of send higher estimate,
corporation within 30 estimate, shareholder value to corporation shareholder entitled to
days (BCL § 1578(a)) entitled only to the within 30 days only the amount of
amount remitted (BCL § 1578(a)) corporation’s estimate
(BCL § 1578(b)) (BCL § 1578(b))
If after 60 days any shareholder’s
demand for payment remains
unsettled, the corporation may
file suit in Pennsylvania Court of
Common Pleas to determine value
of shares
(BCL § 1579(a))
40
[*40] 9. In December 1999, a short-form merger was formalized
between BPSI and its newly formed parent corporation, but
this merger was challenged by the David Berwind Trust, which
also asserted its right to receive the fair market value of its
BPSI shares.
On November 22, 1999, four trustees of the David Berwind Trust
filed a Complaint for Equitable and Legal Relief in the U.S. District
Court for the Eastern District of Pennsylvania. The four trustees were
Gail Berwind Warden, Linda Berwind Shappy, Michael Berwind, and
David Berwind. The action was captioned Gail B. Warden, et al. v. M. B.
McLelland et al., Civil Action No. 99-CV-5797 (E.D. Pa. 1999). We refer
to this action as the “Warden litigation.” 16
The action was brought on behalf of the David Berwind Trust and
derivatively on behalf of BPSI. 17 The defendants were (1) eight present
or former directors of BPSI (including Graham Berwind), 18 (2) Berwind
Corporation, (3) Berwind Group Partners, (4) Graham Berwind (in his
capacity as alleged trustee of the David Berwind Trust), and
(5) McKenney (in his capacity as alleged trustee of the David Berwind
Trust). In the complaint, the plaintiffs alleged that the resignations of
both Graham Berwind and McKenney as trustees of the David Berwind
Trust were invalid because neither Graham nor McKenney named two
or more successor trustees (as required by the David Berwind Trust deed
of trust). Based on this alleged invalidity of their resignations, the
David Berwind Trust argued Graham Berwind and McKenney were still
16 Gail Berwind Warden, the lead plaintiff, was a daughter of David Berwind
and one of the trustees of the David Berwind Trust. As discussed later, the Warden
litigation would later be consolidated with another action we will refer to as the
“appraisal proceeding”.
17 The David Berwind Trust was a shareholder in BPSI, and therefore its
trustees were entitled to bring shareholder-derivative claims on behalf of BPSI.
Counts I through V were shareholder-derivative claims. A shareholder-derivative
claim is a “corporate claim that a shareholder may assert only derivatively on behalf
of the corporation.” Deborah A. DeMott, Shareholder Deriv. Actions L. & Prac. § 2:2
(2022–2023). The claim is property of the corporation. Id. (“Claims or causes of action
that constitute property of the corporation do not belong to its shareholders
individually; nor do corporate claims become the property of the shareholder who acts
as plaintiff in a derivative action . . . [I]n virtually all instances, any judgment
recovered in the action and any settlement amount go to the corporation rather than
to the plaintiff or other individual stockholders.”) (Footnotes omitted).
18 The present or former directors of BPSI named as defendants were Michael
B. McLelland, John J. Byrne, Jr., J.S. Dulaney, James L. Hamling, Edward F. Kosnik,
Lawrence C. Karlson, Robert M. Cohn, and Graham Berwind.
41
[*41] trustees of the David Berwind Trust at the time the merger took
place and that they breached a fiduciary duty owed to the David
Berwind Trust by attempting to have the David Berwind Trust sell its
stock to BPSI.
The complaint alleged ten different claims designated as “counts”.
Count I alleged that the defendants engaged in a pattern of
activity constituting mail and wire fraud and that this pattern was a
racketeering offense under 18 U.S.C. § 1962(c). Count I specifically
referred to seven separate communications from the defendants that
allegedly constituted mail and wire fraud. For example, Count I alleged
that the August 11, 1999 letter from Kosnik to David Berwind was
fraudulent. Count I was a shareholder-derivative claim. Count I sought
treble damages.
Count II alleged the defendants engaged in a conspiracy to
commit racketeering under 18 U.S.C. § 1962(d) as to the same conduct
alleged in Count I. Count II was a shareholder-derivative claim. Count
II sought treble damages.
Count III alleged that the BPSI board of directors usurped a
corporate opportunity of BPSI by allowing BPSI assets to purchase
equity interests in Zymark to be held by Berwind Group Partners and
Berwind Corporation. This claim was a shareholder-derivative claim for
monetary damages.
Count IV was a claim that BPSI’s board of directors violated their
fiduciary duty to BPSI through the following actions: (1) causing BPSI
to provide equity financing and loan collateral to Berwind Aviation,
which was allegedly “a holding entity for jet aircraft used substantially
by [Graham] Berwind and his family for personal travel,” (2) causing
BPSI to pay excess amounts, including management fees, to Berwind
Corporation, and (3) causing BPSI to make loans to Berwind Group
Partners and Berwind Corporation at below market interest rates. This
claim was a shareholder-derivative claim for monetary damages.
Count V was a claim that Berwind Group Partners and Berwind
Corporation aided and abetted the breach of fiduciary duty of loyalty by
the BPSI board of directors alleged in Count IV. This was a shareholder-
derivative claim for monetary damages.
Count VI was a claim for equitable relief to enjoin Berwind Group
Partners and the BPSI board of directors from taking steps to affect the
42
[*42] David Berwind Trust’s minority shareholder interest in BPSI or
the standing of the David Berwind Trust to assert the shareholder-
derivative claims in the complaint. The relief was requested to remedy
the Berwind Group Partners and BPSI board of directors’ alleged
violation of their fiduciary obligations to the David Berwind Trust as a
shareholder in BPSI. In particular, Count VI alleged that that they
refused to provide the David Berwind Trust with information concerning
BPSI’s operations and assets sufficient to form a fair valuation of the
minority interest in BPSI, and are using the squeeze-out merger to
defraud the David Berwind Trust, deprive it of the value of its BPSI
shares, and prevent it from asserting the shareholder-derivative claims
in the complaint.
Count VII was a claim for equitable relief to require Berwind
Partners and the BPSI board of directors to provide an accounting of,
and information on, the operations and management of BPSI from
January 1, 1985.
Count VIII was a claim for equitable relief to rescind the squeeze-
out merger and grant David Berwind Trust an interest in “the corporate
entity into which BPSI or its assets has been merged.” The factual
theory underlying Count VIII was that the purpose of the squeeze-out
merger was to “prevent the David Berwind Trust from seeking legal
relief for the misappropriation of corporate opportunities, the misuse of
corporate assets, and breaches of fiduciary duty and breaches of trust
alleged herein.” The claim was brought against Berwind Group
Partners and the BPSI directors. Because the squeeze-out merger had
not yet occurred when this complaint was filed, Count VIII was
premature.
Count IX was a claim invoking the David Berwind Trust’s right
to a statutory appraisal under BCL § 1571(a) to receive the value of the
Davd Berwind Trust’s interest in BPSI. Because the squeeze-out
merger had not yet occurred when this complaint was filed, Count IX
was premature.
Count X was a claim that Graham Berwind and McKenney
breached their duties as trustees of the David Berwind Trust to
administer the trust solely in the interest of the beneficiaries. Count X
alleged that the resignations of Graham Berwind and McKenney as
trustees of the trust were ineffective. Count X alleged that there were
four types of conduct by which Graham Berwind and McKenney
breached their duties as trustees: (1) “usurping corporate opportunities
43
[*43] available to BPSI for the benefit of Berwind [Group] Partners,
Berwind [Corporation], and/or affiliates thereof,” (2) “using the assets of
BPSI for the benefit of Berwind [Group] Partners, Berwind
[Corporation], and/or affiliates thereof,” (3) “approving and/or ratifying
the squeeze-out merger of the interest of the David Berwind Trust in
BPSI,” and (4) “causing the interest of the David Berwind Trust in BPSI
to be eliminated for less than fair price.” This was a claim for monetary
damages. Also, the claim requested that the income from the alleged
breaches of duty be placed in a constructive trust.
During November and December of 1999, Berwind Group
Partners and Berwind Corporation took steps that were intended to
consolidate BPSI’s ownership entirely in Berwind Group Partners
through a short-form merger under BCL § 1924(b)(1)(ii).
In November 1999, BPSI’s counsel, Morgan Lewis, & Bockius, on
behalf of BPSI, retained Duff & Phelps “to determine the current fair
value of the common stock of [BPSI].” The resulting report, dated
December 15, 1999, stated that Duff & Phelps was an “independent
financial advisor.” The Duff & Phelps’ valuation report provided an
“Equity Value Range” of “$485,000,000 – $510,000,000” for BPSI and
the report provided a “valuation opinion” of $505,000,000 for BPSI’s
common stock, of which the David Berwind Trust held 16.4% as of
November 1999.
On December 10, 1999, Morris resigned as a trustee of the David
Berwind Trust. Pawson was designated to replace him. On December
28, 1999, Pawson accepted the appointment.
As of December 14, 1999, BPSI had four types of stock
outstanding: common, preferred stock, preference stock, and
preferential stock.
As of December 14, 1999, the David Berwind Trust owned 16.4%
of BPSI’s common stock while Berwind Group Partners owned the
remaining 83.6%. Berwind Corporation owned 100% of BPSI’s
outstanding shares of preferred stock (120,000 shares) and preference
stock (3,474,936 shares). Berwind Corporation owned 108,000 shares of
preferential stock, which was 18% of that class. Berwind Group
Partners owned 401,280 shares of preferential stock, which was 66.88%
of that class. Berwind Group Partners and Berwind Corporation owned,
collectively, 84.88% of BPSI’s preferential stock. The David Berwind
44
[*44] Trust and Graham Berwind owned 13.12% (78,720 shares) and 2%
(12,000 shares) of the preferential stock, respectively.
As of December 14, 1999, the percentage ownership of BPSI’s four
classes of stock was as follows:
Common Preferred Preference Preferential
Shareholder Stock Stock Stock Stock
David Berwind
Trust 16.4% — — 13.12%
Graham Berwind — — — 2%
Berwind Group 83.6% — — 66.88%
Partners
The Berwind Corp. — 100% 100% 18%
The record does not clarify when the owners of the preference
stock and preferential stock acquired their interests in these classes of
stock.
The corporate structure at this point (December 14, 1999) was as
follows:
45
[*45] Figure 9
Corporate Structure on Dec. 14, 1999
Graham Graham Graham David Berwind
Berwind Children Berwind Trust
Trust Trusts
47.528% 52.472% 2% preferential •16.4%
common
•13.12%
preferential
Berwind Group
Partners
100% common
•83.6% common
•66.88% preferential
100%
common Berwind
Corporation
•100% preferred
•100% preference
•1,000 Series A 8.75% •18% preferential
noncumulative •note
preferred (bought for
$10 million)
•$20 million note
BPSI
100% common
ZYAC Holding Colorcon, Inc.
100% interest
Zymark
46
[*46] On December 15, 1999, Berwind Group Partners formed BPSI
Acquisition with Berwind Group Partners as its sole shareholder.
On December 15, 1999, Berwind Group Partners and Berwind
Corporation transferred all of their shares of BPSI stock to BPSI
Acquisition through the following transfers:
• Berwind Group Partners contributed all of its BPSI common
and preferential stock to BPSI Acquisition; and
• Berwind Corporation transferred all of its BPSI preferred,
preference, and preferential stock to BPSI Acquisition in
exchange for notes.
After these transfers, the percentage ownership of BPSI’s four classes of
stock was as follows:
Common Preferred Preference Preferential
Shareholder Stock Stock Stock Stock
David Berwind Trust 16.4% — — 13.12%
Graham Berwind — — — 2%
BPSI Acquisition 83.6% 100% 100% 84.88%
The corporate structure thus looked like this:
47
[*47] Figure 10
Corporate structure after creation of BPSI Acquisition
Graham Graham
Berwind Children
Trust Trusts
52.472%
47.528%
Graham David Berwind
Berwind Trust
Berwind Group
Partners 53,200 common
(100%)
100%
stock 2% preferential •16.4%
Berwind common
Corporation •13.12%
preferential
100%
stock note
BPSI
Acquisition
•100% preferred
•100% preference
•84.88% preferential
•83.6% common
•1,000 Series A 8.75% BPSI
noncumulative
preferred
•$20 million note
ZYAC 100% common
Holding
100%
Zymark Colorcon, Inc.
48
[*48] On December 15, 1999, BPSI issued redemption notices to the
holders of its outstanding preferred, preference, and preferential stock.
The notices called for the redemption of their shares on January 15,
2000, a date referred to by the notices as the “redemption date.” The
notices stated that the redemption price was equal to (a) a fixed price
per share ($50 for preferred, $1 for preference, and $1 for preferential)
plus (b) “accrued but unpaid dividends to the [r]edemption [d]ate.” The
redemption notices stated that BPSI had deposited with First Union
National Bank a sum sufficient to pay the redemption price, with
irrevocable instructions to pay the redemption price to the holders upon
surrender of their stock certificates. The redemption notices stated that
as “a result of such action” 19 the shares of the preferred stock, preference
stock, and preferential stock, respectively, “shall no longer be
outstanding as provided in Section 1758(d) of the Pennsylvania
Business Corporation Law.” BCL § 1758(d) provides:
Unless otherwise provided in the articles, redeemable
shares that have been called for redemption shall not be
entitled to vote on any matter and shall not be deemed
outstanding shares after written notice has been mailed to
holders thereof that the shares have been called for
redemption and that a sum sufficient to redeem the shares
has been deposited with a specified financial institution
with irrevocable instruction and authority to pay the
redemption price to the holders of the shares on the
redemption date, in the case of uncertificated shares, or
upon surrender of certificates therefore in the case of
certificated shares, and the sum has been so deposited.
As explained above, BPSI’s articles of incorporation contain provisions
regarding the effect of redemption notices. FINDINGS OF FACT, Parts
4 (preferred stock) & 7 (preference and preferential stock), supra.
On December 15, 1999, a plan of merger of BPSI Acquisition into
BPSI, with BPSI as the surviving corporation, was approved by the
following entities:
• BPSI Acquisition’s board of directors;
19 The term “such action” apparently meant (1) mailing the redemption notices
and (2) making the deposits.
49
[*49] • BPSI Acquisition’s sole shareholder, Berwind Group Partners;
and
• BPSI’s board of directors.
The plan of merger was not submitted to the common shareholders of
BPSI for their approval because the merger was intended and
structured as a short-form merger under BCL § 1924(b).
The plan of merger contained the following statement about
BPSI’s preferred, preference, and preferential stock:
Berwind Pharmaceutical has previously issued notices of
redemption for the outstanding shares of the . . . [p]referred
stock, the . . . [p]reference stock, and the . . . [p]referential
stock and deposited a sum sufficient to pay the redemption
price in a financial institution with . . . instructions to pay
the redemption price to the holders thereof upon surrender
of the certificates therefor. Therefore, the [stock is] no
longer deemed outstanding, and [has] no rights with
respect to the transactions contemplated by this
Agreement and Plan of Merger.
(The plan of merger was self-titled “Agreement and Plan of
Merger.” The stipulation refers to the document as the “plan of
merger.”)
The plan of merger provided that when the articles of merger are
filed, the David Berwind Trust’s BPSI common stock “shall be converted
into the right to receive” a subordinated promissory note from BPSI in
the principal amount of $82,820,000 ($12,625 for each of its 6,560
shares), with all principal and 10% interest (compounded annually)
payable at December 31, 2001, and no payments due before that date.
The note was to be “subordinate and junior in right of payment . . . to all
existing and future indebtedness of the Company [BPSI], including . . .
trade payables.” The note was to be nonnegotiable: it would obligate
BPSI to make payment specifically to the David Berwind Trust. The
plan of merger also acknowledged that the David Berwind Trust had
“dissenters rights” under Pennsylvania law “to dissent from the Merger
and to obtain payment of the fair value of [its] shares . . . .”
The plan of merger provided that all shares of BPSI common stock
owned by BPSI Acquisition “shall be cancelled.”
50
[*50] The plan of merger provided that each share of BPSI Acquisition
common stock (all of which were held by Berwind Group Partners) shall
be converted into one share of common stock of BPSI.
The plan of merger was executed by one officer from BPSI and
one officer from BPSI Acquisition. The David Berwind Trust did not
execute the plan of merger and had no vote regarding its approval. The
David Berwind Trust contested the validity of the merger in the Warden
litigation.
On December 16, 1999, BPSI filed articles of merger with the
Secretary of State of Pennsylvania. The articles of merger stated that
BPSI had merged with BPSI Acquisition and that the surviving
corporation was BPSI. The articles of merger stated that the plan of
merger had been adopted by (1) BPSI Acquisition’s board of directors
through written consent of all board members, (2) BPSI Acquisition’s
sole shareholder (i.e., Berwind Group Partners) by written consent, and
(3) BPSI’s board of directors by written consent of all board members.
The plan of merger of BPSI Acquisition into BPSI, with BPSI as the
surviving corporation, was attached to (and incorporated into) the
articles of merger. The articles of merger stated that “[t]he plan of
merger shall be effective upon filing these Articles of Merger in the
Department of State.”
As explained before, the plan of merger of BPSI Acquisition into
BPSI provided that the David Berwind Trust’s common stock in BPSI
would be converted into an $82.82 million note from BPSI. Because the
David Berwind Trust contested the validity of the disputed merger and
because (as described later) it demanded cash payment for its BPSI
stock on January 26, 2000, the note was never issued to the David
Berwind Trust, and no payments were made with respect to the note.
The only payment received by the David Berwind Trust from BPSI on
or after December 16, 1999, was the redemption payment for its
preferential stock (which the David Berwind Trust received on April 4,
2000) and the payment received by the David Berwind Trust in late 2002
under the settlement agreement that is described later.
On or around December 17, 1999, BPSI issued to the David
Berwind Trust a notice to demand payment under BCL § 1575(a). The
notice to demand payment stated that to receive payment for its BPSI
common shares the trust must send a demand for payment to BPSI on
or before January 31, 2000, accompanied by the share certificates.
51
[*51] On January 4, 2000, the plaintiffs in the Warden litigation filed
an amended complaint with thirteen counts (the amended complaint).
The first ten counts in the amended complaint were essentially
the same as the ten counts in the original complaint. Counts XI, XII,
and XIII were new.
Count XI alleged that Graham Berwind engaged in a pattern of
activity constituting mail and wire fraud and that this pattern
constituted a racketeering offense under 18 U.S.C. § 1962. In particular,
Count XI alleged that Graham Berwind “orchestrated a series of
transactions designed to deprive the David Berwind Trust of the fair
value of its interest in BPSI, and to prevent the David Berwind Trust
from seeking redress for the breaches of fiduciary duty alleged herein.”
The claim was for treble damages. Unlike the other RICO claims in
Counts I and II, Count XI was a direct claim (i.e., it was not a
shareholder-derivative claim).
Count XII sought a declaratory judgment that the disputed
merger was void because it did not comply with the BCL and because it
was intended to deprive the David Berwind Trust of standing to pursue
the shareholder-derivative claims in the amended complaint.
Count XIII was a claim for equitable relief seeking to enjoin the
defendants from taking steps to affect the David Berwind Trust’s
minority shareholder interest in BPSI or the standing of the David
Berwind Trust to assert the shareholder-derivative claims in the
amended complaint. The relief was requested as a remedy for Graham
Berwind’s and McKenney’s alleged violation of their fiduciary
obligations as trustees of the David Berwind Trust. In particular, Count
XIII alleged that Graham Berwind and McKenney directed the
defendants to refuse to provide the David Berwind Trust with
information concerning BPSI’s operations and assets sufficient to form
a fair valuation of the minority interest in BPSI, are using the squeeze-
out merger to defraud the David Berwind Trust and deprive it of the
value of its BPSI shares, and used the squeeze-out merger to block the
David Berwind Trust from asserting the shareholder-derivative claims
in the amended complaint.
Below is a summary of the complaint and the amended complaint
in the Warden litigation:
52
[*52] Plaintiffs Defendants Type of claim Remedy sought
I BPSI (derivatively by All Pattern of racketeering Monetary
David Berwind Trust) consisting of mail and wire fraud damages
in violation of 18 USC § 1962(c) (trebled)
II BPSI (derivatively by All Conspiracy to commit Monetary
David Berwind Trust) racketeering, consisting of acts of damages
mail and wire fraud alleged in (trebled)
count I, in violation of 18 USC
§ 1962(d)
III BPSI (derivatively by Directors of Usurpation of BPSI corporate Monetary
David Berwind Trust) BPSI opportunity by BPSI directors, damages
specifically, by using BPSI assets
to buy equity interests in Zymark
to be held by Berwind Group
Partners and Berwind Corp.
Original complaint was the same
but used the word “diversion”
rather than usurpation.
IV BPSI (derivatively by Directors of Breach of fiduciary duty by Monetary
David Berwind Trust) BPSI having BPSI (1) provide equity damages
financing and loan collateral to
Berwind Aviation; (2) pay excess
management fees to Berwind
Corp.; (3) forego profits to make
BPSI minority shares less
valuable to reduce price to paid
for them in squeeze-out merger;
(4) make loans to Berwind Group
Partners and Berwind Corp. at
below market interest rates.
V BPSI (derivatively by Berwind Aiding and abetting the duty-of- Monetary
David Berwind Trust) Group loyalty breaches alleged in Count damages
Partners; IV.
Berwind
Corp.
VI David Berwind Trust Berwind Breach of fiduciary duty by Equitable relief
Group (1) attempting to squeeze out the to enjoin
Partners; trust’s interest in BPSI to Berwind Group
BPSI deprive the trust of the value of Partners and
Directors its interest and prevent the trust BPSI directors
from lodging a shareholder- from taking
derivative suit against the BPSI steps to affect
board, and (2) refusing to provide the minority
the trust with financial shareholders
information about BPSI. interest of the
trust in BPSI.
53
[*53] Plaintiffs Defendants Type of claim Remedy sought
VII David Berwind Trust Berwind Refusing to provide the trust Equitable relief
Group with financial information about to require
Partners; BPSI. Berwind Group
BPSI Partners and
Directors BPSI directors
to provide an
accounting of,
and information
on, the
operation and
management of
BPSI from
1/1/1985.
VIII David Berwind Trust Berwind Orchestrating squeeze-out Equitable relief
Group merger to prevent the trust from to rescind the
Partners; seeking legal relief for the squeeze-out
BPSI alleged misappropriation of merger and
Directors corporate opportunity, misuse of grant trust an
corporate assets, and breaches of interest in the
fiduciary duty and breaches of corporate entity
trust. into which
BPSI has been
merged.
IX David Berwind Trust Berwind The defendants offered the trust Demand for
Group less than the fair value of its statutory
Partners; interest in BPSI. appraisal under
BPSI BCL § 1571(a)
Directors to receive the
fair value of the
trust’s interest
in BPSI.
X David Berwind Trust Graham Graham Berwind and McKenney Monetary
Berwind breached their duties as trustees damages; place
and of the trust by (1) usurping income from
McKenney corporate opportunities available alleged
to BPSI for the benefit of breaches of
Berwind Group Partners and duty in a
Berwind Corporation, (2) using constructive
assets of BPSI for the benefit of trust
Berwind Group Partners and
Berwind Corporation,
(3) approving the squeeze-out
merger to eliminate the trust’s
interest in BPSI, (4) causing the
interest to be eliminated at less
than a fair price.
54
[*54] Plaintiffs Defendants Type of claim Remedy sought
XI David Berwind Trust Graham Pattern of racketeering Monetary
Berwind consisting of mail and wire fraud damages
in violation of 18 USC § 1962(c) (trebled)
XII David Berwind Trust All Plan of merger not authorized Declaratory
defendants and did not comply with the judgment that
BCL. Also, sole purpose of plan plan of merger
of merger was to deprive the is null and void.
trust of standing to pursue the
Warden litigation.
XIII David Berwind Trust Graham Graham Berwind and McKenney Equitable claim
Berwind violated their duties as trustees to enjoin
and of the trust by directing the Graham
McKenney defendants to refuse to provide Berwind and
the trust with financial McKenney from
information about BPSI and by taking any
using the squeeze-out merger to action to modify
defraud the trust and deprive it the minority
of the value of its BPSI shares, shareholder
and using the squeeze-out interest of the
merger to prevent the trust from trust in BPSI.
asserting the shareholder-
derivative claims in the amended
complaint.
On January 13, 2000, the defendants in the Warden litigation
filed (1) a motion to dismiss the amended complaint pursuant to Fed. R.
Civ. P. 12(b)(6) and (2) a memorandum of law in support of the motion.
One of the reasons given in the memorandum of law was as follows:
[P]laintiffs have no right to demand any of the forms of
equitable relief that they seek: injunction, accounting or
rescission. Because the merger has now been
consummated . . ., Pennsylvania law now limits plaintiffs
to their remedies under the appraisal statute. Accordingly,
Counts VI through VIII should be dismissed.
The motion and memorandum of law sought dismissal of all
counts in the amended complaint, not just Counts VI through VIII (the
counts mentioned in the excerpt above). However, the motion and
memorandum of law did not seek to dismiss the appraisal proceeding.
On January 13, 2000, the plaintiffs in the Warden litigation filed
a motion for a temporary restraining order and a preliminary injunction.
A copy of this filing is not in the record of the present case.
55
[*55] On January 13, 2000, the parties in the Warden litigation entered
into a stipulation to maintain the status quo with respect to BPSI’s
capital and corporate structure until January 18, 2000. On June 1,
2000, the parties to the Warden litigation extended the status-quo-
maintenance date from (1) January 18, 2000, to (2) 30 days after the
resolution of BPSI’s motion to dismiss the Warden litigation.
On January 26, 2000, the David Berwind Trust exercised its
dissenters rights under the BCL §§ 1571–1580 by sending to BPSI a
demand for payment and returning its common stock certificate to BPSI,
as required by BCL § 1575(a). In a cover letter transmitting a copy of
the demand for payment, the David Berwind Trust’s attorney (Steven L.
Friedman of the law firm of Dilworth Paxon) made the following
statement:
As you know, we have taken the position on behalf
of the [David Berwind] Trust that the purported merger did
not comply with Pennsylvania law and is invalid and of no
effect. The [David Berwind] Trust is submitting the
Demand for Payment pursuant to Section 1575 of the
Pennsylvania Business Corporation Law as a
precautionary measure. However, the Demand for
Payment shall not be construed as an acknowledgment by
the [David Berwind] Trust that the purported merger was
valid or effective (which it clearly was not) or operate as a
waiver of any claims or rights that the [David Berwind]
Trust may have in connection with the purported merger,
including, without limitation, any of the claims asserted by
the [David Berwind] Trust in the above-referenced
litigation.
