Estate of Williams v. Comm'r

T.C. Memo. 2009-5
UNITED STATES TAX COURT
ESTATE OF EUGENIA F. WILLIAMS, Deceased, FIRST TENNESSEE BANK,
N.A., Executor, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12210-02. Filed January 6, 2009.
Sheldon Kay, Joseph DePew, and William Merrit for
petitioner.
Martha Weber, Nancy Hale, and James May, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HOLMES, Judge: Eugenia Williams was a wealthy woman who
lived a long life but had no natural heirs. She decided to leave
almost her entire estate to four charities, with one important
exception. She bequeathed the stock in a closely held company to
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the children and grandchildren of her father’s business partner.
After she died, there was hardfought litigation in Tennessee
state court between the charities (acting through her Estate) and
the family of her father’s partner. They fought about whether
the stock had already been sold, about whether the terms of its
sale were unfair, and about whether some members of the family
had abused their positions of trust with Williams in numerous and
varied ways as she grew older. The case was settled. We must
decide whether the settlement supports an additional charitable
deduction to the Estate.
FINDINGS OF FACT
A. Early History
A little more than a century ago the Coca-Cola Corporation
had not yet even been organized, but James Patrick Roddy, Sr.
thought that bottling Coke would be a profitable enterprise. He
needed a partner to sweeten his prospects with capital, so he
approached his friend and doctor, David Hitt Williams. Dr. Will-
iams joined the venture, and in 1902 they started the Roddy Manu-
facturing Company. Roddy Manufacturing was one of the first
Coca-Cola bottlers in the country and had an exclusive franchise
for eastern Tennessee and a bit of Kentucky. Roddy proved him-
self an exceptional entrepreneur, and both Roddy Manufacturing
and its successor, Roddy Coca Cola Bottling Company (Roddy Coke),
became lucrative enterprises.
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J.P. Roddy, Sr. and Dr. Williams later expanded their
business by founding the Coca-Cola Bottling Company of Johnson
City, Tennessee. At trial it was estimated that the David Hitt
Williams Trust (the Williams Trust), which held Dr. Williams’s
stock interests at the time of his death, owned just under 50
percent of Johnson City Coke’s Stock.
Although it was Roddy and his family who actually ran Roddy
Coke and Johnson City Coke, Roddy and Dr. Williams remained
friends until Dr. Williams’s death in 1929. Dr. Williams made
Roddy the executor of his will and the families remained close,
with the Roddy children becoming lifelong friends of Dr. Willi-
ams’s daughter, Eugenia.
But while Roddy and his family were fruitful and multiplied,
the Williamses did not:
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Eugenia was Dr. Williams’s only child to survive into adult-
hood. J.P. Roddy, Sr. had two children, J.P. Jr. and Ellen Kate
Roddy. Ellen Kate Roddy had no children, but J.P. Jr. had three:
J.P. Roddy III, Mary Ellen Roddy Mitchell, and Thomas Roddy (the
Third Generation Roddys). (We include her husband, William
Mitchell, in the Third Generation Roddys). The Third Generation
Roddys have ten children among them, whom we’ll call the Fourth
Generation Roddys.
B. Dispersal of the Stock
The shares of Roddy Coke and Johnson City Coke began to
disperse in 1929 with the deaths of both Dr. Williams and J.P.
Roddy, Sr.
1. J.P. Roddy, Jr.’s stock. J.P. Roddy, Jr. gave a
portion of the stock that he inherited from his father to his own
children while he was still alive. Hoping to avoid the problems
that can happen when a family’s block of shares becomes fragment-
ed over time, the Third Generation Roddys concluded a Stockholder
Agreement at the end of 1971 that established a Voting Trust.
The key term was their agreement to vote their Roddy Coke and
Johnson City Coke stock as a block; and they also agreed that if
any Roddy wanted to sell his stock, the other Roddys would be
granted rights of first refusal.
On January 30, 1993, J.P. Roddy, Jr. withdrew the shares he
still owned from the Voting Trust. In April 1993, the men of the
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Third Generation Roddys–-J.P. Roddy III, William Jess Mitchell,
and Thomas Roddy–-signed a Voting Trust Agreement with the Fourth
Generation Roddys. This further consolidated the Third Genera-
tion Roddys’ control of the companies by expanding the 1971 Vo-
ting Trust to capture the Fourth Generation’s partial ownership
of the stock. It also added one of them, Joseph Hodges McKenzie
Roddy, as a trustee.
2. The Ellen Kate Roddy Trust. Ellen Kate Roddy, J.P.
Jr.’s sister, had no children. When she died, the shares she
inherited from her father were placed in the Ellen Kate Roddy
Trust. The Third Generation Roddys had control over this trust,
and it too was a member of the Voting Trust.
3. The Williams stock. When Dr. Williams died in 1929,
his 386 shares of Roddy Coke stock and 10 shares of Johnson City
Coke stock became the corpus of the Williams Trust. Eugenia was
the trustee, as well as the beneficiary of the Williams Trust’s
“income and profits.” The remainder of the Trust was to be
divided between the National Geographic Society and J.P. Roddy,
Jr.