On January 28, 2000, the defendants in the Warden litigation
filed a memorandum of law in opposition to the January 13, 2000 motion
for a temporary restraining order and a preliminary injunction.
On January 28, 2000, the plaintiffs in the Warden litigation filed
a memorandum of law in opposition to the defendants’ motion to dismiss
the amended complaint. In the memorandum, the plaintiffs argued that
the disputed merger was invalid because, the plaintiffs asserted, the
plan of merger did not comply with § 1922(a) of the BCL by allegedly
failing to provide terms for the manner and basis of converting the
outstanding preferred stock, preference stock, or preferential stock,
56
[*56] which the plaintiffs asserted were still outstanding under BPSI’s
articles of incorporation, into other shares or other consideration.
On February 4, 2000, the plaintiffs in the Warden litigation filed
a memorandum of law in reply to defendants’ opposition to plaintiffs’
motion for a temporary restraining order and a preliminary injunction.
On or about February 4, 2000, BPSI sent the David Berwind
Trust a notice responding to the trust’s January 26, 2000 demand for
payment. The notice stated that BPSI would not make a remittance.
The notice stated that BPSI estimated that the fair value of the trust’s
shares of BPSI was $82,820,000. The notice also stated that BPSI had
the right to make another demand for payment under BCL § 1578(a)
(allowing dissenter who receives a notice of non-remittance to send to
the corporation the dissenter’s estimate of fair value). The notice also
included BPSI’s audited financial statement for the calendar year 1998
and unaudited interim financial statement for the 12-month period
ending September 30, 1999. Pursuant to BCL § 1577(d), BPSI returned
to David Berwind Trust its BPSI common stock certificate, on which
BPSI made the following notation:
THE SHARES REPRESENTED BY THIS CERTIFICATE
ARE THE SUBJECT OF A NOTICE TO DEMAND
PAYMENT UNDER THE DISSENTERS RIGHTS
PROVISIONS OF THE PENNSYLVANIA BUSINESS
CORPORATION LAW, 15 P.C.S. § 1575 ET SEQ., AND
MAY ONLY BE TRANSFERRED, ASSIGNED, PLEDGED
OR HYPOTHECATED SUBJECT TO SUCH
PROVISIONS.
On February 16, 2000, the defendants in the Warden litigation
filed a reply memorandum in support of their motion to dismiss the
amended complaint. In the reply memorandum, the defendants in the
Warden litigation argued that the disputed merger was valid because,
they asserted, the plan of merger provided terms for the manner and
basis of converting the preferred, preference, and preferential stock into
other shares or other consideration by acknowledging that such stock
had been called for redemption and that sufficient funds were deposited
with a financial institution with irrevocable instructions to pay on the
redemption date.
In early 2000, the David Berwind Trust hired Howard, Lawson &
Co, LLC (Howard Lawson), to assist it in providing its estimate of value
57
[*57] to perfect its appraisal rights. Howard Lawson issued a valuation
report to the David Berwind Trust on February 23, 2000 (the 2/23/2000
valuation report). The 2/23/2000 valuation report, which relied, in part,
on BPSI’s unaudited financial results for the 12 months ended
September 30, 1999, as adjusted by Howard Lawson, estimated the
value of David Berwind Trust’s interest in BPSI and Zymark combined
at a range between $165 million and $204 million and recommended
that the David Berwind Trust use $190 million as its estimate, stating
“[I]t is best to lead with an aggressive, but supportable estimate at this
time.” This amount included the value of a 16.4% equity interest in
Zymark, which is $40 million of this estimate, because the David
Berwind Trust maintained that Zymark was a corporate opportunity of
BPSI usurped by Graham Berwind. The 2/23/2000 valuation report
explained that its conclusions were tentative: “The process of adjusting
BPSI’s financials is imperfect and requires numerous assumptions.
Because of the lack of meaningful financial information, the
assumptions are likely to be significantly modified after discovery.”
On March 3, 2000, the David Berwind Trust sent BPSI a notice of
estimate of fair value of its BPSI shares pursuant to BCL § 1578(a). In
the notice, the David Berwind Trust stated that its “estimate of the fair
value of the shares is $190,000,000.” In the cover letter to the notice,
the David Berwind Trust’s attorney (Roger Wood of Dilworth Paxon)
wrote that the David Berwind Trust was preserving its position that the
disputed merger was “invalid and ineffective” and that BPSI “failed to
provide financial and other information that the Trust and its advisers
need to properly value the Company and its shares.” The letter stated
that the David Berwind Trust “is complying with the dissenters rights
provisions of the Pennsylvania Business Corporation Law as a
precautionary measure.”
On March 14, 2000, BPSI filed a statutory appraisal action in the
Court of Common Pleas of Philadelphia County, captioned Berwind
Pharmaceutical Services, Inc. v. Warden, et al., to seek a judicial
determination of the fair value of the BPSI shares on December 16,
1999, pursuant to BCL § 1579. We refer to this action as the “appraisal
proceeding”.
On March 20, 2000, the appraisal proceeding was removed to
federal court and consolidated with the Warden litigation.
On April 4, 2000, the David Berwind Trust received the
redemption payment for its preferential stock.
58
[*58] On April 25, 2000, the District Court granted the motion by the
defendants in the Warden litigation to dismiss the amended complaint
under Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which
relief can be granted. The only explanation given by the District Court
for the dismissal was as follows: “The Court approves and adopts [the
January 13, 2000 motion to dismiss the amended complaint filed by the
defendants in the Warden litigation and the February 16, 2000 reply
memorandum filed by the defendants in support of their motion to
dismiss the amended complaint, as supplemented] which collectively set
forth the legal authority which is dispositive of [p]laintiff’s cause of
action.” See Warden v. McLelland, 288 F.3d 105, 109 (3d Cir. 2002). 20
In June 2000, the parties to the Warden litigation and appraisal
proceeding agreed to a mediation process in an effort to resolve the
claims set forth by each party in the two actions.
In November 2000, the David Berwind Trust (through its counsel)
obtained a second appraisal from Howard Lawson, which valued a 16.4%
interest in BPSI and Zymark as of December 16, 1999. Howard Lawson
created the report “in [c]onnection with [a]nalysis of [i]nterests [o]wned
by the [David Berwind] Trust” and for use in mediation discussions
between the David Berwind Trust and BPSI. In preparing the report,
Howard Lawson reviewed financial statements and forecasts of BPSI
and Zymark and interviewed managers of BPSI and Zymark. The report
concluded that the David Berwind Trust’s interest in BPSI and Zymark
(as if it were a subsidiary of BPSI) as of December 16, 1999, had a value
of $177.8 million (based on enterprise values of $900 million for BPSI
and $184 million for Zymark), but the “inclusion of acquisition activity
in the case of BPSI” would increase the value of the David Berwind
Trust’s interest to $218.8 million in the aggregate.
On January 26, 2001, the David Berwind Trust’s trustees met to
discuss prospective settlement negotiations for the Warden litigation
and the appraisal proceeding. At the meeting, Michael Berwind, as
managing trustee, 21 recommended that (1) $148 million should be the
David Berwind Trust’s “walk away” number below which the David
Berwind Trust would opt to continue litigation and (2) $188 million was
“what we want.” At the meeting, Michael Berwind explained to the
20 The supplement to the February 16, 2000 reply memorandum is not in the
record.
21 The record does not reveal when Michael Berwind became the managing
trustee.
59
[*59] trustees that (1) a 30 multiple of 1999 BPSI earnings resulted in
a value of approximately $143 million, (2) removing the implied minority
discount in “CGB/BPSI’s $82.8 million offer” brought CGB/BPSI’s
number to $96 million, (3) interest, fees, and expenses were “really
nonnegotiable,” and (4) to “avoid the continued litigation pain and
potential downside litigation risk . . . the walk away number should
contain certain discounts.” 22 Michael Berwind calculated the “walk
away” amount by adding (1) a $132 million principal amount and
(2) interest at a 10% annual rate accruing over 13 months. Michael
Berwind calculated the $188 million “what we want” amount by adding
(1) a $168 million principal amount and (2) interest at a 10% annual rate
accruing over 13 months. After discussing the matter, David Berwind,
Michael Berwind, Linda Berwind Shappy, and Pawson agreed that the
trust’s “walk away” amount should be $158 million. Gail Berwind
Warden, who was not able to attend the trustee meeting, also agreed to
that number.
On January 26, 2001, Michael Berwind wrote and sent a
memorandum to Klein, copying Russell Shappy and Pawson, describing
Klein’s settlement authority in the mediation process for the period from
“January 30 through February 15, 2001.” We refer to this as the
“1/26/2001 Michael Berwind memo.” The 1/26/2001 Michael Berwind
memo stated that the David Berwind Trust “would like to receive $188
million dollars to settle the two lawsuits [i.e., the Warden litigation and
the appraisal proceeding].” The 1/26/2001 Michael Berwind memo
described the David Berwind Trust’s “walk away number,” at which the
trustees opt to continue the litigation, as $165 million dollars. While the
1/26/2001 Michael Berwind memo contains no reference to interest, in a
memo dated January 31, 2002, Michael Berwind wrote to Pawson and
Russell Shappy that the $165 million calculation “included interest at
10 percent for 13 months.” The 1/26/2001 Michael Berwind memo also
stated that “[t]he [David Berwind] Trust remains willing to acquire
100% of BPSI and Zymark at the same price the Trust is asking to
receive (however the Trust would not be willing to agree to subsection b
above [compensation to the seller if a transaction occurs prior to
December 31, 2006] as it would require that flexibility in order to finance
the 83.6% transaction).” On or about January 26, 2001, Michael
Berwind also provided to Justin Klein a one-page spreadsheet similar to
that in the two-page document “Thoughts on Mediation Compromise.”
22 “CGB” refers to Charles Graham Berwind, Jr., who we refer to as Graham
Berwind. The $82.8 million offer refers to BPSI’s February 4, 2000 notice that BPSI
estimated that the value of the David Berwind Trust’s shares in BPSI was $82,820,000.
60
[*60] We refer to the one-page spreadsheet as “Michael Berwind’s
second 1/26/2001 mediation compromise spreadsheet”. On Michael
Berwind’s second 1/26/2001 mediation compromise spreadsheet, he
included $18 million for “Interest on BPSI & Zymark” in the desired
$188 million settlement number and $16 million for “Interest on BPSI
& Zymark” in the $165 million “walk away” number. Michael Berwind’s
second 1/26/2001 mediation compromise spreadsheet also contained a
table entitled “After-Tax Analysis,” which contained a column entitled
“After-Tax Proceeds . . . Assuming 100% of Settlement is Treated as
Stock Sale Proceeds.”
On January 31, 2001, Justin provided Meyers with a spreadsheet
that Meyers faxed to McKenney on the same day. The spreadsheet
compared (1) the David Berwind Trust’s position regarding the value of
its BPSI interest and the Warden litigation claims to (2) BPSI’s assigned
value for such items. In the spreadsheet, the David Berwind Trust
attributed $177.616 million to BPSI and Zymark before the line for
“Claims” and $19.242 million to “Interest on BPSI & Zymark.” The
numbers on the spreadsheet were derived from Michael Berwind’s
second 1/26/2001 mediation compromise spreadsheet.
On January 31, 2001, Klein sent a fax to Russell Shappy and
Pawson, transmitting two undated one-page documents prepared by
BPSI and respectively titled “Settlement Proposal” and a “Comparison
of Valuations.” The settlement-proposal document contained a
settlement offer from BPSI of $96,514,000 next to which was a
handwritten notation made by Klein that states “102 w/ interest . . .
5.66% interest rate.” We interpret this fax to mean that on January 31,
2001, BPSI had made a settlement offer, which was communicated by
the settlement-proposal document, under which BPSI would pay the
David Berwind Trust $96,514,000, brought up to $102,000,000 with
interest.
On February 9, 2001, Klein met with Meyers to discuss
settlement of the Warden litigation and the appraisal proceeding.
During or around the time of this meeting, Klein made a settlement offer
of $188 million to Meyers. The parties to the Warden litigation and the
appraisal proceeding were unable to reach a settlement during 2001.
On February 23, 2001, the U.S. Court of Appeals for the Third
Circuit vacated the District Court’s dismissal of the amended complaint
in the Warden litigation, and remanded the case to the District Court
“for it to set forth, in a reasoned opinion, the relevant facts, legal
61
[*61] principles, and authorities that support its decision.” The Third
Circuit order stated “we maintain jurisdiction over this case and hold
this appeal in abeyance, pending our receipt of the reasoned opinion
from the District Court.”
On August 8, 2001, the District Court issued an opinion on
remand dismissing the amended complaint claims in the Warden
litigation under Fed. R. Civ. P. 12(b)(6). Warden v. McLelland, 2001 WL
910934 (E.D. Pa.).
In part B of its opinion, 23 the District Court held that counts I–V
should be dismissed because they were shareholder-derivative claims
that did not meet the “demand” requirement that they be submitted to
the board of directors of BPSI. Id. at *2–5. The District Court explained
that for a shareholder-derivative claim to be heard by a court, the
shareholder must first make written demand upon the board of directors
of the corporation, unless the shareholder (1) shows that irreparable
injury to the corporation would occur if the shareholder had made the
demand before the commencement of the action and (2) made the
demand promptly after the commencement of the action. Id. at *3. The
District Court stated that no demand on the board of directors of BPSI
had been made before the amended complaint was filed. Id. at *4.
Furthermore, the District Court stated that the plaintiffs did not make
any demand on the BPSI board of directors even after the action was
commenced. Id. The District Court held that even though the amended
complaint had alleged that BPSI would suffer irreparable harm if
demand had been made before commencement of the suit, it had failed
to “show with any degree of specificity how, when or why BPSI would be
irreparably harmed if a demand were required to be made or what the
irreparable harm would be.” Id.
In parts C.1, C.2, C.3, and C.4 of its opinion, the District Court
held that the RICO claims (which were Counts I, II, and XI) were not
pled with particularity and should be dismissed. Id. at *4–10. The
District Court identified the following four defects in the RICO claims:
(1) the amended complaint did not “allege the RICO predicate acts with
particularity,” (2) the amended complaint did not sufficiently plead “any
injury that flowed from the purported predicate acts,” (3) the amended
complaint failed to plead a pattern of racketeering activity because the
alleged predicate acts did not pose a “threat of continued criminal
23 This is part II.B of the District Court’s opinion, but we omit the “II” when
referring to this subpart and other subparts of part II of the District Court opinion.
62
[*62] activity,” and (4) the amended complaint did not allege the
plaintiffs “relied upon any alleged predicate acts by the defendants.” Id.
In part C.5 of its opinion, the District Court held that the RICO
claims in Counts I and II should be dismissed against four former
directors of BPSI (Byrnes, Dulaney, Karlson, and Cohn) because these
people were not directors in BPSI in December 1998. Id. at *11.
December 1998 was when the fraudulent communications allegedly
began, according to the amended complaint. Id. at *5, *8.
In part C.6 of its opinion, the District Court held that Count XI,
the RICO aiding-and-abetting claim against Graham Berwind, should
be dismissed because it was brought as a direct claim and should have
been brought as a shareholder-derivative claim. Id. at *11.
Part D of the District Court opinion held that Count III, and
portions of Count IV and V, were barred by the two-year statute of
limitations regarding claims of breach of fiduciary duty by BPSI
directors. Id. at *11–12. The District Court opinion held that Count III
in its entirety was time barred. Id. This was because, according to the
District Court, Count III alleged that the BPSI board of directors
breached its duties to BPSI shareholders by allowing the Zymark
acquisition to occur without BPSI being the owner of Zymark. Id. at *12.
The Zymark acquisition allegedly was consummated on September 3,
1996. Id. However, the original complaint was not filed until November
22, 1999, more than two years later. Id. The District Court also held
that portions of Count IV and Count V (aiding and abetting for breach
of fiduciary duty) were time barred because Count IV alleged conduct
that began in approximately 1992 or in the mid-1990s. Id. The original
complaint was filed more than two years later, on November 22, 1999.
Id.
In part E of the opinion, the District Court held that Counts VI
(injunction against merger), VII (accounting), and VIII (rescission of
merger) should be dismissed. Id. at *12–13. In the District Court’s view,
these claims were precluded by BCL § 1105 and In re Jones & Laughlin
Steel Corp., 488 Pa. 524, 412 A.2d 1099 (1980). Warden v. McLelland,
2001 WL 910934, at *12–13. The District Court stated:
The BCL expressly provides that appraisal rights shall be
the exclusive remedy for the dissenting shareholder. 15
Pa.C.S.A. § 1105. While Section 1105 does allow a
dissenting shareholder to challenge a merger on the
63
[*63] limited basis of fraud or fundamental unfairness, Jones &
Laughlin made clear that once the merger has been
completed, the appraisal statute provides the only remedy.
Moreover, nothing in the BCL allows a dissenting
shareholder to obtain an accounting or to rescind a merger.
Id. at *13.
In part F of the opinion, the District Court held that Counts VI
(injunction against merger) and XIII (rescission of merger) should be
dismissed because the plaintiffs failed to show they would be irreparably
harmed if they did not prevail on these equitable claims. Id. at *13–14.
The District Court explained that the “claim [was] based upon
inadequate price” and that such “claim [was] compensable by money
damages.” Id. at *15. Also significant, explained the District Court, was
that the amended complaint “acknowledges that the minority interest
has been converted into the right to receive a note for almost $83 million
in an amount equal to $12,625 per share.” Id.
In part G of the opinion, the District Court held that Count IX
(right to statutory appraisal) should be dismissed. Id. at *15–16. The
District Court gave five reasons why Count IX did not state a valid
claim. First, the District Court held that the David Berwind Trust had
failed to timely demand payment for its shares and timely deposit share
certificates as required by BCL §§ 1575 and 1576. Warden v. McLelland,
2001 WL 910934, at *15–16. 24 Second, the District Court held that the
David Berwind Trust failed to provide its own estimate of the value of
its interest in BPSI as required by BCL § 1578(a) and (b). Warden v.
McLelland, 2001 WL 910934, at *15–16. 25 Third, the District Court held
that under BCL § 1579(a), the David Berwind Trust’s appraisal action
was premature. Warden v. McLelland, 2001 WL 910934, at *15–16. The
District Court explained that the David Berwind Trust was barred from
commencing an appraisal action until the 60-day window of BCL
§ 1597(a) had expired. Warden v. McLelland, 2001 WL 910934, at *16.
Fourth, the District Court held that an appraisal action under BCL
§ 1579(a) could be commenced only in the Pennsylvania Court of
24 However, as we have explained, the David Berwind Trust demanded
payment for its shares and returned its common stock certificate to BPSI on January
26, 2000. The deadline for doing so was five days later, on January 31, 2000.
25 However, as we have explained, the David Berwind Trust sent BPSI a notice
of its estimate of the fair value of its BPSI shares pursuant to BCL § 1578(a) on March
3, 2000. The estimate was $190,000,000.
64
[*64] Common Pleas. Warden v. McLelland, 2001 WL 910934, at *16.
Thus, by filing suit in the District Court, the plaintiffs filed suit in the
“wrong court.” Id. Fifth, the District Court held that the named
defendants were the “wrong parties” to an appraisal proceeding because
“nothing in the appraisal statute [BCL § 1579(e)] allows plaintiffs to
bring a claim against the directors or majority shareholder” and because
BCL § 1579(e) “directs that an appraisal proceeding be brought ‘in the
name of the corporation.’” Warden v. McLelland, 2001 WL 910934,
at *16.
In part H of the opinion, the District Court held that Counts VI,
VII, VIII, IX, XI, and XII should be dismissed as to the present and
former directors of BPSI. Id. at *16–17. The District Court observed
that Counts VI, VII, VIII, and IX asserted direct claims against the
present and former BPSI directors (although they also went against
Berwind Group Partners). Id. at *17. The District Court also observed
that Count XI was a claim against Graham Berwind in his capacity as a
director of BPSI. Id. at *17. The Court also observed that Count XII
was a declaratory judgment claim against all defendants, including the
present and former directors of BPSI. Id. at *17. The District Court
held that these counts, to the extent they went against present and
former directors of BPSI, were direct claims barred by BCL § 1717
(which provides that the duties of the directors are solely to the
corporation and which, the District Court explained, “may not be
enforced directly by a shareholder.”). Warden v. McLelland, 2001 WL
910934, at *16–17. Recall that in part C.6 of the District Court opinion,
the District Court had also explained why Count IX was an
impermissible direct claim by a shareholder against a BPSI director,
Graham Berwind. Id. at *11. The legal reasoning in part C.6 is similar
to that in part H, although different authorities are cited in part C.6.
For example, part C.6 did not rely on BCL § 1717. But setting aside the
difference in authorities, part H is redundant with part C.6 as to
Count IX.
In part I of the opinion, the District Court held that Counts X and
XIII should be dismissed. Warden v. McLelland, 2001 WL 910934, at
*17–18. Counts X and XIII alleged that Graham Berwind and
McKenney engaged in a breach of trust as trustees of the David Berwind
Trust. In terms of remedy, Count X sought monetary damages against
Graham Berwind and McKenney. Count XIII sought an injunction. As
an initial matter, the District Court interpreted Count XIII to have been
brought not against all defendants, but only against Graham Berwind
and McKenney: “Count XIII is somewhat ambiguous in that it appears
65
[*65] to be brought against [Graham Berwind] and . . . McKenney . . . ,
but it then asks for relief against all defendants. . . . For purposes of this
motion to dismiss, defendants [sic: the District Court] will treat Count
XIII as attempting to state a claim against the two individuals because
nothing in the allegations of Count XIII would support an injunction
against all defendants.” Id. at *17 n.10. The reasons that Counts X and
XIII should be dismissed, according to the District Court, were threefold.
First, the District Court held that Graham Berwind and McKenney had
resigned as trustees of the David Berwind Trust. Id. at *17. The District
Court held that any failure by them to appoint their successors as part
of their resignation process “would have been mere surplusage” because
“there were already five trustees.” Id. The District Court also stated
that the plaintiffs “had no interest in any successor trustees because the
purpose of the resignations was to separate the brothers’ interests” and
that the plaintiffs would not have “welcomed” anyone affiliated with
Graham Berwind and McKenney as additional trustees. Id. Second, the
District Court held that the plaintiffs could not hold both Graham
Berwind and McKenney liable as trustees because McKenney only
became a trustee when Graham Berwind resigned as trustee. Id. at *18.
Third, the District Court held that liability could not be imposed on
Graham Berwind and McKenney based on any “purported conflict of
interest” because the deed of trust of the David Berwind Trust provided
as follows: “The fact that any trustee may be interested in Berwind
Corporation or any of its subsidiaries as director, stockholder, manager,
agent or employee shall not constitute an adverse or conflicting interest,
and the acts of such trustee shall be judged as if he has no interest in
the Corporation.” Id.
Part J of the District Court opinion held that Count XII (seeking
a declaratory judgment that the merger was void) should be dismissed.
Id. at *17. The District Court held that even though the amended
complaint alleged that the “merger did not comply with the BCL”, in
actuality the merger “was specifically contemplated and authorized by
the BCL” and “defendants’ actions with respect to the merger were
proper.” Id. at *18. The District Court also held that a claim for
declaratory judgment, standing alone, is not a valid claim because to
seek declaratory judgment is only to name the relief sought, not the legal
theory upon which relief is predicated. Id.
In accordance with its August 8, 2001 opinion (which we have
summarized above), the District Court again granted the motion of the
defendants in the Warden litigation to dismiss the amended complaint
66
[*66] under Fed. R. Civ. P. 12(b)(6). Warden v. McLelland, 2001 WL
910934, at *19.
On January 18, 2002, the Third Circuit heard oral argument
regarding the appeal of the dismissal of the Warden litigation. 26
During 2002, Pawson and Russell Shappy, the latter as the
financial manager of the David Berwind Trust, conducted settlement
negotiations on behalf of the David Berwind Trust.
On January 26, 2002, Michael Berwind sent a memorandum to
Russell Shappy, with copies to the David Berwind Trust trustees (except
for alleged trustees Graham Berwind and McKenney), addressing what
he stated was Russell Shappy’s “settlement authority” as to
“[m]ediation” for the period ending May 1, 2002. The memorandum
stated that (1) the David Berwind Trust’s desire was to receive a
settlement of $168 million dollars “before interest, fees, and expenses;”
(2) the David Berwind Trust’s “walk away number” at which the trustees
would opt to continue the litigation was “$147 million dollars before
interest, fees, and expenses;” and (3) there were several conditions on
the potential settlement with BPSI. Condition “a” was that
“Graham/BPSI/etc. must either remove all tax consequences to the
Trust that result from the December 16, 1999 merger and the
$82,800,000 [$82,820,000] Note or must pay those tax consequences.”
Condition “b” was that “[i]f BPSI goes public or is sold prior to December
31, 2004, the Trust should receive its proportionate share of any profit.”
The memorandum also stated that “[t]he [David Berwind] Trust
remains willing to acquire 100% of BPSI and Zymark at the same price
the Trust is asking to receive (however the Trust would not be willing to
agree to subsection b above as it would require that flexibility in order
to finance the 83.6% transaction).”
On January 31, 2002, Michael Berwind sent a memorandum to
Pawson and Russell Shappy entitled “BPSI - Negotiation Strategy”. In
the memorandum, after setting forth numerous considerations and
strategies, including continuing the litigation, Michael Berwind
explained his “thoughts on our post-3d Circuit Court hearing
negotiation strategy” as follows: “I would agree to the present value of
26 Recall that in its February 23, 2001 order, the Third Circuit had stated “we
maintain jurisdiction over this case and hold this appeal in abeyance, pending our
receipt of the reasoned opinion from the District Court.” Thus, as of January 18, 2002,
the Third Circuit still had jurisdiction over the case consisting of the Warden litigation
and the appraisal proceeding.
67
[*67] $147,000,000 as of December 15, 1999 with interest at 10% for
BPSI and 6% for all claims including Zymark from December 15th, 1999
plus fees and expenses.” The memorandum characterized this
$147,000,000 amount as reflecting the “walk away” position. A
spreadsheet embedded in the memorandum explained that the total
settlement to the David Berwind Trust was $182,000,000, when interest
was included. The spreadsheet also calculated that a “Would Be Happy”
settlement amount would be $207,000,000, including interest. The
spreadsheet was as follows:
Valuation[1]
Would
Be
Item Walk Away
Happy
BPSI 120 133
Zymark 20 25
Subtotal 140 158
Claims 7 10
Subtotal 147 168
Interest on above 33 37
Subtotal 180 205
Fees and expenses 2 2
Total 182 207
1The amounts in the table are in millions.
On February 16, 2002, Michael Berwind wrote and sent a draft
memorandum to Russell Shappy (and a copy to Pawson). In the draft
memorandum, Michael Berwind provided his views regarding how to
respond to “Potential Difficult Questions from Bruce McKenney,”
including the following:
1. Does the David Berwind family want to sell its stock in BPSI?
a. Prior to the onset of hostilities by Graham Berwind in August of
1999, the answer had been an unqualified “no”.
b. Post August 1999 -- the answer has become a qualified “yes”. The
David Berwind family is willing to sell its stock in BPSI to Graham
Berwind if:
i. Fair value can be established/agreed-upon and a control
premium paid by Graham [Berwind] to obtain what he
desires.
68
[*68] ii. Graham [Berwind] is going to continue to distinguish
between active and inactive stockholders with respect to
liquidity.
iii. Graham [Berwind] is going to continue to withhold
pertinent financial information from inactive
stockholders.
iv. Majority stockholders could someday in the future again
initiate a forced liquidation by a minority stockholder.
Page 2 of Michael Berwind’s February 16, 2002 draft memo stated: “We
are prepared to either (1) determine a price for BPSI stock, or
(2) determine whether we are a buyer or a seller at a price determined
by Graham [Berwind].”
On April 30, 2002, the Third Circuit reversed the dismissal under
Fed R. Civ. P. 12(b)(6) and issued an opinion.
The Third Circuit addressed the question of whether Counts I–V
should be dismissed because those claims failed the “demand”
requirement that as shareholder-derivative claims they first had to be
submitted to the board of directors of BPSI. Warden v. McLelland, 288
F.3d 105, 110–14 (3d Cir. 2002). The Third Circuit held that the
amended complaint sufficiently alleged that BPSI would have been
irreparably harmed had the demand been made to the board of directors
of BPSI. Id. at 111. The Third Circuit explained that it could be inferred
from the amended complaint that had the David Berwind Trust made
the demand of the BPSI board, BPSI would have responded by executing
the squeeze out-merger, that the squeeze-out merger would have
removed the David Berwind Trust as a shareholder, and that therefore
the David Berwind Trust would not have standing to file its shareholder-
derivative claims. Id. The Third Circuit next held that the David
Berwind Trust’s failure to make the demand after the squeeze-out
merger was excusable. Id. at 111–12. After the squeeze-out merger, the
David Berwind Trust was “[n]o longer a shareholder” and was “no longer
in a position to make demand on the board—by no fault of its own”. Id.
at 112. In summary, the Third Circuit opinion rejected the analysis in
part B of the District Court opinion. Warden v. McLelland, 2001 WL
910934, at *2–5. 27
27 The Third Circuit also discussed the question of whether the demand
requirement should be superseded by section 7.01(d) of the ALI Principles. Warden v.
69
[*69] The Third Circuit addressed the holdings in parts C.1, C.2, C3,
and C.4 of the District Court opinion dismissing the RICO claims (i.e.,
Counts I, II, and XI) for failure to allege predicate acts with
particularity, establish a causal connection between predicate acts with
injury, establish sufficient continuity to constitute a pattern, and
establish reliance. Warden v. McLelland, 2001 WL 910934, at *4–10
(E.D. Pa.). The Third Circuit did not dispose of the issue, observing only
that the complaint “does provide a reasonably clear overall picture of
what has been alleged.” Warden v. McLelland, 288 F.3d at 114. The
Third Circuit held:
We believe this issue, along with the other RICO pleading
issues, is best resolved by reexamination of the sufficiency
of the complaint by the District Court. We are confident
the District Court will permit plaintiffs to amend their
complaint, if appropriate . . . . The District Court will be
able to consider these issues in light of any amendments it
permits, something we are in no position to do.
Id. at 114–15. It appears that by “the other RICO pleading issues” the
Third Circuit was referring to part C.5 of the District Court opinion
(dismissing Counts I and II against BPSI directors who were not
directors in December 1998) and part C.6 of the District Court opinion
(dismissing Count XI against Graham Berwind because it was brought
as a direct claim). See 2001 WL 910934, at *5, *8, *11 (E.D. Pa.).
The Third Circuit addressed the holding in part D of the District
Court opinion that Count III, and portions of Count IV and V, were
barred by the two-year statute of limitations on lawsuits for breach of
fiduciary duty. Warden v. McLelland, 288 F.3d at 115, vacating Warden
v. Mclelland, 2001 WL 910934, at *11–12. The Third Circuit explained
that on appeal the plaintiffs contended that even though some of the
events occurred more than two years before they brought suit, “the
statute of limitations should be tolled because defendants fraudulently
McLelland, 288 F.3d at 112. The Third Circuit stated that “this case would seem to be
a good candidate” for application of section 7.01(d) of the ALI Principles. Warden v.
McLelland, 288 F.3d at 112. However, the Third Circuit did not make a dispositive
ruling with respect to the issue of the effect of section 7.01(d) of the ALI Principles.
Warden v. McLelland, 288 F.3d at 114. The Third Circuit observed that the parties in
the Warden litigation did not brief the issue extensively and there may be uncertainty
as to the appropriateness of applying section 7.01(d) of the ALI Principles to the case.
Warden v. McLelland, 288 F.3d at 114. Therefore, the Third Circuit “left [this issue]
. . . unresolved at this point” and directed the District Court, on remand, to “consider
this issue if it proves to be necessary.” Id.
70
[*70] concealed information necessary for recognizing these claims.”
Warden v. McLelland, 288 F.3d at 115. The Third Circuit also explained
that the defendants had countered that “plaintiffs have failed to meet
specific requirements for pleading such tolling.” The Third Circuit did
not resolve the equitable-tolling issue, explaining “[t]hese matters are
better addressed by the District Court in light of any amendments to the
pleadings.” Id.The Third Circuit addressed the holdings in part E of the District
Court opinion, which dismissed Counts VI, VII, and VIII. Warden v.
McLelland, 288 F.3d at 115; Warden v. McLelland, 2001 WL 910934, at
*12–13. The Third Circuit held that the District Court erred in relying
on In re Jones & Laughlin Steep Corp., 488 Pa. 524, 412 A.2d 1099(1980). Warden v. McLelland, 288 F.3d at 115. The Third Circuit
explained that Jones & Laughlin concerned equitable relief sought after
the merger had occurred, but the plaintiffs in Warden v. McLelland filed
suit before the merger. Warden v. McLelland, 288 F.3d at 115.
The Third Circuit addressed part F of the District Court opinion,
which dismissed Counts VI and XIII. Warden v. McLelland, 288 F.3d at
115; Warden v. McLelland, 2001 WL 910934, at *13–14. The Third
Circuit held that under In re Jones & Laughlin Steep Corp., 412 A.2d at
1103, a shareholder challenging a merger need not show irreparable
harm to enjoin a merger, only that the merger is “fraught with fraud or
fundamental unfairness.” Warden, 288 F.3d at 115 (quoting In re Jones
& Laughlin Steep Corp., 412 A.2d at 1103). The Third Circuit stated:
“To the extent defendants contend that plaintiffs have insufficiently
pled fraud or fundamental unfairness, we leave this matter to the
District Court in the first instance.” Id.Relatedly, the Third Circuit addressed an argument by the
defendants in the Warden litigation that Glassman v. Unocol
Exploration Corp., 777 A.2d 242, 248 (Del. 2001), compels the conclusion
that in a short-form merger, the dissenting shareholder seeking
equitable remedies must prove fraud or illegality. Warden v. McLelland,
288 F.3d at 115–16. In a passage heavily relied on by petitioners, the
Third Circuit stated that even if the legal principle asserted by the
defendants in the Warden case was generally correct, the principle
might not govern the case because of its “special features”:
Nevertheless, we note this case has special features that
may require that it be treated differently from standard
short-form merger cases. This is not simply a dispute
71
[*71] between a majority and a minority shareholder in a
corporation. Here the majority shareholder [BPSI] was
allegedly controlled by Graham Berwind, who was also an
alleged trustee of the David Berwind Trust. And Berwind
company [footnote omitted] stock was the central holding
of the Trust as set up by Charles Berwind. Thus, Graham
Berwind’s duty to the trust was not simply that owed by a
majority shareholder to a minority shareholder, but also a
duty owed directly to a trust designed to hold equity in the
family business. In these circumstances, the argument in
favor of equitable remedies would appear to take on a
different character from that of a case focused only on a
short-term merger. The resolution of these matters is best
reserved for the District Court at this juncture.
Id. at 116.
The Third Circuit addressed the holdings in part I of the District
Court opinion, which dismissed Counts X and XIII. Warden v.
McLelland, 288 F.3d at 110; Warden v. McLelland, 2001 WL 910934, at
*17–18. The Third Circuit rejected the District Court’s conclusion that
Graham Berwind and McKenney had resigned. Warden v. McLelland,
288 F.3d at 110. The Third Circuit reasoned that the plaintiffs’
allegation that they had not resigned must be accepted as true for
purposes of Fed. R. Civ. P. 12(b)(6). Warden v. McLelland, 288 F.3d at
110. The Third Circuit also held that the deed of trust of the David
Berwind Trust did not relieve Graham Berwind and McKenney of all
liability for breach of trust as trustees. Id. The Third Circuit concluded
that “we will reverse with respect to plaintiffs’ breach of trust claims
and leave the precise effect of the exculpatory provision for the District
Court to consider on remand.” Id.Next the Third Circuit addressed what it called the “[r]emaining
claims.” It stated:
There are other arguments made by the parties. But many
of these seem to have been abandoned; others are clearly
ancillary to other arguments or other claims. These
remaining issues are best resolved by the District Court in
the context of its reexamination of the central issues in the
case. Accordingly, we will vacate the remainder of the
District Court’s opinion.
72
[*72] Id. These sentences were the expression of the Third Circuit’s
view of all portions of the District Court opinion not addressed
specifically in other portions of the Third Circuit opinion. These not-
specifically-addressed portions of the District Court opinion were
apparently parts C.5, C.6, G, H, and J.
Finally the Third Circuit stated: “For the foregoing reasons, we
will reverse the dismissal under Federal Rule of Civil Procedure 12(b)(6)
and remand the case to the District Court for proceedings consistent
with this opinion.” Warden v. McLelland, 288 F.3d at 116.
On May 4, 2002, David Berwind sent a letter to Graham Berwind
in which he stated “we will commit whatever resources are needed to
ensure that the [David Berwind] Trust receives full and fair value for its
interest in the family business, if we decide to sell that interest.”
On October 10, 2002, Michael Berwind, as managing trustee of
the David Berwind Trust, sent an electronic memorandum to Pawson
and Russell Shappy regarding “BPSI Negotiation Trustee Authority.”
In the October 10, 2002 memo, Michael Berwind requested trustee
approval “to accept $150 million for the Trust’s position in BPSI &
Zymark and the claims associated with the 1999 complaint [before
interest and payment of our legal fees and other litigation expenses].”
(Brackets in original). The October 10, 2002 memo also stated:
[S]ufficient time has passed since December 1999 [when
Graham attempted to impose a squeeze out merger] for us
to determine BPSI’s value with price earnings valuation
calculations.
As detailed in the trustee authority worksheet -- the
requested $150 million trustee authority is reached in
large part by averaging a 27.5 price earnings multiple of
BPSI’s 2001 adjusted net income in a five-year weighted
average together with BPSI’s 2000 adjusted net income
unweighted. I believe that a 27.5 price earnings multiple
is a reasonable and prudent bottom line authority level.
(Brackets in original).
According to the October 10, 2002 memo, Michael Berwind
provided the trustee-authority worksheet “to help [the trustees]
understand how [he] arrived at $150 million.” The trustee authority
73
[*73] worksheet detailed “Would Be Happy” and “Walk Away” numbers.
The trustee-authority worksheet was as follows:
Valuation[1]
Would Be
Item Walk Away Happy
BPSI 133 148
Zymark 10 16
Subtotal 143 164
Claims 7 10
Subtotal 150 174
Interest on [BPSI & Zymark] 24 44
Subtotal 175 218
Fees and expenses 2 2
Total 177 220
1The amounts in the table are in millions.
On October 10, 2002, the David Berwind Trust trustees held a
special meeting. The minutes of the meeting show that four out of five
of the trustees voted to give Michael Berwind settlement authority as to
the Warden litigation and appraisal proceeding of $150 million plus
interest and expenses to expire on December 7, 2002.” The four trustees
voting in favor were David Berwind, Michael Berwind, Valerie Pawson,
and Linda Berwind Shappy. The fifth trustee, Gail Berwind Warden,
abstained from the vote.
In the present case, petitioners allege that Graham Berwind and
McKenney remained as trustees. We do not express a view on this
matter. See infra OPINION, Part I.D. In any event, the record indicates
that Graham Berwind and McKenney did not attend this meeting.
On October 16, 2002, coinciding with the deposition of attorney
Norman E. Donaghue that began that day in Philadelphia in the Warden
litigation, Pawson and Russell Shappy met with Graham Berwind and
McKenney (an officer of Berwind Corporation) to discuss settlement of
the consolidated Warden litigation and appraisal proceeding.
On October 17, 2002, in an email sent to Jes Lawson 28 and others,
Russell Shappy wrote: “After two days of discussions, we mutually
28 Jes Lawson was an investment banker advising the David Berwind Trust on
the current value of BPSI and Zymark.
74
[*74] walked away tonight from negotiations with Berwind. We
narrowed the gap from $105M to $35M!” The deposition continued on
October 18, 2002.
On October 21, 2002, Russell Shappy had a conversation with
David Berwind Trust attorney John Schmehl of Dilworth Paxson, LLP,
which included a discussion of, among other things, an “IRS imputed
tax.” Later that day, Pawson discussed with Russell Shappy the
contents of Shappy’s conversation with Schmehl. Later on October 21,
2002, Russell Shappy had a telephone call with McKenney during which
they discussed, among other things, McKenney’s investigation of a
“synthetical” interest rate and resuming settlement negotiations. Later
that day, Pawson discussed with Russell Shappy the contents of
Shappy’s conversation with McKenney.
On October 24, 2002, the parties to the Warden litigation and the
appraisal proceeding reached an oral settlement agreement. The oral
settlement agreement’s terms were memorialized in an October 26,
2002 settlement term sheet.
At a date undisclosed by the record, but no later than October 26,
2002, Berwind Group Partners was succeeded by Berwind Company,
LLC, a Delaware limited liability company. The first time the Berwind
Company, LLC, is mentioned in the record is October 26, 2002 (in the
settlement term sheet). For simplicity, we will refer to the Berwind
Company, LLC, by the name of its predecessor, Berwind Group
Partners.
On November 22, 2002, the Orphans’ Court in Montgomery
Count, Pennsylvania, held a conference with the parties to the Warden
litigation and the appraisal proceeding. During the conference, the
judge said that the Orphans’ Court did not need to see an independent
valuation.
On November 25, 2002, the parties to both the Warden litigation
and the appraisal proceeding entered into a written settlement
agreement (the settlement agreement). The settlement agreement
superseded the October 24, 2002 oral settlement agreement and the
October 26, 2002 settlement term sheet. BPSI was one of the parties to
the settlement agreement and it executed the agreement by signature
of its executive vice president.
The preamble to the settlement agreement stated that the David
Berwind Trust “has asserted that the Disputed Merger [defined as the
75
[*75] merger of BPSI Acquisition Corporation with, and into, BPSI] did
not comply with Pennsylvania law and is invalid and of no effect, and
has requested that the Disputed Merger be declared null and void as
part of the relief sought.” The preamble also stated BPSI “has asserted
that the Disputed Merger complied with Pennsylvania law and was
valid and effective as of December 16, 1999, and that on that date the
BPSI Shares 29 held by the [David Berwind] Trust were converted into
the right to receive the fair value of such shares.” The preamble also
recited that “as a precautionary matter and without prejudice to its
claim that the Disputed Merger was invalid, the [David Berwind] Trust
made demand upon BPSI for payment of the fair value of the BPSI
Shares pursuant to the dissenters rights provisions of Pennsylvania
law.” It also stated that Berwind Group Partners “owns all of the shares
of common stock of BPSI other than the BPSI Shares . . . the legal status
of which is an issue in the [Warden] Litigation.”
The settlement agreement set forth the terms and conditions
upon which the parties to the agreement agreed to (1) resolve their
respective claims in the Warden litigation and the appraisal proceeding
and (2) terminate the Warden litigation and the appraisal proceeding.
The settlement agreement required the David Berwind Trust, BPSI, and
the other defendants in the Warden litigation, to deliver various items
to the “Escrow Agent” 30 concurrently with the execution of the
settlement agreement:
• The David Berwind Trust was required to deliver “stock
certificate No. C2, which constitutes the only stock certificate
of BPSI that the [David Berwind] Trust currently holds;”
• The David Berwind Trust was to deliver general releases from
all presently serving trustees of the David Berwind Trust and
all current beneficiaries of the David Berwind Trust, as
releasors, in favor of BPSI and the defendants in the Warden
litigation (the David Berwind Trust general release);
• BPSI was to deliver a general release from BPSI, and the
Graham Berwind Family Trust trustees and beneficiaries (the
Graham Berwind Family Trust release); and
29 The “BPSI Shares” were defined as the 6,560 shares of BPSI common stock
owned by the David Berwind Trust.
30 The “Escrow Agent” was defined in the settlement agreement as PNC Bank.
76
[*76] • The David Berwind Trust, BPSI, and the defendants in the
Warden litigation other than BPSI were to deliver stipulations
of dismissal of the Warden litigation and the appraisal
proceeding.
The items to be delivered are collectively referred to as the “escrow
items.”
Paragraph 1(a)(i) of the settlement agreement provided that
“BPSI shall pay to the . . . [David Berwind] Trust the sum of . . .
$191,000,000 . . . in immediately available funds, which the [David
Berwind] Trust shall direct to be wired by BPSI directly to the Escrow
Account (as defined in the Escrow Agreement) for the benefit of the
[David Berwind] Trust.” The “Escrow Agreement” referred to in the
settlement agreement was a separate agreement which was signed by
the parties to the Warden litigation and the appraisal proceeding (as
well as by PNC bank as escrow agent) in conjunction with the settlement
agreement. We refer to it as the “escrow agreement”. The escrow
agreement defined the Escrow Account as “an escrow account at the
Escrow Agent in the name of David Berwind Trust Escrow Account”.
The escrow agreement defined the Escrow Agent as PNC Bank. We
refer to the Escrow Account as the “PNC escrow account.”
The settlement agreement defined the term “Settlement Amount”
to refer to the $191,000,000 amount required by paragraph 1(a)(i) to be
paid by BPSI to the David Berwind Trust. The settlement agreement
provided that the “Settlement Amount” (i.e., the $191,000,000) and the
escrow items had to be held “in escrow” and “not released” except in
accordance with the terms of the settlement agreement and the escrow
agreement. The settlement agreement required the David Berwind
Trust and the Graham Family Trusts to give written notice to PNC
Bank that the conditions to the escrow release have been satisfied, in
which event PNC Bank was required to “release the Settlement
Amount” and the escrow items. 31 This obligation of PNC Bank to
“release the Settlement Amount” was specified by the settlement
agreement to mean that “the Settlement Amount, together with all
interest earned thereon, shall be remitted by wire transfer to the [David
Berwind] Trust.” One of the conditions to the escrow release was that
the Orphans’ Court grant the petitions of both the David Berwind Trust
31 The settlement agreement allowed the David Berwind Trust and the
defendants in the Warden litigation to waive the conditions for the escrow fund release
through a written waiver.
77
[*77] and the Graham Family Trusts to approve the settlement
agreement. This condition related to paragraph 2(a) of the settlement
agreement, which required the David Berwind Trust and the Graham
Family Trusts to file petitions with the Orphans’ Court seeking approval
of the settlement agreement as to each respective trust. If the Orphans’
Court declined to approve the settlement agreement, the David Berwind
Trust and the defendants in the Warden litigation each had the option
to terminate the settlement agreement.
As explained above, paragraph 2(a) of the settlement agreement
required the David Berwind Trust and the Graham Family Trusts to file
petitions with the Orphans’ Court seeking the approval of the settlement
agreement as to each respective trust. The petition filed by the David
Berwind Trust with the Orphans’ Court had to “include a request that
the Orphans’ Court confirm the resignations of [Graham Berwind] and
. . . McKenney as trustees of the [David Berwind] trust, effective as of
June 26, 1997 and December 30, 1997, respectively.”
Paragraph 10 of the settlement agreement required the David
Berwind Trust to represent and warrant to BPSI that, as of November
25, 2002, “it owns the BPSI Stock Certificate, and any interest in BPSI
evidenced thereby, free and clear of any liens, security interests, pledges
or other encumbrances.”
As explained before, in conjunction with the settlement
agreement, the parties to the Warden litigation and the appraisal
proceeding signed an escrow agreement, dated as of November 25, 2002.
The “Settlement Amount” was defined by the escrow agreement as
$191,000,000 that BPSI had agreed to pay the David Berwind Trust
pursuant to the settlement agreement and which BPSI had wired to
PNC Bank. Under the escrow agreement, PNC Bank, as escrow agent,
“agreed to hold the Settlement Amount, together with any and all
investments and reinvestments thereof and any interest and other
income therefrom,” which amounts, in total, were defined as the “Escrow
Fund.” The escrow agreement required PNC Bank to invest the Escrow
Fund in accordance with the instructions of the David Berwind Trust.
The escrow agreement required PNC Bank to release the Escrow Fund
to the David Berwind Trust by wire transfer if it received a joint written
notice from the David Berwind Trust and BPSI that the conditions for
escrow release under the settlement agreement had been satisfied. The
escrow agreement required PNC Bank to release the Escrow Fund to
BPSI if it received a joint written notice from the David Berwind Trust
and BPSI that the settlement agreement had been terminated.
78
[*78] Attached to the escrow agreement was an unsigned 32 copy of the
David Berwind Trust general release which provided, in part, that:
In exchange for good and valuable consideration . . .
each of the undersigned [David Berwind] Trust Releasors
. . . hereby release and forever discharge the Releasees . . .
from any and all obligations, claims, debts, demands . . . of
any nature whatsoever in law or in equity . . . whether
based in tort, contract, statute, regulation, equitable
principles or any other theory of recovery, direct or indirect,
contingent or liquidated, or third party or derivative, which
they or any of them ever had . . . against the Releasees or
any of them . . . from the beginning of time to the date of
this General Release, including but not limited to, all
claims . . . arising from, relating to, or based upon any one
or more of the following:
A. The disputed December 16, 1999 merger of BPSI
Acquisition Corporation with and into BPSI;
B. The fair value of the shares of common stock of BPSI
owned by the [David Berwind] Trust prior to the
December 16, 1999 merger; and
C. The matters asserted or which could have been
asserted in the actions captioned Warden v.
McLelland, et al., Civil Action No. 99-CV-5797 and
Berwind Pharmaceutical Services, Inc. v. Warden, et
al., Civil Action No. 00-CV-1445, pending in the U.S.
District Court for the Eastern District of
Pennsylvania [i.e., the Warden litigation and the
appraisal action].
The “[David Berwind] Trust releasors” were defined to include all
trustees and beneficiaries of the David Berwind Trust, except for alleged
trustees Graham Berwind and McKenney. The “releasees” were defined
as Graham Berwind and his daughters, McKenney, and Morris.
Paragraph 5 of the settlement agreement required Berwind
Group Partners to make an additional cash payment to the David
32 Despite it being unsigned, none of the parties contend that the general
release was not binding.
79
[*79] Berwind Trust if BPSI or Zymark, or substantial assets of either
company, were sold within five years of the date of the settlement
agreement and if the sale price exceeded a specified amount. The
provisions governing an additional cash payment are summarized by
petitioners as follows:
Section 5(a) provided, in pertinent part, as follows:
In the event that at any time after the date of this
Agreement and prior to November 25, 2007 (the “Ride-up
Period”) there shall occur one or more of the following
events (each, a “Zymark Triggering Event”) . . . and, as a
result of any such Zymark Triggering Event, the Berwind
Affiliates shall receive in the aggregate a Zymark Net
Amount that exceeds the Zymark Base Amount for such
Zymark Triggering Event, The Berwind Corporation[33]
will make an additional cash payment (a “Ride-up
Payment”) to the DB Trust in an amount determined in
accordance with Annex I hereto, (the “Ride-up Annex”),
which shall be deemed incorporated in and made part of
this Agreement.
....
The ”Zymark Triggering Events” were, generally,
sales by ZYAC or Zymark to a third party of substantially
all of their assets, sales of all or substantially all of ZYAC’s
or Zymark’s common stock to a third party, or other similar
transactions resulting in a shift of ownership of
ZYAC/Zymark.
....
Paragraph 2 of the Ride-up Annex defined “Zymark
Base Amount,” in part, as the sum of $182,926,829 plus
13.2% annum interest from the date of the Settlement
Agreement to the closing of any Zymark Triggering Event,
compounded on each anniversary of the Settlement
Agreement.
33 Apparently a typographical error–the settlement agreement required the
Berwind Company, LLC, the successor to Berwind Group Partners, and which we refer
to as Berwind Group Partners, to make the ride-up payment, not Berwind Corporation.
80
[*80] . . . .
In addition, the DB Trust received rights from
[Berwind Group Partners] under Section 5(b) of the
Settlement Agreement to participate in any increase in the
value of BPSI if certain interests in BPSI were sold or
transferred within five years of the settlement date.
....
In the event that such interests in BPSI were so sold
or transferred, the DB Trust would share in the excess of
the “BPSI Net Amount” over the “BPSI Base Amount,”
which the Settlement Agreement defined, in part, as
$838,181,191 plus 13.2% per annum interest from the date
of the Settlement Agreement to the closing of any BPSI
Triggering Event, compounded on each anniversary of the
Settlement Agreement.
....
According to the Settlement Agreement, both the
Zymark Base Amount and the BPSI Base Amount were
based on “(A) a capital contribution of $47,473,874 made by
[Berwind Group Partners] to ZYAC on or immediately
prior to the date [of the settlement], the proceeds of which
have been paid to BPSI to repurchase the preferred stock
of ZYAC held by BPSI and to repay the note of ZYAC held
by BPSI, and (B) the payment of the Settlement Amount of
$191,000,000 by BPSI to the Escrow Agent for the benefit
of the DB Trust concurrently with the execution of this
agreement.”