Wealthy families and successful businesses are rarely left
unmarked by litigation; in 1930, Eugenia sued J.P. Roddy, Jr. to
determine whether she owned her father’s estate outright or sub-
ject to the Williams Trust. Chandler v. Roddy, 43 S.W.2d 397
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(Tenn. 1931). The answer was that her father’s property,
including his stock, would largely remain subject to a trust.
More litigation erupted when Roddy Coke declared a stock
dividend. National Geographic claimed the dividend was “corpus”
rather than “profits” of the trust. Natl. Geographic Socy v.
Williams, 497 S.W.2d 908, 909 (Tenn. Ct. App. 1973). If the
dividend was corpus, it would be distributed to National Geogra-
phic and the Roddys, but if it was income, Eugenia would get it.
Eugenia won that suit, and the Williams Trust distributed
additional shares of Roddy Coke stock to her. Added to the stock
in the Williams Trust she owned as a trustee, she ended up in
control of 1,714 shares.
These suits brought by National Geographic made J.P. Roddy
Jr. and Eugenia adversaries in court, but didn’t seem to embitter
relations between the families at all. Despite the lawsuits, but
without a family of her own, Eugenia relied on the Roddy family
more deeply as she grew older. Early in 1985, she appointed J.P.
Roddy, Jr. to be her attorney-in-fact, granting him broad powers
to manage all of her affairs. That appointment was prompted by
the possibility that Eugenia might become unable to care for
herself as she grew older. As it happened, within three years,
she moved to St. Mary’s Medical Center in Knoxville, where she
lived--by all accounts, well cared for--for the rest of her life.
J.P. Roddy Jr. was also becoming quite old and in 1989, Eugenia’s
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power of attorney was amended to allow William Jess Mitchell to
act on Eugenia’s behalf if J.P. Roddy, Jr. became incapacitated.
This meant that, from 1985 until her death, either J.P. Roddy,
Jr. or his son-in-law had the power to control all of Eugenia’s
affairs, including the disposition of her 1,714 shares of Roddy
Coke stock.
Eugenia, it may be remembered, had been the trustee of the
Williams Trust since her father’s death in 1929. She needed to
plan for that Trust and, in 1990, she named J.P. Roddy, Jr. and
the Third Generation Roddys as trustees. This meant the Williams
Trust would have a trustee, but also meant that the Roddys, in
one capacity or another, would control nearly all of Roddy Coke’s
stock.
In January 1991, the Roddys, acting as trustees of the
Williams Trust, agreed with the National Geographic Society to
have Roddy Coke redeem the Trust’s 386 shares for $1,640,500.
Even though Eugenia had an interest in the profits of the Trust
and the Roddys and National Geographic held an interest only in
the Trust’s corpus, Eugenia was not consulted before the redemp-
tion. Instead, the Roddys redeemed her shares with William Jess
Mitchell acting as her attorney-in-fact. After redemption, the
Voting Trust controlled more than 50 percent of the outstanding
Roddy Coke stock for the first time.
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C. The Merger
During the early 1990s, Coca-Cola decided to integrate its
operations by consolidating control over its franchises. What
happened after Coca-Cola reached into eastern Tennessee to gain
control over Roddy Coke and Johnson City Coke is what eventually
led to this case.
Coca-Cola was willing to offer nearly $130 million for Roddy
Coke, but it did not want to get bogged down in disputes over how
to divvy up the money. And so the transaction became quite com-
plicated. In February 1990, the Third Generation Roddys and Rod-
dy Coke signed a right-of-first-refusal agreement with Coca-Cola
Enterprises. The Agreement gave Coca-Cola Enterprises a right of
first refusal over any Roddy Coke stock that members of the Third
Generation Roddys wanted to sell, with certain exceptions for
intrafamily transfers. The Agreement also specified the price
Coca-Cola Enterprises would pay for any shares of the bottling
companies that fell into the control of the Third Generation.
The Roddys’ foresight in creating the Voting Trust was
proved. Rather than a straight cash-for-shares deal, Coca-Cola
Enterprises paid the parties to the Voting Trust a control premi-
um of $24,500,000 for their majority ownership of Roddy Coke.
And Coca-Cola Enterprises also paid the Roddys who managed the
bottlers $8,700,000 as a special premium in the form of a noncom-
petition agreement.
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Left outside this flurry of dealmaking were the shares held
by J.P. Roddy Jr. and Eugenia. The Roddy witnesses testified
credibly that the family did not want to have J.P. Roddy, Jr.’s
low-basis stock sold for a considerable capital gain, only to
have the proceeds taxed again as part of his estate when he died.