Brackets in the excerpt above are in the original brief. References to
“ZYAC” are to ZYAC Holding. References to the “DB Trust” are to the
David Berwind Trust. References to the “Escrow Agent” are to PNC
Bank. The excerpt above is found in petitioners’ proposed findings of
fact. The IRS does not disagree with these particular proposed findings
of fact.
81
[*81] As explained above, paragraph 2(a) of the settlement agreement
required the David Berwind Trust and the Graham Family Trusts to file
petitions with the Orphans’ Court seeking the approval of the settlement
agreement as to each respective trust. The petition filed by the David
Berwind Trust with the Orphans’ Court had to “be supported by a
valuation report of an investment bank or other financial expert selected
by the [David Berwind] Trust regarding the value or range of values of
the interest and/or claim of the [David Berwind] Trust in and to BPSI
and ZYAC Holding . . . and its wholly owned subsidiary, Zymark.” The
David Berwind Trust was required to “ask the Orphans’ Court to avoid
making the valuation report part of the public record because of the
confidential information in the report regarding BPSI, ZYAC [Holding]
and Zymark.” The settlement agreement set forth the additional
following conditions for submitting the valuation report:
The valuation report may be submitted to the Orphans’
Court by the [David Berwind] Trust after the filing of its
Petition to approve this Agreement. The [David Berwind]
Trust shall endeavor to submit the valuation report to the
Orphans’ Court not later than December 6, 2002. The
[David Berwind] Trust shall provide a copy of the valuation
report to the CGB Family Trustees [trustees of the Graham
Family Trusts] for its [sic] review prior to submitting such
report to the Orphans’ Court.
The David Berwind Trust hired Curtis Financial Group, LLC
(Curtis), to create the valuation report and, under the settlement
agreement, the trust was responsible for paying the costs of the
valuation report. The parties to the Warden litigation and the appraisal
proceeding never agreed to the specific effective date on which the
valuation of BPSI, ZYAC Holding, and/or Zymark was to be determined
in Curtis’ report.
Paragraph 6(a) of the settlement agreement provided that:
Unless otherwise permitted by this Section 6(a), neither
BPSI nor the Defendants [i.e., the defendants in the
Warden litigation] shall provide to the [David Berwind]
Trust or file with the Internal Revenue Service or any other
taxing authorities any information returns with respect to
the Settlement Amount or the terms of the Settlement. In
the event that counsel to BPSI and the Defendants shall
conclude that such reporting is required by law, BPSI and
82
[*82] the Defendants shall give adequate prior written notice to
the [David Berwind] Trust and in any event not later than
January 15 of the year following the taxable year for which
reporting is required. The [David Berwind] Trust shall be
given an opportunity to respond and provide to BPSI and
the Defendants a contrary conclusion from its legal counsel
by January 31 of such year. If the parties cannot agree as
to whether the requirement shall apply, counsel to the
[David Berwind] Trust and counsel to BPSI and the
Defendants shall select an independent tax counsel to
render a final opinion, on or before February 20, which
shall be governed by a “more likely than not” standard, and
the parties shall follow such opinion. The cost of the
independent counsel shall be shared equally by the parties.
The defendants in the Warden litigation were Graham Berwind,
McKenney, Berwind Corporation, Berwind Group Partners, McLelland,
Byrne, Dulaney, Hamling, Kosnik, Karlson, and Cohn.
As explained earlier, the November 25, 2002 settlement
agreement required BPSI to transfer $191,000,000 to the PNC escrow
account; required PNC Bank to hold the $191,000,000 in escrow,
specifically in the PNC escrow account; and required PNC Bank to
transmit the $191,000,000, “along with interest thereon,” to the David
Berwind Trust. The parties have stipulated that on November 25, 2002,
BPSI deposited the $191,000,000 amount “in an escrow account.”
Furthermore, the parties stipulated that the deposited amount earned
$7,012 before the total of $191,007,012 was then transferred to the PNC
escrow account. The transmittal of the $7,012 of interest by BPSI to
PNC Bank, and the holding of the $7,012 of interest by PNC Bank was
not directly addressed by the settlement agreement. However, the
escrow agreement defined the “escrow fund” to consist of (1) the
$191,000,000 and (2) “any interest and other income therefrom” (and
thus, the $7,012 of interest). The escrow agreement required that the
escrow fund be held by PNC Bank in the PNC escrow account.
Furthermore, the escrow agreement required PNC Bank to release the
escrow fund if it received written notice from the David Berwind Trust
and BPSI stating that the conditions to the escrow release under the
settlement agreement have been satisfied. Furthermore, the escrow
agreement provided that the escrow fund (which was the $191,000,000
and “any interest and other income therefrom”) was to be released to the
David Berwind Trust by “wire transfer” of the “[s]ettlement [a]mount,
together with all interest earned thereon.” In summary, the escrow
83
[*83] agreement required that the $191,000,000, and the $7,012 earned
as interest on the $191,000,000, be placed by PNC Bank in the PNC
escrow account. No party contends otherwise.
The parties in this case having stipulated that $191,007,012 was
transferred to the PNC escrow account, the parties have further
stipulated that after the $191,007,012 was transferred to the PNC
escrow account, “it was first invested in a BlackRock Short Term Fed
Treasury account for one day, earning $6,423 in dividends, before being
invested in a Federal Fund account, where it earned $243,918 of interest
between November 26, 2002 and December 31, 2002, when the escrow
was released.”
The stipulations regarding the investment returns on the
$191,000,000 amount can be summarized as follows:
Date(s) returns Type of account in which Amount of Type of
earned investment was held investment investment
return return
11/25/02 An escrow account $7,012 Interest
11/26//02 PNC escrow account (a 6,423 Dividends
BlackRock Short Term
Treasury account)
11/27/02 to PNC escrow account 243,918 Interest
12/31/02 (Federal Fund Account)
In early December 2002, the David Berwind Trust, the Graham
Berwind Trust, and the Graham Children Trusts separately petitioned
the Orphans’ Court to approve the settlement agreement and confirm
the resignations of Graham Berwind and McKenney (the petitions for
approval). No valuation report was attached to any of the petitions for
approval. Both the David Berwind Trust and the Graham Berwind
Family Trusts’ petitions for approval contained a request to seal the
settlement agreement. The David Berwind Trust’s petition made the
following representation:
The Trustees of the [David Berwind] Trust believe,
based on advice received from investment banking firms
during the Litigation and the Appraisal Proceeding and the
settlement negotiations, that the fair value of the [David
Berwind] Trust’s interest in BPSI approximates the
consideration to be received by the [David Berwind] Trust
under the Settlement Agreement.
84
[*84] Both petitions for approval acknowledged that the legal status of
the David Berwind Trust’s BPSI shares was an issue in the litigation.
On December 17, 2002, the Orphans’ Court approved the
settlement agreement as to the David Berwind Trust and the Graham
Children Trusts and confirmed the resignations of Graham Berwind and
McKenney as effective June 27, 1997, and December 30, 1997,
respectively.
A December 27, 2002 valuation analysis of BPSI and Zymark was
sent by Curtis to the David Berwind Trust’s attorneys. The analysis,
which valued the entities as of November 15, 2002, is referred to as the
“Curtis valuation”. The Curtis valuation stated that it relied on the
most current financial data from BPSI, including financial statements
through June 30, 2002, and operating budgets through 2004. The Curtis
valuation concluded that the aggregate equity of BPSI and Zymark as
an aggregate enterprise as of November 15, 2002, was between
$995,000,000 and $1,315,000,000. An earlier draft of the Curtis
valuation had been provided to Russell Shappy on December 12, 2002.
An earlier draft contained the same range of values as the Curtis
valuation, i.e., between $995,000,000 and $1,315,000,000.
The Curtis valuation was never submitted to the Orphans’ Court.
On December 27, 2002, the Orphans’ Court approved the
settlement agreement with respect to the Graham Berwind Trust.
On or about December 31, 2002, pursuant to the requirements
and conditions of the settlement agreement, the trustees and
beneficiaries of the David Berwind Trust signed a receipt, release,
refunding and indemnification agreement (the “release agreement”),
filed with the Orphans’ Court, through which the David Berwind Trust:
E. [c]onfirms and acknowledges that . . . C. Graham
Berwind, Jr. [i.e., Graham Berwind], resigned as trustee of
the [David Berwind] Trust effective June 26, 1997, [and]
that Bruce J. McKenney resigned as trustee of the [David
Berwind] Trust effective December 30, 1997 . . . and that
all such resignations were fully effective as of such dates;
F. [a]bsolutely remises, releases, quitclaims and
forever discharges each and all of the Past Trustees . . . of
and from any and all obligations, claims, debts, demands
. . . of any nature whatsoever in law or in equity . . .
85
[*85] whether based on tort, contract, statute, regulation,
equitable principles or any other theory of recovery, direct
or indirect, contingent or liquidated, or third party or
derivative, which the undersigned had, has or can, shall or
may have upon or by reason of . . . any . . . thing whatsoever
against the Past Trustees . . . from the beginning of time to
the date hereof . . .
The “Past Trustees” were defined by the release agreement as Graham
Berwind, McKenney, and Morris.
As of December 31, 2002, the PNC escrow account had earned
$243,918 of interest from the Federal Fund account investment from
November 26, 2002, to December 31, 2002.
On December 31, 2002, the PNC escrow account was released to
the David Berwind Trust. As of that date, the balance of the PNC escrow
account was $191,257,353, which comprised the $191,000,000
settlement payment and the following items of investment income
earned on the settlement payment while held in escrow between
November 25, 2002, and December 31, 2002:
Interest while held in an escrow account on 11/25/02 $7,012
Dividends while being held in the PNC escrow 6,423
account (a BlackRock Short Term Treasury
account) on 11/26/02
Interest while held in the PNC escrow account 243,918
(Federal Fund Account) from 11/27/02 to 12//31//02
Total Investment Income from 11/25/02 to 12/31/02 257,353
We refer to these items of investment income collectively as the
“Investment Income Components.”
In December 2002, stipulations of dismissal for the litigation were
delivered by the David Berwind Trust to BPSI’s counsel for filing with
the District Court.
No court ever granted an injunction to prevent the disputed
merger; issued an order rescinding the disputed merger; or declared the
disputed merger null and void or void ab initio. No court ever issued a
86
[*86] ruling that the disputed merger was valid; or modified the
stipulation dated June 1, 2000.
On January 14, 2003, BPSI faxed to the David Berwind Trust a
notice in which BPSI communicated its position that a portion of the
settlement amount was interest income to the David Berwind Trust and
that BPSI was required to report the payment of interest income on
Form 1099–INT, Interest Income, to the David Berwind Trust and the
IRS.
On January 30, 2003, the David Berwind Trust faxed to BPSI a
notice that in its view BPSI was not required to file a Form 1099–INT
and “if there is such a filing requirement, it can be satisfied by the filing
of a Form 1099–MISC.”
BPSI and the David Berwind Trust ultimately engaged attorney
Victor Keen, a tax partner of the law firm Duane Morris LLP, for the
purposes of resolving the information-return issue in keeping with part
6(a) of the settlement agreement.
On February 19, 2003, Keen issued to BPSI and the David
Berwind Trust an opinion letter regarding the information-return issue.
The opinion letter stated that it was more likely than not that “BPSI is
not legally required to file with the Internal Revenue Service a Form
1099 of any kind with respect to any portion of the Settlement Amount
paid to the [David Berwind] Trust.”
Keen’s opinion letter stated that it had been commissioned to
address the following questions:
1. Is BPSI legally required to file with the Internal
Revenue Service (“IRS”) a Form 1099 of some kind
with respect to any portion of the Settlement
Amount paid to the [David Berwind] Trust?
2. If the answer to question 1 above is yes, can BPSI
satisfy such legal requirement by filing a Form
1099–MISC that includes the total Settlement
Amount paid to the [David Berwind] Trust less the
[David Berwind] Trust’s tax basis in the BPSI stock
that is the subject of the Settlement Agreement (the
“BPSI Stock”)?
87
[*87] 3. If the answer to question 1 above is yes, can BPSI
satisfy such legal requirement by filing a Form
1099–INT that includes only a portion of the total
Settlement Amount paid to the [David Berwind]
Trust?
4. If the answer to questions 1, 2, and 3 above are yes,
which Form 1099 is most appropriate given all of the
facts and circumstances presented by both parties in
this case?
Keen’s opinion letter defined the “Settlement Amount” as BPSI’s
“payment to the [David Berwind] Trust of $191 million . . . in late 2002
pursuant to the terms of a settlement agreement dated as of November
25, 2002.” Keen’s opinion letter stated that Keen had been provided
with a copy of the settlement agreement and was to assume that the
facts stated in the settlement agreement were true. Keen’s opinion
letter contained no discussion of legal authorities, such as section 483.
Consistent with Keen’s opinion letter, BPSI did not issue an information
return to BPSI or the IRS with respect to the $191,000,000 deposit.
For its 2002 taxable year, the David Berwind Trust timely filed a
Form 1041, “U.S. Income Tax Return for Estates and Trusts.” The
return reported long-term capital gain of $189,462,989. The return does
not reveal how this amount was computed. However, the parties in the
present case agree that (1) the amount reflects the gain from the sale of
BPSI stock and (2) the gain from the sale of BPSI stock was calculated
such that $191,000,000 was the amount realized from the sale. 34 The
$257,353 Investment Income Components were reported by the David
Berwind Trust as investment income on its Form 1041 for 2002 ($7,012
as interest, $6,423 as dividends, and $243,918 as interest).
The manner in which the return reported the $191,000,000
deposit made by BPSI (i.e., by reporting the deposit as capital gain from
the sale or exchange of BPSI common stock) is consistent with
petitioners’ position that the sale or exchange of BPSI stock occurred on
November 25, 2002. If such a position were correct, none of the
$191,000,000 deposited by BPSI in an escrow account on November 25,
2002 (or the $191,257,353 released from the PNC escrow account to the
34 Because we do not have other information about how the $189,462,989
amount was computed, we do not know whether the amount includes gain or losses
from the sale or exchange of assets other than the BPSI shares. Nor do we know what
adjusted basis was used to calculate the gain from the sale or exchange of BPSI stock.
88
[*88] David Berwind Trust on December 31, 2002) would be treated as
interest under section 483.
On its 2002 tax return, BPSI claimed an interest deduction of
$31,103,795 in connection with the payment made to the David Berwind
Trust for its BPSI common stock. Colorcon, Inc. v. U.S., 110 Fed. Cl.
650, 652 n.2, 658 (2013). Petitioners attempt to explain the computation
of this amount as follows:
In BPSI’s 2002 federal tax return, BPSI deducted
$31,103,795 of the 2002 Settlement Payment [implicitly
defined by petitioners as $191,000,000] as interest by
reducing the entire $191,000,000 to present value from
December 31, 2002 back to December 16, 1999 at the lowest
3 month mid-term applicable federal rate applicable to a
December 1999 transaction, which was 5.47%.
The IRS argues that petitioners’ explanation is not supported by the
record. We agree with the IRS. We make no finding as to how the
$31,103,795 amount was computed. Furthermore, the record does not
reveal whether BPSI separately claimed a deduction for the $257,353 of
Investment Income Components. See also id. at 658.
In July 2003, Berwind Group Partners sold its interest in Zymark
to Caliper Technologies, Inc. (Caliper), an unrelated third-party. BPSI
calculated the total purchase price of Zymark at $79,720,744, which
included a cash payment of approximately $55 million and shares of
Caliper stock worth approximately $24 million. The sale price did not
exceed the Zymark Base Amount so the David Berwind Trust received
no consideration from Berwind Group Partners under the ride-up
provisions of the settlement agreement.
Effective January 1, 2006, BPSI changed its name to Colorcon,
Inc. We nonetheless will continue to refer to the company as BPSI.
On July 25, 2008, the IRS mailed the David Berwind Trust a
notice of deficiency determining a deficiency of $5,363,311 for the 2002
tax year. The notice of deficiency determined that total unstated
interest was $31,103,795. This calculation assumed that (1) the “sum of
the payments” to which section 483 applies was $191,000,000 and (2) the
$191,000,000 amount should be discounted from December 31, 2002 to
December 16, 1999. Having computed total unstated interest was
$31,103,795, the notice of deficiency subtracted from this amount
$7,012. Recall that $7,012 was the interest earned by the $191,000,000
89
[*89] on November 25, 2002, while being held in “an escrow account.”
Recall further that the David Berwind Trust reported this $7,012 as
income along with the rest of the $257,353 of Investment Income
Components. Having subtracted the $7,012 from $31,103,795, the
notice of deficiency determined that the difference ($31,096,783) was
imputed interest. Thus, the total increase in the David Berwind Trust’s
interest income was $31,096,783. The notice of deficiency did not
determine an adjustment to the way the David Berwind Trust reported
the Investment Income Components, i.e., the trust’s inclusion of this
amount as interest income. Petitioners and the IRS agree that the
notice of deficiency made three errors in computing total unstated
interest. First, because the assumed payment date was December 31,
2002, the payment amount should have been $191,257,353 (not
$191,000,000 as assumed by the notice of deficiency). Second, because
the assumed payment date was December 31, 2002, the number of days
assigned to the time variable in the formula for total unstated interest
should have been 3.04109589 years (not 3.041666 years as assumed by
the notice of deficiency). Third, the total unstated interest should not
have been reduced by $7,012. Correcting these errors results in a total
unstated interest of $31,140,364. This is the IRS’s position in the
present case because the IRS contends that the date of the sale or
exchange of the David Berwind Trust’s common stock of BPSI was
December 16, 1999; and that the payment for these shares was a
$191,257,353 payment on December 31, 2002. In addition, the IRS takes
the position that the David Berwind Trust’s income should be reduced
by $257,353.
On July 25, 2008, the IRS mailed a notice of deficiency to David
and Jeanne Berwind determining a $12,603 deficiency for their 2002 tax
year. The notice stated that, as a result of the determination that
$31,096,783 of income reported as capital-gain income by the David
Berwind Trust was interest income, there was a change in the “taxable
nature” of a $40,000 distribution from the trust to David and Jeanne
Berwind, such that $39,556 of the distribution was taxable.
On July 25, 2008, the IRS mailed a notice of deficiency to Michael
and Carol Berwind determining a $102,783 deficiency for the 2002 tax
year. The notice stated that, as a result of the determination that
$31,096,783 of income reported as capital-gain income by the David
Berwind Trust was interest income, there was a change on the “taxable
nature” of a $300,000 distribution from the trust to Michael and Carol
Berwind, such that $296,671 of the distribution was taxable.
90
[*90] On July 25, 2008, the IRS mailed a notice of deficiency to Duncan
Warden and Gail Berwind Warden determining a $104,441 deficiency
for the 2002 tax year. The notice stated that, as a result of the
determination that $31,096,783 of income reported as capital-gain
income by the David Berwind Trust was interest income, there was a
change on the “taxable nature” of a $300,000 distribution from the trust
to Gail Berwind Warden, such that $296,671 of the distribution was
taxable.
On July 25, 2008, the IRS mailed a notice of deficiency to Russell
Shappy and Linda Berwind Shappy determining a $108,375 deficiency
for the 2002 tax year. The notice stated that, as a result of the
determination that $31,096,783 of income reported as capital-gain
income by the David Berwind Trust was interest income, there was a
change on the “taxable nature” of a $300,000 distribution from the trust
to Linda Berwind Shappy, such that $296,671 of the distribution was
taxable.
On July 25, 2008, the IRS mailed a notice of deficiency to BPSI
that determined a deficiency of tax of $10,883,874 for BPSI’s 2002 tax
year. It also determined a substantial understatement penalty of
$2,176,775. The deficiency resulted from the IRS’s disallowance of
BPSI’s interest deduction.
On October 23, 2008, all the taxpayers who had received the
aforementioned notices of deficiency filed with the Tax Court timely
petitions for redetermination of the deficiencies (except BPSI).
On December 19, 2008, BPSI paid the deficiency, penalty, and
deficiency interest.
On January 29, 2009, BPSI filed a timely administrative claim for
refund. The claim for refund asserted that BPSI was entitled to an
interest deduction of $31,096,783. See Colorcon, Inc., 110 Fed. Cl. at 652
n.2, 658. This was the amount of adjustment made in the David
Berwind Trust’s notice of deficiency.
On June 1, 2009, the IRS disallowed BPSI’s refund claim.
On September 10, 2009, BPSI filed a timely tax-refund suit with
the U.S. Court of Federal Claims claiming the $31,096,783 deduction.
On October 21, 2009, we consolidated the Tax Court cases. We
refer to the petitioners in the consolidated cases as “petitioners.”
91
[*91] On November 2, 2010, Graham Berwind died.
On April 30, 2013, the U.S. Court of Federal Claims entered an
opinion in favor of BPSI in Colorcon, Inc. v. United States, 110 Fed. Cl.
650 (2013). By the time of the Court of Federal Claims litigation, BPSI
had changed its name to Colorcon, Inc. For ease of discussion, we refer
to Colorcon, Inc., the plaintiff in the Court of Federal Claims suit, as
BPSI. Colorcon involved the question of whether there should be a
deduction to BPSI for an amount of total unstated interest under section
483 on the theory its deposit of $191,000,000 was a deferred payment
for a sale or exchange of the David Berwind Trust’s shares of BPSI that
had occurred on December 16, 1999. Colorcon, Inc., 110 Fed. Cl. at 658.
In its opinion, the Court of Federal Claims held
(1) BPSI merged with BPSI Acquisition in December 1999
pursuant to the short form merger statute of the
Pennsylvania BCL; and (2) BPSI’s $191,000,000
settlement payment was made solely ‘in lieu’ of its
obligation to compensate the [David Berwind] Trust for the
shares redeemed under that 1999 merger.
Colorcon, Inc., 110 Fed. Cl. at 663. It held that BPSI “ha[d] established
that it correctly imputed interest on the deferred $191,000,000
payment” because “the parties [i.e., BPSI, the plaintiff, and the United
States, the defendant] agree that [BPSI] computed its interest in a
manner consistent with the method of computing interest under Section
483.” Id. at 663–64.
Having described the holdings in Colorcon, we now describe
Colorcon’s reasoning. The Court of Federal Claims described the dispute
as involving two issues:
First, the parties [i.e., BPSI and the United States] dispute
whether a short-form merger that is subject to a suit for
rescission should be treated, for the purposes of Section
483, as having been consummated as of the date of the
merger, rather than as of the date when the suit for
rescission is settled or a final judgment entered. Second, if
Section 483 requires treating the settlement payment as
resolving BPSI’s obligation to pay the fair value of the
[David Berwind] Trust’s shares in BPSI following the 1999
short-form merger, whether there is a genuine dispute as
to how the $191,000,000 settlement payment should be
92
[*92] allocated across the various claims in the consolidated
Warden Litigation and dissenters rights action.
110 Fed. Cl. at 659–60. Addressing the first issue, Colorcon observed
that the United States conceded that the filing of the articles of merger
in 1999 was a “contract” within the meaning of section 483(c) (providing
section 483 applies only to a “payment on account of a sale or exchange
of property . . . under a contract”). 110 Fed. Cl. at 658 n.16.
Furthermore, Colorcon observed that the United States conceded that
the filing of the articles of merger “effected a sale or exchange of
property” within the meaning of section 483(c). 110 Fed. Cl. at 660.
Colorcon stated that the United States took the position that “the 2002
settlement agreement superseded any payment obligation of [BPSI] for
the [David Berwind] Trust shares in BPSI under the 1999 merger” and
that “because the 1999 merger was challenged, and the parties settled
the litigation prior to the final judgment, the court must treat the [David
Berwind] Trust’s claim for rescission in the Warden litigation as if it had
been granted.” 110 Fed. Cl. at 660. The United States thus concluded
that “the $191,000,000 payment could not have been made to satisfy a
payment obligation stemming from the merger in 1999, but rather was
consideration as part of a settlement agreement that was consummated
in 2002.” 110 Fed. Cl. at 660. In support of its argument, the United
States contended that Lyeth v. Hoey, 305 U.S. 188 (1938), “requires,
when characterizing settlement payments, the court to treat a plaintiff’s
request for an equitable remedy as having been granted.” Colorcon, Inc.,
110 Fed. Cl. at 661. In Lyeth, a grandson challenged his grandmother’s
will (under which his inheritance would have been modest) alleging a
lack of testamentary capacity and undue influence. 305 U.S. at 189.
The suit was settled under a settlement by which the heir received a
$200,000 payment. Id. at 190. Lyeth held the settlement payment
should be considered an inheritance, which is exempt from income tax,
reasoning that “if the contest had been fought to a finish and petitioner
[the grandson] had succeeded, the property which he would have
received would have been exempt under the federal act.” Id. at 196.
Lyeth held that it was irrelevant that under Massachusetts law the
settlement payment would be treated as a payment under a contract.
Id. at 193–95. Lyeth held that state law affects the federal tax treatment
if the federal tax law implies that the federal tax treatment depends on
the operation of state law. Id. at 194. In application of this last
principle, Colorcon, Inc., 110 Fed. Cl. at 661, held that section 483 does
not define the terms “sale” or “exchange” and therefore section 483
implies that state law determines whether there has been a sale or
exchange. Colorcon, Inc., 110 Fed. Cl. at 661–62, held there was a sale
93
[*93] or exchange under the Pennsylvania BCL because (1) the David
Berwind Trust “sought to receive the fair value of its shares by invoking
its dissenters rights under the BCL; (2) the [David Berwind] Trust
obtained an appraisal of the 1999 value of its interest in BPSI; and
(3) BPSI . . . filed a statutory appraisal action that was . . . consolidated
with the Warden litigation.” Addressing the second issue, Colorcon
rejected the United States’ argument that “even if the settlement
resolved the [David Berwind] Trust’s claim for dissenters rights, the
2002 settlement payment also included compensation for other claims
on which Colorcon could not impute interest.” Id. at 662. Colorcon
agreed with BPSI that “the [David Berwind] Trust’s sole claim against
BPSI was for the value of the dissenters rights obligation,” that “the
“derivative claims and RICO claims were against BPSI’s directors or
other individuals,” and that “BPSI’s payment of $191,000,000 must,
therefore, have been made solely in lieu of the one claim—dissenters
rights—for which BPSI faced liability.” Id. at 662. The United States
had also argued that “the settlement agreement’s references to the
[David Berwind] Trust’s rights in ZYAC and Zymark must mean that
the settlement payment included money for resolving claims other than
the appraisal action, because the [David Berwind] Trust only owned
BPSI stock.” Id. at 662. Colorcon agreed with BPSI that Berwind Group
Partners, not BPSI, was “the party liable to the [David Berwind] Trust
with respect to those payments under the terms of the settlement
agreement” and that “for this reason . . . the Ride-Up agreement has no
connection to the $191,000,000 payment.” Id. at 663.
On July 19, 2016, petitioners and the IRS entered into
stipulations regarding the effect of section 483 in the present case. We
quote these stipulations in full:
181. The following table represents the applicable
Federal rates (compounded semiannually) for October,
November, and December 1999 as respectively published
in Revenue Rulings 99-41, 99-45, and 99-48:
Oct-99
Short-term (<3 yrs): 5.47%
Mid-term (3–9 yrs): 5.93%
Nov-99
Short-term (<3 yrs): 5.49%
Mid-term (3–9 yrs): 6.99%
Dec-99
Short-term (<3 yrs): 5.66%
Mid-term (3–9 yrs): 6.11%
94
[*94] 182. To calculate the total unstated interest under
IRC § 483(b) asserted in the [David Berwind] Trust Notice
[the July 25, 2008 notice of deficiency mailed to the David
Berwind Trust], [the IRS] (1) used the October 1999 Mid-
term applicable Federal rate of 5.93% (semiannual
compounding), which was based on the [David Berwind]
Trust having sold or exchanged its BPSI stock on December
16, 1999 and receiving a December 31, 2002 payment,
(2) used the $191,000,000 Settlement Amount as the “sum
of the payments” to which IRC 483 applies, and (3) did not
include in the “sum of the payments” the $257,353 of
Investment Income Components that were part of the
Escrow Fund released to the [David Berwind] Trust on
December 31, 2002 . . . . Petitioners and [the IRS] agree
that if the payment discussed in the Settlement Agreement
is subject to IRC § 483 as of December 16, 1999 and is
treated for Federal income tax purposes as paid to the
[David Berwind] Trust on December 31, 2002, then for the
purpose of calculating the total unstated interest under
IRC § 483(b): (1) the October 1999 Mid-Term rate of 5.93%
(semiannual compounding) is the applicable Federal rate;
(2) the sum of the payments to which IRC § 483 applies
equals $191,257,353 (i.e., the released Escrow Fund, which
included both the $191,000,000 Settlement Amount and
$257,353 from the Investment Income Components); and
(3) the income reported by the [David Berwind] Trust for
Investment Income Components on its 2002 Form 1041
should be reduced to zero (0). Petitioners and [the IRS]
agree that if the payment discussed in the Settlement
Agreement is subject to IRC § 483 as of December 16, 1999
and is treated for Federal income tax purposes as paid to
the [David Berwind] Trust on November 25, 2002, then for
purpose of calculating the total unstated interest under
IRC § 483(b): (1) the October 1999 Short-term rate of 5.47%
(semiannual compounding) is the applicable Federal rate;
(2) the sum of the payments to which IRC § 483 applies
equals $191,000,000 (i.e., the Settlement Amount); and
(3) the income reported by the [David Berwind] Trust for
the Investment Income Components on its 2002 Form 1041
should not be adjusted. Thus, the date of payment for
purposes of IRC § 483 to the [David Berwind] Trust is
unagreed and to be decided by the Court.
95
[*95] 183. Petitioners and [the IRS] agree that the
resolution of the deficiency determinations against each of
the four petitioners other than the [David Berwind] Trust
(i.e., the [David Berwind] Trust beneficiaries) is solely
dependent upon the resolution of the [David Berwind]
Trust Notice [the July 25, 2008 notice of deficiency mailed
to the David Berwind Trust]; that is, if a portion of the
Settlement Amount is treated as interest under Internal
Revenue Code § 483, then the Notices of Deficiency for each
beneficiary are correct, subject to any adjustments that
may be required by resolution of the issue described in the
immediately preceding paragraph. Conversely, if no
portion of the Settlement Amount [$191,000,000] is treated
as interest under Internal Revenue Code § 483, then none
of the four beneficiaries will have tax deficiencies for their
respective 2002 tax years. The parties agree that a Rule
155 computation will apply after the interest issue is
decided.
On December 22, 2022, the Tax Court ordered the parties to
clarify their positions as to certain questions by filing a joint
memorandum.
In a joint Memorandum filed with the Tax Court on January 10,
2023, petitioners and the IRS stated that they agree that if the payment
described by the settlement agreement is “subject to” section 483 and
the payment occurred on November 25, 2002, then the total unstated
interest with respect to the payment is $28,043,669. They further stated
they agree that if the payment described in the settlement agreement is
“subject to” section 483 and the date of the payment is December 31,
2002, then the total unstated interest with respect to the payment is
$31,140,364.
On March 1, 2023, the Tax Court issued an Order recognizing
certain inadvertent numerical errors in its December 22, 2022 Order
and in the parties’ January 10, 2023 joint Memorandum.
In the present case, petitioners’ primary position is that the sale
or exchange of the David Berwind Trust’s BPSI common stock occurred
on November 25, 2002. Petitioners’ alternative position is that if the
sale of the David Berwind Trust’s common stock occurred on December
16, 1999, the payment for the stock was made on November 25, 2002.
The IRS’s position is that the sale or exchange of the David Berwind
96
[*96] Trust’s BPSI common stock occurred on December 16, 1999, and
that the payment for the stock was made on December 31, 2002. We
summarize the parties’ positions in the table below:
Date of Date of Amount of Total Discount Tax
sale or payment payment for unstated rate treatment of
exchange for stock stock interest Investment
of David Income
Berwind Components
Trust’s ($257,353)
BPSI separate from
common § 483
stock computations
P: primary 11/25/02 11/25/02 $191,000,000 0 — Includable
P: 12/16/99 11/25/02 191,000,000 28,043,669 5.47% Includable
alternative
IRS 12/16/99 12/31/02 191,257,353 31,140,364 5.93% Excludable
OPINION
As a general rule, it is the petitioner in a Tax Court case who
bears the burden of proof. Rule 142(a). Petitioners in this case do not
argue that they do not have the burden of proof. We conclude that
petitioners in this case bear the burden of proof.
The dispute in this case involves the application of section 483 to
the payment received by the David Berwind Trust for BPSI common
stock. Several provisions of section 483 and the regulations thereunder
are relevant. We summarize them below.
Section 483(a) provides that
in the case of any payment –
(1) under any contract for the sale or exchange of any
property, and
(2) to which this section applies,
there shall be treated as interest that portion of the
total unstated interest under such contract which, as
determined in a manner consistent with the method of
computing interest under section 1272(a), is properly
allocable to such payment.
97
[*97] Section 483(b) provides that
the term “total unstated interest” means, with respect to a
contract for the sale or exchange of property, an amount
equal to the excess of –
(1) the sum of payments to which this section applies
which are due under the contract, over
(2) the sum of the present values of such payments
and the present values of any interest payments due
under the contract.
By its terms, section 483(a) relies on section 1272(a) to allocate
total unstated interest among payments to which section 483 applies.
No party in the present case asserts that there are multiple payments
to which section 483 simultaneously applies. Therefore it is unnecessary
to discuss how total unstated interest should be allocated among
multiple payments, including how section 1272(a) operates in that
regard.
Both section 483(a) and (b) refer to a “payment” to which section
483 “applies.” Section 483(c) provides the following rule for determining
whether section 483 applies to a payment:
[T]his section [i.e., section 483] shall apply to any payment
on account of the sale or exchange of property which
constitutes part or all of the sales price and which is due
more than 6 months after the date of such sale or exchange
under a contract—
(A) under which some or all of the payments are due
more than 1 year after the date of such sale or exchange,
and
(B) under which there is total unstated interest.
There are exceptions to this rule, but they are not relevant to the present
case.
Section 483(b) provides that for the purpose of calculating the
total unstated interest, “the present value of a payment shall be
determined under the rules of section 1274(b)(2) using a discount rate
equal to the applicable Federal rate determined under section 1274(d).”
Elaborating on section 483(b), regulations provide that the “present
value of any deferred payment or interest payment is determined by
discounting the payment from the date it becomes due to the date of the
sale or exchange.” Treas. Reg. § 1.483-2(b)(2). A “deferred payment” is
98
[*98] defined by these regulations as a “payment that constitutes all or
a part of the sales price . . . and that is due more than 6 months after
the date of the sale or exchange.” Treas. Reg. § 1.483-2(b)(1). A “sales
price” is defined by these regulations generally as “the amount due
under the contract (other than stated interest).” Treas. Reg. § 1.483-
2(b)(2). Section 1274(b)(2), referred to in section 483(b), works in
conjunction with section 1274(a). Section 1274(a) provides that under
certain conditions, the issue price of a debt instrument is equal to the
imputed principal amount of the debt instrument. The imputed
principal amount of a debt instrument is defined by section 1274(b)(1)
as the “sum of the present values of all payments due under [the] debt
instrument.” Section 1274(b)(2) provides that the present value of a
payment “shall be determined in the manner provided by regulations
prescribed by the Secretary—(A) as of the date of the sale or exchange,
and (B) by using a discount rate equal to the applicable Federal rate,
compounded semiannually.” Because the parties to the present case
have stipulated to the appropriate discount rate to be used to determine
the present value of any payment to which section 483 “applies,” we need
not discuss the determination of the discount rate referred to in section
1274(b)(2)(B) or the regulations thereunder. Similarly, the parties’
stipulation as to the appropriate discount rate to be used to determine
the present value of any payment to which section 483 “applies” relieves
us of the need to discuss the operation of section 1274(d) (a provision
referred to in section 483(b)(2)).
Section 483(f) provides:
The Secretary shall prescribe such regulations as may be
necessary or appropriate to carry out the purpose of this
section including regulations providing for the application
of this section in the case of—
(1) any contract for the sale or exchange of
property under which the liability for, or the amount
or due date of, a payment cannot be determined at
the time of the sale or exchange, or
(2) any change in the liability for, or the
amount or due date of, any payment (including
interest) under a contract for the sale or exchange of
property.
One of the regulations authorized by section 483(f) is Treasury
Regulation § 1.483-4(a), which requires “[e]ach contingent payment
under the overall contract” to be “characterized as principal and
99
[*99] interest.” An example given of this regulatory requirement is that
of a taxpayer who exchanges its shares of a corporation for a contingent
right, over the next three years, to receive shares in another corporation
in any year in which the profits from the other corporation exceed
certain amounts. Id. para. (b) (example 2). This regulatory example
states that such transfer of shares pursuant to the contingent right is
“subject to section 483 and a portion of the shares is treated as unstated
interest under that section.” Id.
With these statutory and regulatory provisions in mind, we now
discuss the appropriate tax treatment of the following transfers: (1) the
November 25, 2002 deposit by BPSI of $191,000,000 in “an escrow
account” and (2) the December 31, 2002 release by PNC Bank of
$191,257,353 from the PNC escrow account to the David Berwind Trust.
I. On December 16, 1999, there was a “sale or exchange” of the David
Berwind Trust’s shares of BPSI common stock within the meaning
of section 483.
The IRS takes the position that there was a sale or exchange of
the David Berwind Trust’s shares of BPSI common stock on December
16, 1999. Petitioners agree that there was a sale or exchange of the
shares, but contend the date of the sale or exchange was November 25,
2002.
At the outset we explain why the holding in Colorcon, Inc. v.
United States, 110 Fed. Cl. 650, 660 (2013), does not require us to hold
that the sale or exchange of the BPSI common stock occurred on
December 16, 1999. The plaintiff in Colorcon was Colorcon, Inc., the
corporate successor to BPSI, which we refer to as BPSI. The defendant
was the United States, which is considered in privity with the IRS in
our case. Lea, Inc. v. Commissioner, 69 T.C. 762, 764 (1978). In
Colorcon, Inc., 110 Fed. Cl. at 660, the Court of Federal Claims agreed
with BPSI that the sale or exchange of the BPSI stock occurred on
December 16, 1999. The Court of Federal Claims rejected the argument
by the United States that the “2002 settlement agreement superseded
any payment obligation of [BPSI] for the [David Berwind] Trust shares
in BPSI under the 1999 merger.” Id. None of the petitioners in the
present case were parties to Colorcon. For this reason, we suppose, the
IRS does not argue that petitioners are bound by the holding of Colorcon.
See Peck v. Commissioner, 90 T.C. 162, 166 (1988) (collateral estoppel
may only be invoked against the parties to a prior judgment or their
privities), aff’d, 904 F.2d 525 (9th Cir. 1990). For their part, petitioners
100
[*100] do not argue that we must reject the IRS’s position in the present
case because it is inconsistent with the position taken by the United
States in Colorcon. Furthermore, Colorcon is not binding on us (unlike,
say, a published Tax Court opinion). Although the holding in Colorcon
does not require us to resolve the dispute in the present case one way or
another, we will on occasion cite the Colorcon opinion for propositions
for which we find the opinion persuasive. However, we observe that the
reasoning of Colorcon does not easily carry over to the present case
because petitioners in the present case make arguments considerably
more extensive than the arguments made by the United States in
Colorcon.
In determining under section 483 whether a sale or exchange of
property has occurred, it is state law that controls. See Williams v.
Commissioner, 1 F.3d 502, 505 (7th Cir. 1993) (“section 483 simply
attaches federal tax consequences to a transaction defined by state
law”), aff’g 94 T.C 464 (1990); see also Colorcon, Inc., 110 Fed. Cl. at 661.
BCL § 1928 provides that a merger is effective upon the filing of the
articles of merger. BCL § 1929(a) provides that upon the merger being
effective, the existence of the nonsurviving corporation will cease. The
articles of merger for the merger between BPSI Acquisition and BPSI
were filed on December 16, 1999. The existence of BPSI ceased on this
date. On this date, therefore, the shareholders of BPSI, including the
David Berwind Trust, no longer had an ownership interest in BPSI. As
dissenting shareholders, they instead had the right under BCL § 1571(a)
to obtain payment for the fair market value of their shares.
That the David Berwind Trust had no ownership interest in the
shares of BPSI as of December 16, 1999, is reinforced by the terms of the
plan of merger. Under BCL § 1922(a)(3), the plan of merger must state
what the shareholders will receive in exchange for their shares in the
companies to be merged. Consistent with BCL § 1922(a)(3) (and with
BCL § 1929(a), discussed in the paragraph above) the plan of merger
between BPSI Acquisition and BPSI provided that all shares of BPSI
common stock were cancelled as of the date the articles of merger were
filed. The plan of merger stated that the holders of BPSI stock would
receive an $82,820,000 note, and also recognized that the owners of the
shares had the right to obtain payment for the fair market value of the
shares under the dissenters-rights provision of the BCL.
By operation of the BCL, therefore, on December 16, 1999, the
David Berwind Trust’s shares in BPSI were cancelled in exchange for
either the $82,820,000 note or the fair market value of the shares. See
101
[*101] BCL §§ 1928, 1929. It was on that date—December 16, 1999—
that there was a “sale or exchange” of the shares. Petitioners oppose
this conclusion with a variety of arguments. We will discuss their
arguments in depth, but these are the basic reasons we are unpersuaded
by petitioners’ arguments:
• Petitioners have not shown that the merger was void under
Pennsylvania law. See OPINION, infra, Part I.A. If the merger
were void, that would render irrelevant the provisions of the BCL
that would otherwise give effect to the merger. See, e.g., BCL
§§ 1928, 1929.
• The U.S. District Court did not enter a judgment rescinding or
voiding the merger. Such a judgment seemingly would have been
relevant because it would have negated the effect of the BCL
provisions regarding the consequences of the merger. See, e.g.,
BCL §§ 1928, 1929.
• The settlement agreement did not provide that the merger was
rescinded or void. See OPINION, infra, Part I.G. Such a
provision seemingly would have been relevant because it would
have had legal effect under Pennsylvania law that would have
negated the effect of the BCL provisions regarding the
consequences of the merger. See, e.g., BCL §§ 1928, 1929. See
OPINION, infra, Part I.G.
• Furthermore, to the extent it is relevant, we disagree with
petitioners’ characterization of the nature of the claims of the
Warden litigation and the appraisal proceeding. See OPINION,
infra, Part I.E. In particular we disagree that the plaintiffs in
that the claims (1) sought only rescission of the merger or (2) that
rescission of the merger was the only remedy that could have been
awarded to the plaintiffs had the claims gone to judgment.
Thus, we agree with the IRS that “the December 16, 1999 Merger
[i.e., the merger of BPSI Acquisition into BPSI] triggered a sale or
exchange of the [David Berwind] Trust’s stock.” And we reject
petitioners’ argument that the November 25, 2002 settlement
agreement represented “a 2002 sale of stock.”
As we said, we have not yet fully discussed petitioners’ extensive
arguments against December 16, 1999 being the date of the sale or
exchange of the stock and November 25, 2002 being the correct date. We
discuss these arguments in the subparts that follow.
102
[*102] A. The plan of merger between BPSI Acquisition and BPSI
did not violate BCL § 1922(a)(3); even if the plan of merger
did violate that provision, the merger was not void.
Petitioners contend that the plan of merger filed by BPSI with the
Commonwealth of Pennsylvania on December 16, 1999, violated BCL
§ 1922(a)(3) because it did not set forth what would be received by the
holders of three classes of stock of BPSI (preferred, preference, and
preferential) in exchange for their shares. Petitioners contend that
therefore the merger was void. The contention is intended to support
petitioners’ larger argument that the sale or exchange of the David
Berwind Trust’s BPSI shares did not occur on December 16, 1999. We
disagree with petitioners’ contention and we hold that the plan of
merger did not violate BCL § 1922(a)(3).
1. The plan of merger complied with BCL § 1922(a)(3).
BCL § 1922(a)(3) requires a plan of merger to set forth what the
shareholders of the merging corporation will receive for their shares:
(a) Preparation of plan.—A plan of merger . . . shall be
prepared, setting forth:
....
(3) The manner and basis of converting the shares of
each corporation into shares or other securities or
obligations of the surviving . . . corporation . . . and, if any
of the shares of any of the corporations that are parties to
the merger . . . are not to be converted solely into shares or
other securities or obligations of the surviving . . .
corporation, the shares or other securities or obligations of
any other person or cash, property or rights that the
holders of such shares are to receive in exchange for, or
upon conversion of, such shares, and the surrender of any
certificates evidencing them, which securities or
obligations, if any, of any other person or cash, property or
rights may be in addition to or in lieu of the shares or other
securities or obligations of the surviving . . . corporation.
BPSI filed the plan of merger with the Commonwealth of
Pennsylvania on December 16, 1999. On the day before, December 15,
1999, BPSI had issued notices of redemption to the holders of shares of
the following classes of BPSI stock: (1) preferred, (2) preference, and
(3) preferential. As explained earlier, BPSI’s articles of incorporation
103
[*103] contained several provisions regarding the redemption of these
classes of stock: first, they authorized BPSI to redeem these shares at
any time by paying in cash the redemption price of the shares; second,
they required BPSI to send the shareholders of those classes of stock
notices of redemption at least 30 days before the date fixed for such
redemption; and third, they provided that “from and after the date fixed
for such redemption, the shares represented thereby shall no longer be
deemed outstanding . . . and all rights with respect to such shares so
called for redemption shall forthwith on such redemption date cease and
terminate.” See FINDINGS OF FACT, infra, Parts 4, 7. The December
15, 1999 notices of redemption called for redemption of all the preferred,
preference, and preferential shares on January 15, 2000. The notices of
redemption stated that the redemption prices were equal to (a) a price
per share of $50 per preferred share, $1 per preference share, and $1 per
preferential share; plus (b) accrued dividends as of the redemption date.
The notices of redemption stated that BPSI had irrevocably deposited
funds sufficient for the redemptions. See BCL § 1758(d). The notices of
redemption also stated that “[a]s a result of such action, the shares . . .
shall no longer be outstanding as provided in Section 1758(d) of the
Pennsylvania Business Corporation law.” The term “such action”
apparently meant (1) mailing the redemption notices and (2) making the
deposits. The plan of merger made the following statement about BPSI’s
preferred, preference, and preference stock:
[BPSI] has previously issued notices of redemption for the
outstanding shares of the . . . [p]referred [s]tock, the . . .
[p]reference [s]tock and the . . . [p]referential [s]tock and
deposited a sum sufficient to pay the redemption price in a
financial institution with irrevocable instructions to pay
the redemption price to the holders thereof upon surrender
of the certificates therefore [sic]. Therefore, the . . .
[p]referred [s]tock, the . . . [p]reference [s]tock and the . . .
[p]referential [s]tock are no longer deemed outstanding,
and have no rights with respect to the transactions
contemplated by this Agreement and Plan of Merger.
The term “Agreement and Plan of Merger” meant the plan of merger
itself, because the plan of merger was self-titled “Agreement and Plan
of Merger.”
BCL § 1758(d) provides that “[u]nless otherwise provided in the
articles, redeemable shares that have been called for redemption shall
not . . . be deemed outstanding shares after written notice has been
104
[*104] mailed to holders thereof that the shares have been called for
redemption.” See FINDINGS OF FACTS, infra, Part 9. As discussed in
the paragraph above, BPSI’s articles of incorporation include the
provision that “from and after the date fixed for such redemption, the
shares represented thereby shall no longer be deemed outstanding . . .
and all rights with respect to such shares so called for redemption shall
forthwith on such redemption date cease and terminate.” Thus, while
BCL § 1758(d) imposes the rule that shares will no longer be considered
outstanding as of the date of the redemption notice, this rule governs
only “[u]nless otherwise provided in the articles,” and BPSI’s articles
provide that shares are no longer deemed outstanding as of the date of
the redemption. Petitioners argue that the BPSI preferred, preference,
and preferential shares remained outstanding after the December 15,
1999 notices of redemption until the redemption date of January 15,
2000. If petitioners are correct that BPSI preferred, preference, and
preferential shares remained outstanding after the December 15, 1999
notices of redemption, then it would follow that BCL § 1922(a)(3)
required the plan of merger to state what the holders of these shares
“are to receive in exchange for . . . such shares.” Petitioners argue that
the plan of merger failed to meet this requirement because it
erroneously stated that the preferred, preference, and preferential stock
were “no longer deemed outstanding.”
We hold that the plan of merger did make the statement required
by BCL § 1922(a)(3) even though it was seemingly in error in stating
that the non-common shares were no longer outstanding as of December
15, 1999. Despite this error, the plan of merger nonetheless explained
that the shares had been called for redemption and that their holders
would receive the redemption price. This was a correct statement of
what the holders of the shares “are to receive in exchange for . . . such
shares.” See BCL § 1922(a)(3). Because the plan of merger accurately
stated what the owners of non-common shares would receive for their
shares in the merger, we conclude that the plan of merger complied with
BCL § 1922(a)(3).
2. Even if the plan of merger violated BCL § 1922(a)(3), the
merger was not void.
But even assuming arguendo that the plan of merger violated
BCL § 1922(a)(3), such a violation would not result in the merger
between BPSI Acquisition and BPSI being void ab initio.
105
[*105] The parties in the present case disagree on the consequences of
a violation of BCL § 1922(a)(3). Petitioners claim that noncompliance
with BCL § 1922(a)(3) means that the merger between BPSI Acquisition
and BPSI was void ab initio. Under this view, the merger never
happened and the David Berwind Trust still held its shares of BPSI
common stock until the November 25, 2002 settlement agreement. In
support of their argument that the merger is void ab initio, petitioners
rely on the opinion of the Delaware Court of Chancery in Arnold v.
Society for Savings Bancorp., Inc., 1995 WL 376919 (June 15, 1995),
aff’d in part on relevant grounds, rev’d in part on other grounds, 678 A.2d
533 (Del. 1996). In Arnold, a shareholder of a corporation that had
purportedly undergone a merger challenged the merger on the grounds
that, even though the shareholders of the corporation had voted in favor
of the merger, the vote was ineffective because the corporation’s board
of directors had failed to disclose to the shareholders information about
the history of the merger negotiations. 1995 WL 376919, at *2; 650 A.2d
1270, 1275–76 (Del. Ch. 1994) (in a prior proceeding holding that
corporation failed to disclose there had been an appraisal of the value of
its shares or a prior contingent bid for one of its subsidiary). In
analyzing the merits of the shareholder’s argument, Arnold explained
that a “merger that fails to comply with the statutory requirements for
a merger is void ab initio,” a statement upon which petitioners in the
present case rely. 1995 WL 376919, at *2. 35
Petitioners also invoke another opinion of the Delaware Court of
Chancery, Jackson v. Turnbull, 1994 WL 174668 (Del. Ch. Feb. 8, 1994),
aff’d, 653 A.2d 306 (Del. 1994). In Jackson, the court held that a merger
was void ab initio because of a combination of three grounds, one of
which was that the merger violated Del. Code Ann. tit. 8, C. § 251(b);
35 The rest of the Arnold opinion is not as important for our purposes. Arnold
held that the board of directors’ failure to disclose did not violate the Delaware
statutory requirements for a merger. Id. at *2. Arnold explained that Delaware
statutory law, Del. Code Ann. tit. 8, § 251(c) (West 2020), merely required the board of
directors, before submitting the merger agreement to the shareholders for a vote at a
shareholder meeting, to (1) notify them of the time, place and purpose of the meeting
and (2) supply them with a copy or brief description of the merger agreement. 1995
WL 376919, at *3. Arnold held that the statute did not require the corporation to
disclose to its shareholders all material facts about the merger. Id. According to
Arnold, that requirement existed as “separate fiduciary duty of disclosure, derived
from the common law.” Id. The requirement did not come from the statute. Id. Arnold
concluded that the merged corporation “complied with all the statutory requirements
for a valid merger” and that therefore the merger was “not void.” Id. We assume
arguendo in Part 1.A of this OPINION that the merger of BPSI Acquisition and BPSI
violated BCL § 1922(a)(3).
106
[*106] 1994 WL 174668, *3. That statute requires the board of directors
of a corporation desiring to merge to adopt a resolution approving an
agreement of merger. Del. Code Ann. tit. 8, § 251(b); 1994 WL 174668,
at *3. It further requires the agreement of merger to state what the
shareholders are to receive in the merger. Del. Code Ann. tit. 8, § 251(b);
Jackson, 1994 WL 174668, at *3. The provision thus has similarities to
BCL § 1922(a)(3). In Jackson, the board of directors of the corporation
had approved a merger agreement under which the shareholders were
to receive a payment equal the greater of (a) $1,501.19 per share or
(b) the appraised value of the shares pursuant to a future appraisal by
an investment banker. 1994 WL 174668, at *4. Because the appraised
amount was unknown at the time of the merger agreement, Jackson
held that the merger agreement “does not specify the amount of cash the
stockholders will receive.” Id. Jackson held that the merger violated
Del. Code Ann. tit. 8, § 251(b) and that the merger was void ab initio.
Jackson, 1994 WL 174668, at *6. By analogy to Jackson, petitioners in
the present case contend that the merger of BPSI Acquisition and BPSI
is void ab initio.
The IRS argues that noncompliance with BCL § 1922(a)(3), and
with other requirements for mergers in the BCL, does not mean that the
merger is void, only that it was voidable by a court. The IRS explains
that Arnold and Jackson are irrelevant for the reasons given by the
Pennsylvania Court of Common Pleas in First Union National Bank v.
Quality Carriers, Inc., 48 Pa. D. & C. 4th 1, 2000 WL 33199269, at *7
(Pa. Ct. C.P. Oct. 10, 2000). We agree with the IRS.
In First Union National Bank, a corporation merged with another
corporation without notifying all of its shareholders. 2000 WL
33199269, at *3. Some of the unnotified shareholders sued for equitable
relief on grounds of (1) breach of the BCL and (2) breach of fiduciary
duty. 2000 WL 33199269 at *3. Referring to Arnold and Jackson, First
Union National Bank observed that the “Delaware general rule finding
mergers void ab initio if they fail to comply with the relevant statutes is
not universally recognized.” 2000 WL 33199269 at *6. First Union
National Bank continued, “the courts of this Commonwealth [i.e.,
Pennsylvania] have refused to regard corporate decisions that fail to
comply with the BCL as void.” 2000 WL 33199269 at *6. Finally, First
Union National Bank held that “a merger that fails to comply with the
BCL should be deemed voidable, not void.” 2000 WL 33199269 at *7.
On the weight of First Union National Bank (and similar
authorities applying Pennsylvania law, see, e.g., MicroSignal Corp. v.
107
[*107] MicroSignal Corp., 147 F. App’x 227, 233 (3d Cir. 2005) (merger
is not void under Pennsylvania law even where shareholders received
no notice of merger)), we conclude that a violation of BCL § 1922(a)(3)
would not render the BPSI squeeze-out merger void ab initio. Because
the merger is not void ab initio, it remains effective to the present day
because no court (including the District Court in the Warden litigation)
has held the merger void. See First Union National Bank, 2000 WL
33199269 (stating that the weight of precedent is that a voidable merger
may be declared void by a “Pennsylvania court” when that court
considers various factors, such as the nature of the violation of the BCL,
the identity of the plaintiff, and the practicality of undoing the merger).
Thus, even if the merger violated BCL § 1922(a)(3), the merger was still
valid.
B. The merger of BPSI Acquisition and BPSI did not violate BPSI’s
articles of incorporation.
Petitioners next argue that the merger of BPSI Acquisition and
BPSI violated the requirement in BPSI’s articles of incorporation that
any merger must be approved by the holders of the majority of BPSI
preferred shares. This argument is intended to support petitioners’
larger argument that the sale or exchange of the David Berwind Trust’s
common stock of BPSI occurred on November 25, 2002, not December
16, 1999.
BPSI’s articles of incorporation prohibit BPSI from merging with
another corporation without the “consent (given by vote at a meeting
called for that purpose)” of the holders of a majority of the shares of
preferred stock. The only holder of BPSI preferred shares at the
relevant time was BPSI Acquisition. BPSI Acquisition’s board of
directors approved the merger. And an officer of BPSI Acquisition
executed the plan of merger. But petitioners contend that as a matter
of fact BPSI Acquisition did not vote its BPSI preferred shares in favor
of the merger. In petitioners’ words, “[preferred] shares of BPSI were
not voted.”
We assume arguendo that the approval of the plan of merger by
BPSI Acquisition’s board of directors, and its execution by one of its
officers, is not the equivalent of BPSI Acquisition voting its preferred
shares in favor of the merger. Under this assumption the record does
not establish whether BPSI Acquisition submitted a vote as the sole
holder of BPSI’s preferred stock. Petitioners in the present case have
the burden of proof. They have not adduced evidence on this point.
108
[*108] Estate of Gilford v. Commissioner, 88 T.C. 38, 51 (1987).
Resolving this factual issue against petitioners is required by the
allocation of burden of proof in this case.
Resolving this factual issue this way is also consistent with
procedural fairness. Petitioners’ factual claim—that BPSI Acquisition
did not submit a vote as the holder of BPSI’s preferred stock—was not
raised by petitioners until post-trial briefing. Petitioners did not notify
the IRS before trial (in their Pretrial Memorandum or otherwise) that
they would argue that BPSI Acquisition failed to approve the plan of
merger as holder of BPSI preferred stock. Petitioners’ argument (unlike
the argument that the plan of merger violated BCL § 1922(a)(3)) was not
made by the David Berwind Trust in the Warden litigation.
We hold that the merger between BPSI Acquisition and BPSI did
not violate the requirement in BPSI’s articles of incorporation that a
merger must get the “consent (given by vote at a meeting called for that
purpose)” of the holders of at least a majority of the shares of preferred
stock.
C. The remedies of the plaintiffs in the Warden litigation would not
have been limited to the dissenters-rights provisions had the
merger been tainted with fraud or fundamental unfairness.
However, petitioners do not ask us to determine that the merger
was so tainted.
One reason petitioners argue that the sale or exchange of the
David Berwind Trust’s common stock of BPSI occurred on November 25,
2002, not December 16, 1999, is that “[f]raud or fundamental unfairness
is grounds for an injunction against a merger.” Placing this argument
in context requires some explanation.
BCL § 1105 provides in relevant part that a shareholder “shall
not have any right to obtain, in the absence of fraud or fundamental
unfairness, an injunction against any proposed plan . . . authorized
under any provision of this subpart [i.e., BCL §§ 1101–4162]” and that
“[a]bsent fraud or fundamental unfairness” the shareholder’s exclusive
remedies are the dissenters-rights provisions of BCL §§ 1571–1580. A
“proposed plan” of the type referred to by BCL § 1105 includes a plan of
merger. See BCL §§ 1921(a), 1922. BCL § 1105 has been interpreted by
Pennsylvania courts to mean that an injunction is available against a
merger that is tainted by “fraud or fundamental unfairness” provided
that the injunction was sought before the merger. In Barter v.
109
[*109] Diodoardo, 771 A.2d 835, 839 (2001) (citations omitted), the
Superior Court of Pennsylvania stated that “[a]lthough granted by
negative implication, section 1105 thus provides a dissenting
shareholder with the right to enjoin a merger in cases of ‘fraud or
fundamental unfairness’”. In In re Jones & Laughlin Steel Corp., 412
A.2d 1099, 1104 (1980), the Supreme Court of Pennsylvania held that to
exercise the right to enjoin proposed unfair or fraudulent corporate
actions, the shareholder must institute the action “prior to the
consummation of the proposed transaction.” (Emphasis added).
The District Court in the Warden litigation (in part E of its
August 8, 2001 opinion) held that Counts VI (injunction against merger),
VII (accounting) and VIII (rescission of merger) of the amended
complaint filed by the plaintiffs (including the David Berwind Trust) did
not state a claim upon which relief could be granted because, the District
Court held, the plaintiffs were limited to an appraisal remedy. Warden
v. McLelland, 2001 WL 910934, at *13. The District Court was reversed
on this point by the Third Circuit, which pointed out that the original
complaint had been filed before the plan of merger had been filed.
Warden v. McLelland, 288 F.3d at 115.
Petitioners in the present case contend that we must similarly
reject the view of the District Court in the Warden litigation that the
David Berwind Trust’s remedy with respect to the misconduct alleged in
Counts VI, VII, and VIII, was necessarily limited to an appraisal
proceeding. Petitioners explain their argument in their opening brief as
follows: “BPSI argued in the Warden litigation that the [David Berwind]
Trust’s remedy was limited to an appraisal proceeding, and [the IRS]
now does the same. The law in Pennsylvania, however, does not support
the argument made by BPSI or [the IRS].” In response to this, the IRS
clarifies that it is not the IRS’s contention that the David Berwind
Trust’s remedies were limited to appraisal:
In their opening brief, Petitioners mistakenly argue that it
is [the IRS’s] position that Petitioners were limited to an
appraisal proceeding after the Merger took place . . .
Contrary to Petitioners’ assertions, [the IRS] merely takes
the position that the [David Berwind] Trust walked away
from its claims for equitable relief when it agreed to accept
the $191 million cash settlement.
We agree with petitioners inasmuch we think that the tax
consequences of the 2002 settlement agreement should not be
110
[*110] determined under the assumption that part E of the District
Court opinion in the Warden litigation was correct in holding that the
plaintiffs’ claims in Counts VI (injunction against merger), VII
(accounting), and VIII (rescission of merger) did not state a claim upon
which relief could be granted. Warden v. McLelland, 2001 WL 910934,
at *12–13. Our agreement is consistent with the IRS’s concession
(discussed in the paragraph above) that the David Berwind Trust was
not limited to the appraisal remedy as a matter of law. Our agreement
does not mean we take the view that the particular claims for relief
would have been successful had they continued to be litigated.
Petitioners do not urge us to determine that the particular claims would
have been successful, and specifically they do not request that we
determine that the merger was tainted by “fraud or fundamental
unfairness”. Consequently, the IRS did not advance any views about
the potential success of the claims. We do not ordinarily reach issues
not raised by the parties. Therefore we do not opine on whether the
plaintiffs’ particular claims would have been successful.
Our limited agreement with petitioners’ argument stated above
does not lead to the conclusion that that the sale or exchange of the
David Berwind Trust’s common stock of BPSI occurred on November 25,
2002. And it is not contrary to our holding that the sale or exchange
occurred on December 16, 1999.
D. Count XIII of the amended complaint in the Warden litigation
should not be treated as failing to state a claim on the grounds
that the Graham Berwind and McKenney’s resignations as
trustees of the David Berwind Trust were effective.
In urging us to hold that the sale or exchange of the David
Berwind Trust’s common stock of BPSI occurred on November 25, 2002,
not December 16, 1999, petitioners argue that we should reject a certain
argument they say is made by the IRS: “[The IRS] argues that the
breach of trust grounds for rescission should be ignored because both
Graham [Berwind] and McKenney had resigned as trustees of the
[David Berwind] Trust prior to the Disputed Merger.” To explain the
significance of petitioners’ point, we must discuss the following four
interrelated subjects: first, the purported resignations of Graham
Berwind and McKenney in 1997; second, the positions taken by the
parties in the Warden litigation regarding the purported resignations;
third, the District Court and Third Circuit’s holdings regarding the
purported resignations; and fourth, the positions taken by the parties in
111
[*111] the present case with respect to the significance of the purported
resignations to the David Berwind Trust’s federal income tax liability.
As to the first subject (the purported resignations), recall that
Graham Berwind was a trustee of the David Berwind Trust when it was
established in 1963. The deed of trust allows a trustee to resign without
court approval if the trustee designates in writing two individuals as a
succession of trustees. On June 26, 1997, the following events occurred:
(a) Graham Berwind designated in writing McKenney as his successor
trustee, but did not designate the next successor trustee; (b) Graham
Berwind and McKenney signed a document stating that Graham
Berwind resigned and that McKenney accepted appointment as Graham
Berwind’s successor; and (c) McKenney designated in writing Graham
Berwind as his successor trustee, but did not designate the next
successor trustee. Then, on December 30, 1997, McKenney signed a
document stating that he resigned as trustee.
As to the second subject (the positions of the plaintiffs in the
Warden litigation), recall that this litigation began on November 22,
1999, when four trustees of the David Berwind Trust (but not Graham
Berwind or McKenney) filed the original complaint. Count X of the
original complaint alleged that Graham Berwind and McKenney’s
resignations were ineffective and that they had violated their duties as
trustees of the David Berwind Trust. As a remedy for these alleged
violations, Count X sought (a) recovery of monetary damages or
(b) placement of the income from the alleged breaches of duty in a
constructive trust. On January 4, 2000, the plaintiffs amended the
complaint to allege—in new Count XIII—that as a remedy for Graham
Berwind’s and McKenney’s alleged violation of their duties as trustees
they should be enjoined from taking steps to affect the David Berwind
Trust’s minority shareholder interest in BPSI or the standing of the
David Berwind Trust to assert the shareholder-derivative claims in the
amended complaint.
As to the third subject (the holdings of the District Court and the
Third Circuit), the District Court’s holding on the purported
resignations was stated in part I of its August 8, 2001 opinion, where it
held that Counts X and XIII did not state a claim upon which relief could
be granted. Warden v. McLelland, 2001 WL 910934, at *17–18. One
reason given by the District Court was that Graham Berwind and
McKenney had resigned as trustees and that their resignations were
effective. Id. at *17. The Third Circuit reversed this holding on the
grounds that the plaintiffs’ allegation that Graham Berwind and
112
[*112] McKenney had not effectively resigned must be accepted as true
for purposes of Fed. R. Civ. P. 12(b)(6). Warden v. McLelland, 288 F.3d
at 110.
As to the fourth subject (the positions of the parties in our case
regarding the purported resignations), we begin with petitioners’
position. Petitioners argue that “[t]hese resignations . . . were not in
compliance with the terms of resignation in the [David Berwind] Trust
document regarding naming two successors and lodging the resignation
with the trustees.” Petitioners argue further that Graham Berwind
continued to behave like a trustee by writing checks and correspondence
for the trust. Petitioners argue further that even a valid resignation by
a trustee cannot absolve the trustee of liability for improper conduct.
Petitioners clarify, though, that they do not seek a determination by this
Court of the “validity of its [i.e., the David Berwind Trust’s] claims
regarding the . . . breach of trust [by alleged trustees Graham Berwind
and McKenney].” The IRS’s position regarding the purported
resignations is that the “[e]vidence shows that Bruce McKenney and
Graham Berwind resigned as trustees of the [David Berwind] Trust
before 1999.” Thus, the IRS contests petitioners’ view that Graham
Berwind and McKenney’s resignations were not effective. However, the
IRS also states that the “merits of the [David Berwind] Trust’s equitable
claims for rescission of the Merger, based on Graham Berwind and
Bruce McKenney’s alleged breach of fiduciary duties to the [David
Berwind] Trust, are not relevant because the [David Berwind] trust
abandoned those claims when it accepted the 2002 settlement payment,
and the Merger was never rescinded.”
We agree with petitioners’ argument inasmuch we think the tax
consequences of the 2002 settlement agreement should not be
determined under the assumption that the District Court in the Warden
litigation was correct, in part I of its opinion, that (a) Graham Berwind
and McKenney had effectively resigned as trustees of the David Berwind
Trust and (b) therefore Count XIII did not state a claim upon which
relief could be granted. Warden v. McLelland, 2001 WL 910934, at *17–
18. By so agreeing, we do not adopt the view that Count XIII would have
been successful had it continued to be litigated. The success of Count
XIII would have depended in part on whether Graham Berwind and
McKenney violated their fiduciary obligations as trustees of the David
Berwind Trust. Petitioners do not urge us to determine that Count XIII
would have been successful. As a result, the IRS has not advanced any
views about the potential success of Count XIII. We do not ordinarily
113
[*113] reach issues not raised by the parties. Therefore, we do not opine
on whether Count XIII would have been successful.
Our limited agreement with petitioners’ argument stated above
does not lead to the conclusion that that the sale or exchange of the
David Berwind Trust’s common stock of BPSI occurred on November 25,
2002. It is not inconsistent with our holding that the sale or exchange
occurred on December 16, 1999.
E. Application of the origin-of-the-claim test does not lead to the
conclusion that the sale or exchange occurred on November 25,
2002.
Petitioners observe that under the “origin-of-the-claim” test, the
tax treatment of a settlement payment is resolved by determining the
“nature of the claim.” See, e.g., Robinson v. Commissioner, 102 T.C. 116,
126 (1994) (“In the context of a settlement agreement, the nature of the
claim underlying the taxpayer’s damage award, rather than the validity
of his or her claim, determines whether he or she received the damages
on account of tortlike personal injuries . . . . A key question to ask is: ‘In
lieu of what were the damages awarded.’”) (emphasis in original), aff’d
in part, rev’d in part, 70 F.3d 34 (5th Cir. 1995). Petitioners further
contend that the origin of the claims in the Warden litigation (and the
appraisal proceeding) was “an effort to prevent or rescind a merger, not
to seek dissenter’s rights.” Therefore, they urge, the payment by BPSI
to the David Berwind Trust for the trust’s common BPSI shares was a
substitute for the relief that the plaintiffs sought (i.e., rescinding the
merger), and the merger must be treated for tax purposes as if it did not
occur. If the merger did not occur, that would support petitioners’ larger
argument that the sale or exchange of the David Berwind Trust’s
common stock of BPSI occurred on November 25, 2002, not the effective
date of the merger, December 16, 1999.
The IRS resists the idea that the tax treatment of the redemption
payment made by BPSI to the David Berwind Trust should be
determined under the origin-of-the-claim test. The IRS explains that in
cases resolving the tax treatment of a settlement payment based on the
origin of the claim, the dispute involved what the settlement payment
was for. An example of one such type of dispute was whether to classify
the settlement payment as (a) return of capital versus (b) lost profits.
See Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir.
1944), aff’g 1 T.C. 952 (1943). Another such type of dispute was whether
to classify the settlement payment as (a) compensation for personal
114
[*114] injury versus (b) damages for breach of contract. See Robinson,
102 T.C. at 134. But in the present case, the IRS explains, the parties
are in agreement as to what the redemption payment was for. They
agree that the payment was for the BPSI common stock held by the
David Berwind Trust. The IRS argues that the origin-of-the-claim test
is not an appropriate test for determining the timing of a sale or
exchange, which the present case involves, nor is it an appropriate test
for applying section 483, which the present case involves.
The origin-of-the claim test determines the tax treatment of a
settlement payment by the nature of the claim the payment resolved.
Alexander v. IRS, 72 F.3d 938, 942 (1st Cir. 1995) (“the classification of
amounts received in settlement of litigation is to be determined by the
nature and basis of the action settled, and amounts received in
compromise of a claim must be considered as having the same nature as
the right compromised”), aff’g T.C. Memo. 1995-51; Sager Glove Corp. v.
Commissioner, 36 T.C. 1173, 1180 (1961) (“The taxability of the proceeds
of a lawsuit, or of a sum received in settlement thereof, depends upon
the nature of the claim and the actual basis of recovery.”), aff’d, 311 F.2d
210 (7th Cir. 1962); Freeman v. Commissioner, 33 T.C. 323, 327 (1959)
(stating that absent a statement in a settlement agreement, we look to
the “nature of the claim and the actual basis of recovery”). Petitioners’
origin-of-the-claim argument supposes that the nature of the claims in
the Warden litigation and the appraisal proceeding control the tax
treatment of the payment by BPSI to the David Berwind Trust through
the following analysis: (1) if the claims were for an appraisal remedy,
then the relevant sale or exchange of the shares took place in 1999, and
(2) if the claims were for an injunction against the merger, then the
relevant sale or exchange of the shares took place in 2002. Petitioners
assert that the claims sought an injunction, i.e., the alternative we
denote as (2). Therefore they conclude that under this analysis the
relevant sale or exchange of the shares took place in 2002.
We disagree with petitioners’ premise that their claims sought
merely an injunction against the merger. The amended complaint in the
Warden litigation was not only a request for an injunction against the
merger. It also sought an appraisal remedy in Count IX. Furthermore,
the Warden litigation was consolidated with the appraisal proceeding.
The entire purpose of the appraisal proceeding was to press for an award
of the appraised value of the shares. The settlement agreement settled
both the Warden litigation and the appraisal proceeding.
115
[*115] Petitioners urge us to consider the case consisting of the Warden
litigation and the appraisal proceeding to be solely an injunction action
because “[t]here was no litigation action under the dissenter’s rights
claims.” This is not true. The defendants in the Warden litigation and
the appraisal proceeding moved to dismiss the amended complaint,
including Count IX (right to statutory appraisal) under Fed. R. Civ. Proc.
12(b)(6). Warden v. McLelland, 2001 WL 910934, at *15–16. That
motion would qualify as a “litigation action.” And though the
defendants’ Fed. R. Civ. P. 12(b)(6) motion did not address the appraisal
proceeding, we do not see why it is relevant how active a particular piece
of litigation is in determining the nature of the litigation, so long as that
piece of the litigation was unresolved by the time a settlement
agreement came along to resolve it. The appraisal proceeding was
extant, waiting to be resolved, when the settlement agreement was
executed.
Petitioners also urge us to consider the case consisting of the
Warden litigation and the appraisal proceeding to be solely an injunction
action because there was “no court-appointed appraiser.” BCL § 1579(c)
allows the court handling the appraisal proceeding to appoint an
appraiser, but it does not require the court to do so. Furthermore, the
2002 settlement agreement cut short the appraisal proceeding. Had the
appraisal proceeding not been resolved by the agreement, there could
have been a court-appointed appraisal.
Petitioners also urge us to consider the case consisting of the
Warden litigation and the appraisal proceeding to be solely an injunction
action because the David Berwind Trust only asserted its dissenters
rights “as a precautionary measure.” That may be true as a matter of
subjective intent. But the David Berwind Trust’s January 26, 2000
demand for payment for its BPSI common stock had the objective effect
of preserving its dissenters rights as required by BCL §§ 1575 and
1576(a). And its March 3, 2000 notice of estimate of fair value of its
shares similarly had the objective effect of preserving its right to seek
more than the $82,820,000 estimated by BPSI under BCL § 1578(a) and
(b). These actions preserved David Berwind Trust’s entitlement to the
dissenters rights given by BCL §§ 1571–1580. Its entitlement to these
rights was only terminated with the 2002 settlement agreement and the
payment required under that agreement. The trust may have preferred
to prevail in its sought-after injunction of the merger, but it
simultaneously had launched a claim for a cash award through the
appraisal remedy.
116
[*116] Furthermore, even if we agreed with petitioners that the
Warden litigation and the appraisal proceeding somehow involved only
an injunction, we observe that had the District Court ruled in favor of
the plaintiffs in the case on their injunction theories, the District Court
might not necessarily have rescinded the merger. Instead, it conceivably
could have ordered rescissory damages: i.e., cash damages to
compensate the David Berwind Trust, plus interest. See Goldring v.
United States, 15 F.4th 639, 642 (5th Cir. 2021) (observing that a
Delaware court had declined to award plaintiff rescission because of
practical difficulties of undoing the merger; the Delaware court had
instead awarded plaintiff cash damages). Thus, even had the amended
complaint sought solely an injunction, the District Court could have
considered awarding cash instead of rescission.
We make one further clarifying observation about the nature of
the Warden litigation and the appraisal proceeding. We have discussed
the Warden litigation and the appraisal proceeding as if there were only
two types of relief sought: injunctive relief against the merger and the
appraisal remedy. These two types for relief match up easily with
certain counts in the amended complaint: VI (injunction sought for
breaches of fiduciary duty of BPSI board members), VIII (injunction
sought for alleged unlawful purpose of the merger), IX (right to statutory
appraisal), XII (declaratory judgment that merger was void), XIII
(injunction for violation of obligations of trustees of trust). But the two
types of relief do not as easily match up with the following counts: I
(monetary damages for racketeering), II (monetary damages for
racketeering conspiracy), III (monetary relief for usurpation of corporate
opportunity, IV (monetary damages for breaches of fiduciary duties of
BPSI board members), V (monetary damages for aiding and abetting
such breaches, VII (accounting), X (monetary damages for breaches of
duties of trustees, and XI (treble damages for racketeering). None of the
parties push the proposition that the amount required to be paid by the
settlement agreement should be allocated to these remaining counts.
Petitioners state: “Here, the parties agree that the Settlement Amount
was paid for the [David Berwind] Trust’s BPSI stock.” Petitioners define
the “Settlement Amount” as $191,000,000. The IRS similarly states:
“[T]he parties agree that the Settlement Amount was paid in respect to
the sale or exchange of the [David Berwind] Trust’s BPSI interest.” The
IRS defines the “Settlement Amount” as $191,000,000. Thus it is
appropriate to characterize the Warden litigation and the appraisal
remedy as either seeking an injunctive remedy or an appraisal remedy
(or both in the alternative), but not some other form of relief, in
determining the tax consequences of the 2002 settlement agreement.
117
[*117] Thus we have explained why we disagree with petitioners’ view
that the claims in the consolidated case (i.e., the case consisting of the
Warden litigation and the appraisal remedy) were entirely for injunctive
relief. In light of the disagreement, it is unnecessary to opine on the
consequences of the nature of the claims being entirely for injunctive
relief.
F. Lyeth v. Hoey does not require us to determine the tax
consequences of the payment by BPSI to the David Berwind Trust
for the Trust’s BPSI common stock as if the plaintiffs in the
Warden litigation had successfully enjoined the merger between
BPSI Acquisition and BPSI.
Petitioners argue that Lyeth v. Hoey, 305 U.S. 188 (1938),
requires that the “[s]ettlement [a]greement should be treated as if the
[David Berwind] Trust successfully defended the title to the BPSI Stock
through 2002.” This argument is intended to support petitioners’ larger
argument that the sale or exchange of the David Berwind Trust’s
common stock of BPSI occurred on November 25, 2002, not December
16, 1999.
In Lyeth, the Supreme Court suggested that an amount received
by a plaintiff in settlement of a lawsuit should be treated the same for
tax purposes as the amount that the plaintiff would have received
pursuant to a judgment had the lawsuit proceeded to judgment. Id. at
195–96; see Fresenius Medical Care Holdings, Inc. v. United States, 763
F.3d 64, 71 (1st Cir. 2014) (attributing to Lyeth the proposition that
“amounts paid . . . in settlement should receive the same tax treatment,
to the extent practicable, as would have applied had the dispute been
litigated and reduced to judgment.”) The underlying lawsuit in question
in Lyeth had been brought by a grandson to set aside his grandmother’s
will and thus to receive his inheritance in an amount unaffected by the
will’s instructions. Lyeth, 305 U.S. at 195. Lyeth, held that the payment
the grandson received in settlement of his suit should be treated as a
tax-free inheritance because the settlement payment was a substitute
for an inheritance. Id. at 197.
But here the parties are in agreement that the payment by BPSI
to the David Berwind Trust, whether it is $191,257,353, as the IRS
claims, or $190,000,000, as petitioners claim, was a payment for BPSI
stock. Lyeth does not control the question of whether the stock was
exchanged on December 16, 1999 (when the plan of merger was filed) or
on November 25, 2002 (when the settlement agreement was executed).
118
[*118] G. The 2002 settlement agreement did not provide that the
merger was rescinded or that the merger was void.
Petitioners set forth a vast array of arguments explaining why
the provisions of the 2002 settlement agreement lead to the conclusion
that the sale or exchange of the BPSI common stock occurred on
November 25, 2002. Petitioners list 24 differences between what they
contend are the characteristics of a “dissenters’ rights award” and the
actual terms of the settlement. For example, petitioners explain that
the date of the settlement agreement was November 25, 2002, while the
date of a dissenters’-rights award would have been (they argue) 1999.
Petitioners also place particular emphasis on the fact that the
settlement agreement required a deposit by BPSI in the amount of
$191,000,000, which supposedly suggests that the settlement relates to
the value of the BPSI common stock in 2002, not 1999. Petitioners
explain this point as follows: “The 2002 Settlement Amount of
$191,000,000 for 16.4% of BPSI is so grossly in excess of BPSI’s
December 1999 determination of $82,820,000 for the value of the same
percentage interest held by the [David Berwind] Trust . . . that it must
reflect the increased value of BPSI [three] years later, and not merely
an interest factor.” Petitioners also contend that the $191,000,000
amount relates to a 2002 sale or exchange because “the Settlement
Payment in 2002 includes [the] value of Zymark.” Petitioners also
emphasize the existence of the ride-up provisions: “Pursuant to the Ride-
Up, the Base Amounts of value for BPSI and Zymark are agreed at $161
million and $30 million, respectively, with no mention of interest.”
We begin our analysis of these arguments by acknowledging that
the provisions of settlement agreements are significant under non-
section 483 tax law such as the origin-of-the-claim test. The provisions
of a settlement agreement may be relevant to the non-section 483 tax
treatment of a corresponding settlement payment. 36 The underlying
theory of the relevance is sometimes articulated as follows: (1) the tax
treatment of a settlement payment is determined by the intent of the
36 See Robinson v. Commissioner, 102 T.C. 116, 127 (1994) (courts respect the
“allocation” of settlement proceeds “clearly” made by a settlement agreement if that
allocation was “entered into by the parties in an adversarial context at arm’s length
and in good faith”), aff’d in part, rev’d in part, 70 F.3d 34 (5th Cir. 1995); see also Bagley
v. Commissioner, 105 T.C. 396, 406 (1995) (“Where there is an express allocation
contained in the agreement between the parties, it will generally be followed in
determining the allocation if the agreement is entered into by the parties in an
adversarial context at arm’s length and in good faith.”), aff’d, 121 F.3d 393 (8th Cir.
1997).
119
[*119] payor and (2) the intent of the payor is discernible from the text
of the settlement agreement. 37 This theory cannot be reflexively carried
over to the section 483 context. That is because the intent of the parties
is not relevant under the mechanistic rules of section 483. 38
Furthermore, the relevant issue to be determined in applying section
483 is the date of the sale or exchange of the BPSI common stock. This
date is determined by state law. 39 Under the BCL, the plan of merger
eliminated the BPSI common stock as of the date it was filed. BCL
§§ 1928, 1929. Under the principle that state law controls the date of
the sale or exchange, it would have been arguably relevant had the
District Court entered a judgment that the merger was rescinded or was
void under Pennsylvania law. However, no such judgment was entered.
It also would have been arguably relevant had the settlement agreement
provided that the merger was rescinded or was void under Pennsylvania
law. However, the settlement agreement expressly disavowed that it
37 See Bagley, 105 T.C. at 406 (“Where there is an express allocation contained
in the agreement between the parties, it will generally be followed in determining the
allocation if the agreement is entered into by the parties in an adversarial context at
arm’s length and in good faith. [Citation omitted] However, an express allocation set
forth in the settlement is not necessarily determinative if other factors indicate that
the payment was intended by the parties to be for a different purpose”); Federal Paper
Board Co., Inc. v. Commissioner, 90 T.C. 1011, 1024 (1988) (“When an allocation of
settlement payments must be made and there is no express allocation contained in a
settlement agreement, the most important fact for purposes of making the allocation
is the ‘intent of the payor’”); Green v. Commissioner, 507 F.3d 857, 867–68 (5th Cir.
2007) (“We first look to the . . . agreement itself for indicia of purpose. Where the
settlement agreement lacks express language of purpose, the court looks beyond the
agreement to other evidence that may shed light on the intent of the payor as to the
purpose in making the payment”) (quotation marks and citations omitted), aff’g T.C.
Memo. 2005-250; Freda v. Commissioner, 656 F.3d 570, 577 (7th Cir. 2011), aff’g T.C.
Memo. 2009-191.
38 See Solomon, 570 F.2d 28, 33–34 (2d Cir. 1977) (“Congress opted for a broad,
prophylactic approach to the problem of unstated interest, making the operation of
section 483 dependent upon certain objectively verifiable circumstances which had
usually evidenced a potential for the abuse against which the section was aimed and
not on the subjective intent of the parties to a sale. . . . [T]his approach . . . avoided the
insoluble problems that might arise if the IRS were required to probe the minds of the
parties to each such transaction in an effort to determine whether the deferred
purchase price had in fact been adjusted upward to reflect an interest charge”), aff’g
67 T.C. 379, 386 (1976) (“The existence of deferred payments without provision for
adequate interest, not the manner in which the deferred payments are computed, is
determinative of the applicability of section 483.”); Jeffers v. U.S., 556 F.2d 986, 995
(Ct. Cl. 1977) (“nowhere in the statute or legislative history has Congress hinged the
application of § 483 upon a showing of intentionality.”).
39 See Williams, 1 F.3d at 505; see also Colorcon, Inc. v. United States, 110 Fed.
Cl. at 661.
120
[*120] had any such effect. The settlement agreement states that the
“legal status of [the shares is] an issue in the litigation” and that the
defendants were “not approving or agreeing with the legal position of
the [David Berwind] Trustees as to the [merger].” Furthermore, the
settlement agreement contained no provision under which the merger
was rescinded or was void. Absent such a provision, it is inappropriate
to infer from the other provisions of the settlement agreement upon
which petitioners rely that the parties to that agreement intended that
the sale or exchange of BPSI common stock occurred on November 25,
2002.
H. Merely because the David Berwind Trust’s holding period of
BPSI common stock would have included the period from
December 16, 1999, to November 25, 2002, for purposes of
section 1231 of the Internal Revenue Code of 1954, does not
mean that the sale or exchange of the trust’s BPSI common
stock did not occur on December 16, 1999, for purposes of
section 483.
The David Berwind Trust contends that under Merrill v.
Commissioner, 40 T.C. 66, 74 (1963), aff’d per curiam, 336 F.2d 771 (9th
Cir. 1964), which interpreted section 1231 of the Internal Revenue Code
of 1954, its holding period would have included the period from
December 16, 1999, to November 25, 2002. In Merrill, 40 T.C. at 75, a
joint venture partly owned by the taxpayer bought a grain-elevator
property on April 27, 1956 and sold it the same year. The taxpayer
contended that the joint venture held the property for more than six
months, and that therefore the profit from its sale was taxable as long-
term capital gain under section 1231 of the Internal Revenue Code of
1954. That provision gave favorable tax treatment to gain on sales of
“property . . . held for more than 6 months.” Merrill, 40 T.C. at 73 n.5.
The taxpayer contended that the sale of the property took place on
November 16, 1956. Id. at 77. However, the court held that the sale of
the property took place not later than September 5, 1956. Id. at 76.
That resulted in a holding period of less than six months. Id. at 75.
In order to understand Merrill’s holding about the timing of the
sale of the grain-elevator property, one must first understand the nature
of the transaction by which the joint venture sold the property. The
buyer of the grain-elevator property was the owner of an office-supply
company. Id. at 68–69. The buyer wished to move the retail store of the
office-supply company to the grain-elevator property. Id. at 69.
121
[*121] On April 16, 1956, even before it had acquired the grain-elevator
property, the joint venture granted the buyer an option to buy the grain-
elevator property. Id. The option could be exercised for 90 days. Id. As
consideration for the option, the buyer was required to pay $25,000 at
the execution of the option, which would be applied against the purchase
price of the property. Id. The purchase price of the property was
$250,000. Id. This $250,000 comprised (a) the $25,000 option price that
had to be paid at the execution of the option (which execution date was
April 16, 1956), (b) $175,000 payable at the close of escrow, and
(c) $50,000 payable at the rate of $4,000 per month and accruing interest
of 5%. Id. The option agreement provided that if the option were
exercised, the escrow was to be opened. Id. The option agreement
allowed the buyer to take immediate possession of the property after
exercising the option, but only upon paying $25,000 of the $250,000
purchase price. Id. The option agreement also provided that if the
option was exercised by the buyer, the joint venture must make specified
repairs to the building. Id.On the day the option was executed, April 16, 1956, the buyer
paid the $25,000 option price to the joint venture. Id.In late May 1956, the taxpayer, who operated his own contracting
firm, began to perform the repairs specified in the option agreement on
behalf of the joint venture. Id. at 70.
On May 28, 1956, the buyer paid the joint venture $15,000, which
was a payment against the total purchase price. Id.On June 20, 1956, the buyer exercised the option. Id. at 69.
On July 5, 1956, the joint venture and the buyer opened an escrow
with an escrow agent. Id. at 70. Under the escrow arrangement, the
escrow was to close on or before November 12, 1956. Id. The escrow
arrangement provided that of the total purchase price of $250,000,
$50,000 was to be paid outside of escrow (directly to the joint venture);
$50,000 was to be paid into escrow on or before August 16, 1956;
$100,000 was payable into escrow on or before the closing date; and
$50,000 (with 5% interest) was to be paid in installments of $4,000 per
month beginning December 12, 1956. Id. These terms of the escrow
accelerated $50,000 of the purchase price compared to the terms of the
option agreement. Id. at 68–69. Under the escrow arrangement, this
$50,000 was to be paid on or before August 16, 1956, but the same
122
[*122] $50,000 under the option agreement was only to be to be paid at
the close of escrow. Id.Around the time the escrow was opened, i.e., around July 5, 1956,
the joint venture and the buyer agreed that the buyer was to be given
the right of possession of the property as of July 5, 1956. Id. at 75.
On July 16, 1956, the buyer paid the joint venture $10,000, which
was a payment against the total purchase price. Id. at 70.
On July 17, 1956, the taxpayer entered into an agreement with
the buyer to make certain repairs, improvements, and additions to
property, beyond the repairs specified in the option agreement. Id. at
70–71. The payment required for this work was $21,620. Id. The
agreement also provided that the taxpayer would perform asphalt
concrete work at cost plus 20%. Id. at 71. Additional contracts were
made between the buyer and the taxpayer for work on the property
between July 17, 1956, and December 31, 1956. Id.On August 14, 1956, the taxpayer received $10,000 for his work
on the property. Id.On August 16, 1956, the buyer made a $50,000 payment into
escrow, thus bringing the total amount paid to $100,000. Id. In making
the $50,000 payment, the buyer agreed to release the escrow agent from
the requirement that the $50,000 be held in escrow, thus allowing the
escrow agent to immediately pay the $50,000 directly to the joint
venture. Id.By September 5, 1956, the joint venture completed the repairs to
the building specified by the option agreement. Id. at 76.
On September 25, 1956, the taxpayer received $7,500 for his work
on the property. Id. at 71.
By September 30, 1956, approximately 65% of the work
commissioned by the buyer from the taxpayer was done. Id.On October 24, 1956, the taxpayer received $5,000 for his work
on the property. Id.By October 31, 1956, approximately 85% of the work
commissioned by the buyer from the taxpayer was done. Id.
123[*123] During the three months of August, September, and October,
1956, the office-supply company had all of its office-furniture inventory
moved to the grain-elevator property. Id. at 70. This inventory
amounted to about 20% of its total inventory (both office furniture and
non-office furniture) in terms of value. Id.On November 15, 1956, the buyer paid $100,000 into escrow Id.
at 71.
On November 23, 1956, the buyer made a final payment into
escrow of $6,123.84. Id. at 73.
On November 27, 1956, the joint venture recorded a grant deed of
the property. Id.On December 17, 1956, the taxpayer received $5,000 for his work
on the property. Id. at 71.
By December 31, 1956, substantially all of the work
commissioned by the buyer from the taxpayer was done. Id.On February 18, 1957, the taxpayer received $7,500 for his work
on the property. Id.On March 20, 1957, the taxpayer received $1,102.56 for his work
on the property. Id.In explaining the legal test for determining when the joint
venture transferred the property to the buyer, Merrill stated that
“[n]ormally, ownership of real estate would be considered transferred on
the date of delivery of the deed,” but that when delivery of the deed is
delayed, what controls is “the intent of the parties as to when the
benefits and burdens of ownership of the property are to be transferred.”
Id. at 74. Under that standard Merrill decided that the joint venture’s
ownership period ended on or before September 5, 1956. Id. at 76.
Merrill explained that as of that date (1) the joint venture had already
received half the purchase price that was to be paid in cash, (2) the joint
venture had a claim to the remainder of the purchase price, and (3) all
of the repairs that the joint venture had agreed to perform were
completed. Id. Merrill therefore held that as of that date, the buyer had
assumed “almost” all the incidents of ownership. Id. Furthermore,
Merrill emphasized, as of that date, the buyer could have “forced
conveyance of the legal title.” Id. Rejecting the taxpayer’s argument
that his ownership must have extended until the title transfer date of
124
[*124] November 16, 1956, Merrill opined that the title transfer date is
not conclusive of the holding period, otherwise a taxpayer could “buy a
capital asset one day, sell it the next day at a profit under an escrow
agreement which gave the purchaser all the benefits and burdens of
ownership immediately but which did not call for delivery of a deed for
more than 6 months, and thus get the advantages of the long-term
capital gains provisions.” Id. at 77. This result, Merrill opined, could
not have been intended by Congress in enacting section 1231 of the
Internal Revenue Code of 1954. Merrill, 40 T.C. at 77.
Petitioners assert that an ownership transfer of the David
Berwind Trust could not have taken place on December 16, 1999
because, under Merrill, an ownership transfer depends on the “intent of
the parties.” Petitioners explain that the David Berwind Trust did not
intend that an ownership transfer take place on December 16, 1999.
But Merrill did not involve a forced transaction like the merger
between BPSI Acquisition and BPSI. That type of merger is referred to
as a “squeeze-out” merger because it squeezes a dissenting shareholder
out of the ownership structure of a company by operation of state law.
The intent of the parties to a transaction might affect the timing of the
transfer of ownership in a voluntary transaction, but in a forced
transaction, one party by definition does not intend the transfer to occur.
Thus, we are skeptical that under Merrill the David Berwind Trust’s
holding period under section 1231 of the Internal Revenue Code of 1954
would have extended until the settlement agreement finally evinced the
trust’s “intent” to divest itself of the stock.
Furthermore, it is significant that Merrill was decided under
section 1231 of the Internal Revenue Code of 1954. Even if we were to
form the view that the holding period of the David Berwind Trust would
under that provision be calculated to extend to November 25, 2002, that
would not answer the question of whether the holding period would so
extend under the current Code provisions regarding the capital-gains
holding period (interpreted in accordance with regulations and cases
applicable to those current Code provisions).
Furthermore, even if we were to agree that under current law the
David Berwind Trust’s holding period extended to November 25, 2002,
petitioners have not explained how the length of the holding period
affects the application of section 483. For example, in Merrill, one
reason the joint venture was considered to have divested itself of
ownership of the grain-elevator property by September 5, 1956, was that
125
[*125] it had by that date been paid at least half the cash consideration
for the property. 40 T.C. at 76. And here, petitioners take the view that
because none of the consideration for the David Berwind Trust’s
common stock was paid until 2002, the stock was not sold or exchanged
until 2002. As petitioners’ brief claims: “The following factors, in
addition to the case law cited above, lead inevitably to the conclusion
that no sale of the BPSI stock took place until 2002 . . . [N]o payments
were made by BPSI to or for the benefit of the [David Berwind] Trust
until November 25, 2002.” Thus petitioners seem to view Merrill as
authority that the sale or exchange of the BPSI common stock occurred
in 2002 because that is when BPSI made payment for the stock. But
section 483 is expressly written to assume that there are some
transactions for which the consideration for the sale or exchange of
property is given after the sale or exchange of property. See § 483(c)(1)
(for § 483 to apply to a payment, the payment must be on account of the
sale or exchange of property which constitutes part or all of the sales
price and which is due more than 6 months after the date of such sale or
exchange); (c)(1)(A) (for § 483 to apply to a payment, the payment must
be on account of the sale or exchange of property under which some or
all of the payments are due more than one year after the date of such
sale or exchange). Thus, even if the David Berwind Trust’s capital-gains
holding period extended until 2002, it does not mean that the sale or
exchange for section 483 purposes did not occur in 1999.
I. That the sale or exchange of the David Berwind Trust’s BPSI
common stock occurred on December 16, 1999, is not
inconsistent with Megargel v. Commissioner, 3 T.C. 238(1944), and cases following it.
Petitioners contend that under Megargel v. Commissioner, 3 T.C.
238 (1944), and other cases relying on Megargel, the 2002 settlement
should be “treated as a 2002 disposition as if the [David Berwind] Trust
was successful in its claims and then sold its BPSI stock.” The IRS
concedes that the Megargel line of cases involves litigation that bears a
superficial similarity to the Warden litigation and the appraisal
proceeding. However, the IRS contends the cases are not instructive.
We first address Megargel itself.
In May 1933, one Roy Megargel instituted an action against the
Pepsi-Cola Co.—the company that at that time owned the Pepsi-Cola
trademark and the Pepsi-Cola syrup formula—to recover amounts
allegedly due under a contract with him. 3 T.C. at 240. Megargel had
126
[*126] been one of the organizers and original shareholders of Pepsi-
Cola Co., but by the time of the lawsuit he had transferred much of his
stock in Pepsi-Cola Co. to his wife, and most of the other stock in the
company was held by one Charles Guth. Id. at 239–40. Megargel was
incapacitated and his affairs were being handled by a receiver. Id. at
240. Pepsi-Cola Co. told Megargel’s wife that it would settle the lawsuit
with Megargel only if she first surrendered her stock in the company.
Id. at 240. Megargel’s wife complied. Id. On October 25, 1933, she
transferred to Pepsi-Cola Co. her stock in the company comprising
95,000 shares. Id. But on April 25, 1939, Megargel’s wife filed a
complaint against Pepsi-Cola Co. alleging that the representation made
to her was fraudulent and she requested that the transfer of stock from
her to Pepsi-Cola Co. be held void and that the stock be returned to her,
or if the stock could not be returned to her, that Pepsi-Cola Co. be
required to pay her “the present value thereof.” Id. On October 4, 1939,
Pepsi-Cola Co. settled the lawsuit by Megargel’s wife by agreeing to pay
her $120,000 in 1939 and another $120,000 in 1940. Id. at 241. The
opinion does not say how Megargel’s suit against Pepsi-Cola Co. was
resolved.
Megargel’s wife took the position that the $120,000 payment in
1939 was the proceeds realized from the sale or exchange of Pepsi-Cola
Co. stock and consequently she reported the gain as capital gain. Id.The IRS in Megargel took the position that the $120,000 payment was
ordinary income. Id. at 242. The IRS in Megargel argued that “the
income was ordinary, there having been a mere buying of peace by . . .
Pepsi-Cola Corporation, having no such relation to the original
transaction whereby the petitioner [Megargel’s wife] parted with the
95,000 shares of stock in 1933, as to justify application of principles of
capital gain to the income received.” Id. Megargel rejected the
argument, holding that the $120,000 payment should be treated as
capital gain. Id. at 245–46. Megargel suggested that the sale of stock
occurred in 1939 (the year of the settlement): “[T]he compromise worked
in substance and proper effect not only a recovery of capital, but a sale
thereof in 1939.” Id. at 246. And, in a passage relied on by petitioners
as instructive for the present case, Megargel stated:
We consider the disposition made when the petitioner first
realized anything from her stock, which was in 1939, and
that in that year there was sale by the petitioner of capital
assets. . . . The release for which petitioner received
$120,000 in the taxable year [1939] and another $120,000
in 1940 settled forever the petitioner’s claim to the stock,
127
[*127] transfer of which she alleged to be a nullity and ownership
in which she asserted to be in herself. Title was affected,
and in effect quieted, for the consideration received by
petitioner. In our opinion, a sale was effected equally as
if she had again signed a transfer of stock.
Id. at 247.
Although Megargel stated that the sale of Pepsi-Cola Co. stock
had taken place in tax year 1939, that statement was dicta. The
question in dispute was whether the $120,000 should be treated as an
amount realized from the sale or a capital asset or as ordinary income.
Id. at 239.
To put this another way, Megargel would be conceivably
instructive as to the tax treatment of the payment by BPSI to the David
Berwind Trust if the IRS’s argument in the present case was that the
payment was ordinary income because the payment was unrelated to
the David Berwind Trust’s common stock. See id. at 242 (“[the IRS]
contends that the income was ordinary . . . having no such relation to
the original transaction whereby the petitioner parted with the 95,000
shares of stock in 1933.”) The IRS did not make such an argument in
the present case. That a similar argument was rejected in Magargel
does not instruct the disposition of the present case.
Finally, in Megargel the IRS did not take the position that a
portion of the $120,000 payment should be considered interest. Nor
could the IRS have invoked section 483 for such a theory. Section 483
was only added to the Code in 1964 and applies only to contracts entered
into after June 30, 1963. Act of February 26, 1964, Pub. L. No. 88-272,
78 Stat. at 76–79. For that reason, too, Megargel does not reach the
issue in the present case.
Petitioners also rely on Goldsmith v. Commissioner, 22 T.C. 1137(1954). In Goldsmith, the taxpayer sold stock in 1940. Id. at 1138–39.
He later sued to rescind the sale on the ground that it had been induced
by fraud. Id. The suit was settled in 1949 with a payment of $8,000.
Id. at 1140. Goldsmith held that the tax treatment of the $8,000 was
controlled by Megargel, which Goldsmith explained had held that (1) the
“sale or exchange of the taxpayer’s [Megargel’s wife] stock [occurred] in
the year of the settlement” and that (2) the “proceeds received were
taxable as capital gains.” Goldsmith, 22 T.C. at 1143. Petitioners in the
present case take Goldsmith’s indirect reference to the “year of the
128
[*128] settlement” to imply that the sale or exchange in that case took
place in 1949. Yet in Goldsmith, like Magargel, the issue was not the
year in which the sale or exchange took place, but whether the
settlement payment related to the sale or exchange at all. See
Goldsmith, 22 T.C. at 1137 (stating that the IRS contended that “the
petitioner has failed to prove that the payment was actually related to
the basis for the litigation”). Thus Goldsmith is also distinguishable.
Petitioners also rely on Reid v. Commissioner, 26 T.C. 622 (1956).
In Reid the taxpayer transferred intangibles to a company in 1946 but
several years later she threatened to file suit to rescind the transfer. Id.at 624–25, 629–30. In 1949, she entered into a settlement agreement
with the company under which the company agreed to make royalty
payments to her equal to 1% of its annual net sales in exchange for
which she confirmed that the company had the right to use the
intangibles. Id. at 630. Reid held that the royalty amounts paid were
“the proceeds of a sale entitled to capital gains treatment” and not “for
personal services rendered.” Id. at 630. Reid also held that there was a
sale or exchange of the intangibles, not a “merely license thereof.” Id. at
632. Reid suggested that it did not resolve whether the exchange of the
intangibles took place in 1946 or 1949. It held that “the payments in
question were made in respect of the transfer of such rights . . . [w]hether
they may be viewed as payments for finally perfecting those rights, or
additional consideration for that to which [the company] was already
entitled.” Id. at 633. Reid rejected the IRS’s argument in that case that
a suit for rescission would have been unsuccessful. Id. (“[the IRS] has
attempted to discuss the merits of petitioner’s claim of a right to rescind
the 1946 agreement and recover her assets. He argues that she could
not.”). Reid held that it did not matter whether the taxpayer could have
prevailed in her injunction suit because “[t]he determinative factor is
that petitioner believed in good faith that she could.” Id. Reid further
explained that “[h]ad she commenced litigation seeking rescission and
settled her suit for the payments in question, we would have no doubt
that those would be entitled to treatment as capital gains.” Id. (citing
Goldsmith, 22 T.C. 1137; Megargel, 3 T.C. 238). Reid explained that the
underlying claim threatened by the taxpayer was a title to the
intangibles and that the “amounts received by [her] must be held
referable thereto. Cf. Lyeth v. Hoey, 305 U.S. 118.” Id. at 634.
Petitioners attempt to leverage Reid’s statement that it was
determinative that the taxpayer had a “good faith” belief in the merits
of her claim. The David Berwind Trust, they say, also believed in good
faith that its amended complaint had merit.
129
[*129] Interpreted broadly, Reid might arguably stand for the
proposition that when the owner of a property files suit to rescind a
transfer of the property (and believes in good faith in the merits of the
lawsuit), a payment received by the plaintiff in settlement of the lawsuit
should be considered a payment for the property. Here, the David
Berwind Trust owned BPSI common stock, filed suit (in part) to rescind
the transfer of the stock to BPSI, and received a payment in settlement
of the suit. But, here, the IRS agrees that the payment was made in
exchange for the common stock. Therefore Reid is not relevant to the
issue in the present case.
J. That the sale or exchange of the David Berwind Trust’s BPSI
common stock occurred on December 16, 1999, is not
inconsistent with Victor E. Gidwitz Family Tr. v.
Commissioner, 61 T.C. 664 (1974).
Victor E. Gidwitz Family Tr. v. Commissioner, 61 T.C. 664, at 665,
668–69 (1974), concerned the tax treatment of a payment received by
two trusts in settlement of their lawsuit regarding options orally
granted to them by a company called Empire Properties. The facts of
the case require some explanation.
The two trusts owned stock in Material Service Corp. before it
engaged in a merger with General Dynamics. Id. at 665, 668. There
was to be a meeting of the shareholders of Material Service to approve
the merger. Id. at 665. Before the meeting, the two trusts reviewed the
terms of the merger and took the position that another shareholder,
Empire Properties, would be overcompensated for its shares. Id. at 666.
The relevant terms of the merger were that the shareholders of Material
Service (except Empire Properties) would exchange their Material
Service stock for stock of General Dynamics. Id. at 668. Empire
Properties would receive the businesses of Material Service that
General Dynamics did not wish to be conducted by the merged company.
Id. at 666, 668. The two trusts took the position that the value of the
property to be given to Empire Properties exceeded the value of its stock
in Material Service by at least $20 million. Id. at 666. The two trusts
told Material Service that they would take steps to block the merger
unless the two trusts participated in the distribution of the property to
Empire Properties. Id. In response, Material Service promised the two
trusts that they would receive options to buy a portion of the properties
to be given to Empire Properties. Id. at 667. Then, at the meeting of
the Material Service shareholders to approve the merger with General
130
[*130] Dynamics, the two trusts did not vote against the merger. Id.
at 668. Nor did they file a lawsuit to stop the merger. Id. at 667–68.
In 1959, the merger was consummated. Id. at 668. But the two
trusts had still not received the options that had been promised them.
Id. They filed suit against Material Service for damages resulting from
its failure to deliver the options. Id. at 668, 672. The suit was settled
for a payment of $225,000 in 1966. Id. at 669. The two trusts reported
the payment as capital gain, but the IRS in that case determined that
the payment was ordinary income. Id.Gidwitz first resolved a factual dispute between the two trusts
and the IRS about what the two trusts had exchanged for the promise of
the options. Gidwitz agreed with the two trusts that the promise of the
options was “additional consideration for the Material Service stock
owned by [the trusts].” Id. at 673. Gidwitz rejected the IRS’s view in
that case that the promise of the options was “in the nature of
compensation for [the trusts] refraining from blocking the merger.” Id.at 672–73.
Having found that the promise of the options was additional
consideration for the two trust’s stock in Material Service, Gidwitz then
addressed how this finding affected the tax treatment of the $225,000
settlement payment. Id. at 673. Gidwitz stated that the tax treatment
of a settlement payment is ultimately controlled “by the origin and
character of the claim which gave rise to the litigation.” Id. Gidwitz
held that the claim by the two trusts against Material Service arose out
of the alleged inadequacy of the consideration given the two trusts for
their stock in Material Service under the terms of the merger. Id. at
673–74. Therefore, Gidwitz held that the settlement payment was
additional consideration for the stock and should be given capital
treatment. Id.Gidwitz is significant, according to petitioners in the present case,
because in their view the $225,000 settlement payment was held to be
“proceeds as received from the sale of a capital asset (without interest).”
By pointing out that Gidwitz did not allocate any of the settlement
payment to interest, petitioners are suggesting that Gidwitz implicitly
held that the transfer of shares took place in 1966, the year of the
settlement, and not 1959, the year of the merger. We disagree.
Had the IRS in Gidwitz invoked section 483, specifically by
attempting to apply section 483 to the $225,000 settlement payment on
131
[*131] the theory that the payment was a deferred payment for a sale
or exchange that had taken place in 1959, the two trusts might have
responded that the sale and exchange took place in 1966. Had the two
trusts attempted to defeat a section 483 theory by arguing that the
payment of $225,000 in 1966 was not a deferred payment because the
sale or exchange had taken place in 1966, Gidwitz might have had
occasion to consider that theory. But in actuality, the IRS in Gidwitz
did not raise section 483. The two trusts in Gidwitz had therefore no
reason to argue that the sale or exchange in Gidwitz had occurred in
1966. And Gidwitz therefore had no occasion to take a position as to
when the sale or exchange occurred. Indeed, the IRS in Gidwitz
contended that the $225,000 payment was not a payment for property
at all, much less a deferred payment. Gidwitz, 61 T.C. at 672–73.
Having denied that the payment was for the sale or exchange of
property, the IRS in Gidwitz did not bring into dispute the timing of the
sale or exchange of property. In the present case, unlike in Gidwitz, the
IRS does contest the timing of the sale or exchange of property: The IRS
contends that the David Berwind Trust’s sale or exchange of BPSI
common stock occurred in 1999, not 2002. And in the present case,
unlike in Gidwitz, the IRS concedes that the payment by BPSI to the
David Berwind Trust was for the trust’s BPSI common stock. We
therefore do not view Gidwitz as holding that the sale or exchange of
Material Service stock took place in 1966 and therefore we need not
consider whether by analogy the sale or exchange of the David Berwind
Trust’s BPSI common stock took place on November 25, 2002.
K. That the sale or exchange of the BPSI common stock of the
David Berwind Trust occurred on December 16, 1999 is not
inconsistent with judicial interpretations of section 163(a).
Petitioners argue: “In interest deduction cases . . . interest must
be based on an existing, unconditional and legally enforceable obligation
to pay a principal sum. No portion of the Settlement Amount is interest
under the Internal Revenue Code for the additional reason that there
was no indebtedness until 2002.” (The “Settlement Amount” is defined
by petitioners as $191,000,000.). Petitioners’ argument relies on cases
interpreting section 163(a), which provides that “[t]here shall be allowed
as a deduction all interest paid or accrued within the taxable year on
indebtedness.” The word “indebtedness” as used in that provision has
been interpreted to mean “an existing, unconditional, and legally
enforceable obligation for the payment of a principal sum.” Howlett v.
Commissioner, 56 T.C. 951, 960 (1971).
132
[*132] In Midkiff v. Commissioner, 96 T.C. 724, 725 (1991), aff’d sub.
nom. Noguchi v. Commissioner, 992 F.2d 226 (9th Cir. 1993), which is
relied on by petitioners in the present case, the taxpayer leased land
from a trust that had been established by the will of Bernice Pauahi
Bishop, the last princess of Hawaii. Under the Hawaii Land Reform Act
of 1967, the State of Hawaii was authorized to (1) acquire land such as
that leased by the taxpayer either by condemning the land by exercising
its eminent domain power, or by buying the land under threat of
eminent domain, and to (2) transfer the land so acquired to the lessee.
Midkiff, 96 T.C. at 725. In exchange for the land, lessees such as the
taxpayer were required to pay for the value of the land as of the date
Hawaii “designated” the land for acquisition (i.e., the date Hawaii
officially decided to acquire the land). Id. at 726, 728. In 1979, the
taxpayer requested that Hawaii designate the land for acquisition. Id.
at 726, 728–29. On January 23, 1981, Hawaii designated the land for
acquisition. Id. at 730. It brought an eminent-domain action against
the trust to acquire the land. Id. The taxpayer was joined in the action.
Id. In 1985, a jury determined that the value of the land on the
designation date was $473,000. Id. at 730–31. In 1986, the case settled
with the trust agreeing to offer to sell the land to the taxpayer for an
amount equal to the jury’s $473,000 determination of value on the date
of designation plus 5% per year from the date of the designation until
the date the taxpayer received the legal title to the land. Id. at 731. The
settlement agreement provided that the taxpayer could reject any offer
by the trust to sell the land. Id. at 732. The trust offered to sell the land
to the taxpayer. Id. The taxpayer accepted the offer. Id. at 733. The
taxpayer paid the trust $611,286.71, consisting of (a) the $473,000 value
established by the jury as of the date of designation and (b) $138,286.71
corresponding to interest from the date of designation through the date
of land-sale closing, November 28, 1986. Id. The taxpayer sought to
deduct the $138,286.71 as interest under section 163(a), which provides
a deduction for “all interest paid or accrued within the taxable year on
indebtedness.”
The Tax Court in Midkiff, 96 T.C. at 737, held no indebtedness
arose on the date of the designation, January 23, 1981. It reasoned that
under Hawaiian law, the taxpayer could have declined to go through
with the purchase of land until the taxpayer had accepted the trust’s
offer to sell. Id.Midkiff is distinguishable, most importantly, because the court
interpreted section 163(a), not section 483. Section 483 is written
differently from section 163(a). Section 483 may apply to contingent
133
[*133] payments. Treas. Reg. § 1.483-4(b) (example 2); Cocker v.
Commissioner, 68 T.C. 544, 563 (1977); Solomon, 570 F.2d 20, 34.
Section 163(a) does not apply to contingent debt. Howlett, 56 T.C. at 960.
Midkiff is also factually distinguishable because the taxpayer in Midkiff
was not required to buy the property on the date of the land was
designated in 1981. See Noguchi, 992 F.2d at 227 (“Until a lessee finally
pays for his houselot and actually acquires the fee interest, he is free
under the HLRA [Hawaii Land Reform act of 1967] to back out of the
deal.”). By contrast, once BPSI filed the articles of merger on December
16, 1999, BPSI was obligated to pay the David Berwind Trust for its
BPSI common stock by the dissenters-rights provisions of the BCL. See
BCL §§ 1572, 1579. BPSI could not unilaterally back out of the deal.
Petitioners also rely on Jordan v. Commissioner, 60 T.C. 872(1973), aff’d, 514 F.2d 1209 (8th Cir. 1975). The taxpayer in that case
was one of the organizers of a newly-formed life insurance company. Id.
at 874. The life insurance company offered shares of its stock to both
the public and to the organizers. Id. at 876. The shares sold to the
public carried restrictions on resale. Id. at 875–76. The shares sold to
the organizers carried no restrictions on resale. Id. at 876. The
insurance company did not disclose to the public that the shares offered
to the organizers carried no restrictions on resale. Id. Because of this
nondisclosure, some public shareholders of the insurance company sued
the company and its organizers for fraud. Id. In 1965, the taxpayer and
other organizers offered to buy any of the stock that had been sold by
the life insurance company to the public during the period November 4
through 7, 1962. Id. at 876–77. Under the terms of the offer, the
purchase price was equal to the original purchase price paid the
insurance company for such shares plus interest at the rate of 5% per
year from the date the insurance company sold the shares until the date
the taxpayer bought the shares. Id. In 1965, the taxpayer bought
38,066.25 shares pursuant to this offer. Id. Of the payments made by
the taxpayer, $44,246.14 was interest as calculated at the 5% rate. Id.
at 877. The taxpayer claimed this amount as an interest deduction on
his 1965 return under section 163(a). Jordan, 60 T.C. at 877. However,
the Tax Court held that the amount was not deductible because “there
was in fact no indebtedness.” Id. at 881.
Jordan too is not applicable to the present case because it
interprets section 163(a), not section 483. Jordan is also factually
distinguishable. In 1962, the taxpayer in Jordan had no obligation to
buy the insurance-company stock from the public. BPSI by contrast was
required by the BCL dissenters-rights provisions to compensate the
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[*134] David Berwind Trust for its shares of common stock once the
articles of merger were filed on December 16, 1999.
Petitioners also rely on Indeck Energy Services, Inc. v.
Commissioner, T.C. Memo. 2003-101, 85 T.C.M. (CCH) 1128. In that
case, Indeck (a corporation) agreed to employ Polsky, its president, for
a seven-year term ending June 1, 1993. Id. at 1129–30. The
employment agreement conferred on Polsky the right to purchase shares
of Indeck. Id. at 1130. The employment agreement provided that
Polsky’s employment could be terminated during the seven-year term
under certain conditions. Id. If Polsky’s employment were so
terminated, the employment agreement required Polsky to sell his stock
to Indeck and required Indeck to buy it. Id. The employment agreement
provided that the price for the sale would be equal to the greater of
(1) the net book value of the stock shortly before the employment-
termination date and (2) a price per share equivalent to any bona fide
third-party offer to buy the stock made within one year of the
termination date. Id. On September 22, 1990, Polsky’s employment was
terminated with Polsky owning 30 shares of Indeck. Id. He brought an
arbitration proceeding against Indeck. Id. He received an offer to buy
his Indeck shares for $750,000 per share and another offer for $501,000.
Id. at 1131. In 1994, Indeck settled Polsky’s claims against it under
which Indeck paid Polsky approximately $20 million and Polsky gave up
his 30 shares of Indeck stock. Id. at 1134. Indeck contended that
$4,856,922 of the settlement agreement was interest. Id. at 1135. The
Tax Court agreed with the IRS in that case that “the disputed
$4,856,922 portion of the settlement payment cannot constitute interest
deductible under section 163(a) by Indeck because there was no
indebtedness within the meaning of that section.” Id. at 1138. Indeck
emphasized that before Polsky and Indeck struck the settlement
agreement, they had various points of disagreement about the amount
of Indeck’s liability. Id. at 1140. For example, Indeck had taken the
position that the $750,000 per share offer was not bona fide. Id.
In petitioners’ view, Indeck is analogous to the present case:
“There was too much indefiniteness to any obligation of Indeck, just as
there was too much indefiniteness to the Disputed Merger [between
BPSI Acquisition and BPSI] to give rise to BPSI indebtedness, the
timing and amount of any obligation being vigorously disputed in both
cases.” Indeck is distinguishable because the question in the present
case is whether there was a sale or exchange of BPSI common stock in
1999, not whether the sale or exchange gave rise to indebtedness within
the meaning of section 163(a). Under the BCL, the David Berwind
135
[*135] Trust’s ownership interest in BPSI was converted into a liability
owed to it by BPSI in 1999. Whether that liability of BPSI is indefinite
like the liability of Indeck is not relevant under section 483. An
unconditional obligation is not a prerequisite for imputed interest under
section 483. Treas. Reg. § 1.483-4(b) (example 2); Cocker, 68 T.C. at 563;
Solomon, 570 F.2d at 34 (holding § 483 applied to contingent payments).
II. The plan of merger was the contract for the sale or exchange of the
David Berwind Trust’s BPSI shares.
For a payment to be recharacterized as interest by section 483,
there must be a “contract for the sale or exchange of . . . property.”
§ 483(a)(1), (b), (c). Having held infra OPINION, Part 1, that there was
a sale or exchange of the David Berwind Trust’s common stock in BPSI
on December 16, 1999, we now hold that the plan of merger was the
contract for the sale or exchange. This holding reflects our agreement
with the IRS’s argument that “[t]he [m]erger satisfies the ‘contract’
language in section 483.” And it reflects our rejection of petitioners’
argument that “the squeeze-out Disputed Merger [defined by petitioners
as the use of the BCL short-form merger statute by Berwind Group
Partners and Berwind Corporation—meaning essentially the merger of
BPSI Acquisition into BPSI] does not constitute a contract for purposes
of IRC § 483.”
Petitioners argue that the plan of merger cannot be considered a
contract under section 483 because a contract must have at least two
parties. Petitioners argue that, although the plan of merger was
approved by BPSI Acquisition, BPSI Acquisition was not a party to the
plan of merger because BPSI Acquisition’s existence “is disregarded for
federal income tax purposes” under Rev. Rul. 78-250, 1978-1 C.B. 83.
The plan of merger was executed by BPSI Acquisition and by
BPSI and was approved by both of those corporation’s boards of
directors. Thus, there were two parties to the plan of merger: BPSI
Acquisition and BPSI. The plan of merger was an agreement between
BPSI and BPSI Acquisition. It was filed with the Pennsylvania
Department of State with the articles of merger, which rendered the
plan of merger effective under BCL § 1928. In our view, the plan of
merger was a contract under section 483.
It does not matter that BPSI Acquisition’s role in the merger was
similar to the role of the subsidiary “Y” in a merger described in Rev.
Rul. 78-750. In Rev. Rul. 78-250, the Internal Revenue Service ruled
136
[*136] that Y’s existence should be disregarded in determining various
federal tax consequences of a squeeze-out merger. But Rev. Rul. 78-750
is irrelevant to whether BPSI Acquisition’s existence should be
disregarded. In Rauenhorst v. Commissioner, 119 T.C. 157, 171 (2002),
we held that the IRS is bound to follow revenue rulings in Tax Court
proceedings because such rulings are the equivalent of concessions made
by the IRS in Tax Court. But Rev. Rul. 78-250 did not involve section
483. Thus, Rev. Rul. 78-250 cannot constitute the IRS’s concession in
the present case that BPSI Acquisition must be disregarded in
determining whether the plan of merger between BPSI Acquisition and
BPSI formed a “contract” within the meaning of section 483. In New
Jersey Council of Teaching Hospitals v. Commissioner, 149 T.C. 466, 478
n.7 (2017), we explained that although the Tax Court is not bound by
revenue rulings, we afford them weight depending on their
persuasiveness and consistency. But Rev. Rul. 78-250 contains no
reasons for its ruling that Y should be disregarded for federal tax
purposes, and thus, we cannot consider whether those reasons are as
persuasive in the context of section 483 as they were in the context of
the statutes involved in Rev. Rul. 78-250. We conclude that Rev. Rul.
78-250’s ruling as to the transitory merger subsidiary Y does not
preclude the 1999 plan of merger between BPSI and BPSI Acquisition
from being a contract for the sale or exchange of the David Berwind
Trust’s common stock in BPSI.
III. The payment from BPSI to the David Berwind Trust for its BPSI
common stock was “under” the plan of merger even if the David
Berwind Trust did not voluntarily contract to receive the payment
as part of the plan of merger.
Petitioners contend that a payment is not “under” a contract
unless “the party against whom the interest was imputed was a
consenting contracting seller that agreed to a deferred payment
structure.” Petitioners argue “even assuming the [p]lan of [m]erger is a
contract, the [David Berwind] Trust was certainly not a party to it and
did not agree to any terms pursuant to that contract, including any
deferred payments.” Petitioners explain: “[T]he [David Berwind] Trust
did not voluntarily contract in 1999 to receive contingent payments or
otherwise receive any payments.”
The text of section 483 does not require that the person who
exchanges or sells property be a party to the contract for the sale or
exchange of property. By its terms, section 483 operates when there is
“any payment . . . under any contract for the sale or exchange of any
137
[*137] property.” § 483(a)(1). It does not require the parties to the
“contract for the sale or exchange . . . of the property” to include the
person who sells or exchanges the property. See Jeffers v. United States,
556 F.2d 986, 990, 997 (Ct. Cl. 1977) (when taxpayers exchanged their
shares of Hayes International in return for shares of City Investing
stock pursuant to a merger, section 483 applied to the payment of City
Investing stock in exchange for Hayes International stock even though
the merger was consummated not by the taxpayers but by the board of
directors of Hayes International); see also RJR Nabisco Inc. v.
Commissioner, T.C. Memo. 1998-252, 76 T.C.M (CCH) 71, 89. Thus,
even if the David Berwind Trust were not a party to the plan of merger,
that does not prevent the plan of merger from qualifying as a contract
under section 483. 40 Similarly, although section 483 requires that the
payment be “under” the contract, it does not go further and require the
person who exchanges or sells the property to agree to the deferred
payment.
Tribune Publ’g Co. v. United States, 836 F.2d 1176 (9th Cir. 1988),
relied on by petitioners, is not to the contrary. The taxpayer, Tribune,
held 7.1% of the outstanding stock in Newsprint, a company that
produced its newsprint. Id. at 1177. In 1969, Newsprint merged with
another corporation, Boise Cascade. Id. Under the merger agreement,
Tribune received Boise Cascade stock in exchange for its Newsprint
stock. Id. Shortly after the merger, it was reported in the press that
Boise Cascade had failed to disclose material facts about its financial
condition. Id. The value of Boise Cascade shares fell precipitously. Id.Tribune sued Boise Cascade for securities fraud. Id. In 1977, Tribune
and Boise Cascade entered into a settlement agreement resolving the
suit whereby Boise Cascade agreed to provide Tribune with $451,000
cash and a discount on newsprint purchased in 1978 and 1979. Id. at
1177, 1181. Tribune received the $451,000 cash payment in 1977. Id.
at 1177. It received discounts on newsprint in 1978 and 1979. Id.Addressing the tax consequences to Tribune of the cash payment and
the newsprint discounts, the government argued that interest should be
imputed under section 483 on the cash payment and the discounts on
newsprint for the period between (1) the merger date and (2) the dates
the cash and discounts were received by Tribune. Id. at 1180. The Ninth
Circuit opinion stated that it was “clear[]” that the interest should be
imputed on the newsprint discounts from (1) the date of the settlement
40 The IRS argues that the David Berwind Trust was a party to the plan of
merger through the operation of the dissenters-rights provisions of the BCL. We need
not reach this argument. The trust need not be a party to the plan of merger.
138
[*138] (in 1977) to (2) the dates the newsprint discounts were received
(in 1978 and 1979). Id. However, the Ninth Circuit rejected the
government’s argument that interest should be imputed to “all of the
settlement proceeds [the cash payment and the discounts on newsprint]
from the date of the merger to the date of the settlement.” Id. The Ninth
Circuit gave two reasons for this holding: (1) Tribune “actually received
the additional consideration [the cash payment] in 1977” and
(2) Tribune “did not voluntarily contract to exchange its Newsprint stock
for Boise Cascade stock plus a right to be paid cash and to receive
newsprint discounts.” Id. at 1181. Tribune’s holding is best viewed as
resolving the question of which sale or exchange the additional
consideration was related to. Was it (1) the 1969 exchange by Tribune
of its Boise Cascade stock or (2) the 1977 settlement agreement?
Tribune held that the relevant sale or exchange was the 1977 settlement
agreement because it explained that Tribune did not “voluntarily
contract” to make the cash payment and newsprint discounts as part of
the 1969 merger. Tribune is distinguishable. The payment by BPSI to
the David Berwind Trust was contemplated by the plan of merger, which
specifically referred to the David Berwind Trust’s right to receive the
appraised value of its shares under the BCL dissenters-rights
provisions.
We make one final note regarding petitioners’ argument about
the lack of consent by the David Berwind Trust to the merger. They did
not argue that the lack of consent precluded the merger from being a
“sale or exchange.” That argument would have failed anyway. A sale
or exchange of property can occur without the consent of the property
owner. See Helvering v. Hammel, 311 U.S. 504, 510–11 (1941) (holding
that a forced judicial foreclosure sale constituted a “sale[] or exchange[]”
under section 23(e)(2) of the Revenue Act of 1934)).
IV. The payment made by BPSI to the David Berwind Trust for the
trust’s BPSI shares was a $191,257,353 payment that was made
on December 31, 2002.
Recall the following: on November 25, 2002, BPSI transferred
$191,000,000 to an “escrow account”; on November 26, 2002,
$191,007,012 was transferred from that “escrow account” to the PNC
escrow account; and that on December 31, 2002, $191,257,353 was
released from the PNC escrow account to the David Berwind Trust.
The IRS argues that the “Escrow Fund should be viewed as ‘paid’
for purposes of section 483 when it was released to the [David Berwind]
139
[*139] Trust on December 31, 2002.” The IRS defines the “Escrow
Fund” as (1) the $191,000,000 amount (referred to by the IRS as the
“Settlement Amount”) plus (2) the $257,353 of “investments and
reinvestments thereof and any interest and other income therefrom”.
Thus, the Escrow Fund, as defined by the IRS, is a total amount of
$191,257,353. Under the IRS’s argument, $191,257,353 is the amount
of the payment to which section 483(a) applies—and the date of the
payment is December 31, 2002.
Petitioners’ counter argument is that “[t]he effective date of
receipt of the Settlement Amount [defined by petitioners as
$191,000,000] for purposes of IRC Section 483 should be November 25,
2002.” Thus, under petitioners’ argument, $191,000,000 is the amount
of the payment to which section 483(a) applies—and the date of the
payment is November 25, 2002. Petitioners’ argument is an alternative
argument that assumes arguendo that the sale or exchange of the stock
occurred on December 16, 1999, the plan of merger was a contract for
the sale of the stock, and the payment for the David Berwind Trust’s
stock was under the plan of merger.
A payment for the purposes of section 483 means the delivery of
consideration to the payee. See Catterall v. Commissioner, 68 T.C. 413,
419 (1977), aff’d, 589 F.2d 123 (3d Cir. 1978); Solomon, 570 F.2d at 34.
The settlement agreement and the escrow agreement required PNC
Bank (as the escrow agent) to hold the $191,000,000 and all interest
earned on that amount. PNC Bank was required to release the funds
from escrow to the David Berwind Trust only if certain nonministerial
conditions were met, such as the approval of the Orphans’ Court. Thus,
the deposit of the $191,000,000 by BPSI into “an escrow account” on
November 25, 2002, did not constitute a payment to the David Berwind
Trust. Rather, the payment occurred when the conditions were
satisfied, and the funds released to the David Berwind Trust, on
December 31, 2002. Cf. Bizzack Bros. Constr. Corp. v. Commissioner,
T.C. Memo. 1980-457 (holding funds held in escrow were contingent and
not income to the taxpayer because receipt of the funds was contingent
on the approval of a municipal government). The payment amount to
the David Berwind Trust was $191,257,353.
Petitioners point out that the David Berwind Trust had (1) some
measure of control over how the $191,000,000 was invested while in
escrow and (2) the right to request the release of the escrow funds to pay
federal and state taxes. Despite its control of how to invest the
$191,000,000, the David Berwind Trust’s receipt of a beneficial interest
140
[*140] in the settlement proceeds was not guaranteed. For example, the
escrow agreement specifically provided that if the settlement was
terminated, the $191,000,000 amount and all the investment earnings
would be returned to BPSI. Similarly, while the escrow agreement
provided that the David Berwind Trust could request the payment of
federal taxes from the amounts, the settlement agreement provided that
the trust was also required to refund the amounts to BPSI if the
settlement was terminated.
We conclude that the payment occurred on December 31, 2002,
when the funds, including the Investment Income Components, were
released from escrow.
V. Conclusion
In the terminology of paragraph 182 of the stipulation, it is our
holding that (1) the “payment discussed in the Settlement Agreement
. . . is treated for Federal income tax purposes as paid to the [David
Berwind] Trust on December 31, 2002” and (2) the payment “is subject
to IRC § 483 as of December 16, 1999”.
Therefore under paragraph 182 of the stipulation, the following
results ensue: (1) for the purpose of calculating the total unstated
interest under section 483(b) the October 1999 Mid-Term rate of 5.93%
(semiannual compounding) is the applicable federal rate and (2) for the
purpose of calculating the total unstated interest under section 483(b)
the sum of payments to which section 483 applies equals $191,257,353.
Furthermore, under paragraph 182 of the stipulation, the amount
reported by the David Berwind Trust for the Investment Income
Components ($257,353) should not be adjusted.
In the terminology of the joint memorandum filed with the Court
by petitioners and the IRS, it is our holding that the payment described
in the settlement agreement is subject to section 483 and the date of the
payment is December 31, 2002. Therefore, the joint memorandum
reflects the agreement of the parties in this case that, given the holdings
in this Opinion, the total unstated interest under section 483(b) is
$31,140,364.
To reflect the foregoing,
Decisions will be entered under Rule 155.