They also testified that, from their perspective, Eugenia
was in a similar situation. She too was old, and she too would
be taxed on an enormous capital gain if she just sold her shares
into the merger. But we find her position to have been diffe-
rent. As the Roddys knew, she had no obvious heirs; and her
will, as they also knew, left her estate to charity--except for
the Roddy Coke stock. So, if the Roddys sold her stock, all of
the proceeds would end up being taxed away as capital gains or
given away to charity. If the stock could somehow be kept in her
name, none of its accumulated value would be taxed away as capi-
tal gains, and the stock would go to the Roddys under the terms
of her will. Under the Roddys’ agreement with Coca-Cola Enter-
prises, that stock would then be sold at a set price. The Roddys
would have to pay any tax on the capital gains (reduced by the
step-up in basis), and the Estate would have to pay any tax on
the stock’s value at the time of Eugenia’s death. But at least
the money would not all go to charity.
The Roddys’ solution to these problems was put in place in
April 1993. Coca-Cola Enterprises and a subsidiary that it had
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created to acquire the Roddy Coke stock agreed with William Jess
Mitchell (acting under his power of attorney for Eugenia) to a
“Right of First Refusal Agreement” with Coca-Cola Enterprises.
This Agreement barred J.P. Roddy, Jr. and Eugenia from transfer-
ring their Roddy Coke stock--other than by will--without the
consent of Coca-Cola Enterprises. It set no purchase price at
which Coca-Cola would buy the shares. It allowed for transfers
of Roddy Coke stock to Roddys who had signed the Right of First
Refusal Agreement with Coca-Cola Enterprises or were parties to
related agreements with Coca-Cola Enterprises or its affiliates.
And it required Eugenia’s shares themselves to bear a legend
noting that the shares were from that time on subject to these
restrictions. But the Agreement was not a gratuitous transfer:
Coca-Cola Enterprises agreed to pay both Eugenia and J.P. Roddy,
Jr. four percent of the value of their stock holdings each year.
Between 1993 and Eugenia’s death, these payments totaled nearly
$6 million, and implicitly valued her stock at about $30 million.
On the same day that it signed this Right of First Refusal
Agreement with the elderly Roddy Coke stockholders, Coca-Cola
Enterprises and its acquisition subsidiary signed a Conditional
Agreement with the Third and Fourth Generation Roddys. This
Conditional Agreement included a promise by those Roddys that, if
any of them acquired Roddy Coke stock, they would “immediately”
sell it to Coca-Cola Enterprises at a price per share that was
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equal to what Coke had been willing to pay in its initial offer,
but with a yearly increase of 1.5 percent in purchase price and
5.5 percent for interest. The effect was to give both J.P.
Roddy, Jr. and Eugenia an income stream for the rest of their
lives, Coca-Cola Enterprises the right to buy that stock when
either of them died, and the Roddys who stood to inherit that
stock a higher sale price when they finally received and sold the
stock.
On April 21, 1993, the transaction between Roddy Coke and
Coca-Cola Enterprises closed. Under the merger agreement, Roddy
Coke remained in existence as a corporate subsidiary of Coca-Cola
Enterprises. In that capacity it began to pay management fees to
its new parent for risk management, tax management, information
technology, and other similar services.1
D. Eugenia’s Will and the Estate Distribution
Eugenia Williams never changed her will after the merger.
She died on February 26, 1998 and bequeathed all of her property
except the bottling-company stock to several charities. These
included bequests of $10,000 to the Old Gray Cemetery of
1
What happened to the Johnson City stock is somewhat un-
clear from the record. It seems, however, that nearly half of
the Johnson City shares were in the Williams Trust with the rest
subject to the Roddy family’s Voting Trust, and that the stock
found its way to Coca-Cola Enterprises in a parallel deal, albeit
with much lower numbers. In any event, the Johnson City stock,
because it was entirely subject to a trust in which Eugenia had
no residuary interest, never found its way to her estate. It
doesn’t affect the outcome of this case.
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Knoxville, more than $6 million to the University of Tennessee,
and the residue in equal shares to four Tennessee institutions:
St. Mary’s Memorial Hospital, the Printing House For the Blind,
Vanderbilt University, and the East Tennessee Children’s Hospital
(collectively, the Charities).
Eugenia had named First Tennessee Bank as her executor, but
as early as October 1998 the Charities began to suspect that the
Roddys’ handling of Eugenia’s financial affairs had prevented
them from receiving a larger share of her estate. Fearful of
litigation, the Bank was hesitant to distribute the stock to the
Roddys. This meant that the Roddys could not take possession of
the stock, and could not sell it under the Conditional Agreement
to Coca-Cola Enterprises.
The Roddys and First Tennessee Bank began moving toward a
solution by executing an Estate Distribution Agreement. Under
this Agreement, the stock was put in a Restricted Fund. The
Roddys were allowed to withdraw the stock to sell it to Coca-Cola
Enterprises, but with the proceeds going into the Restricted
Fund. The Roddys could then withdraw some cash from the Fund, as
long as the Fund’s value did not drop below a minimum amount.
This Fund was to be the sole property of the Fourth Generation
Roddys, because the Third Generation Roddys had all disclaimed
any interest in Eugenia’s stock they might inherit.
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After receiving the Fund, the Fourth Generation Roddys
entered into a Tenants in Common Agreement. Under this Agree-
ment, they paid to the Bank as executor the amount of the estate
taxes attributable to the Roddy Coke stock. Each of the Roddy
beneficiaries also kept an interest in the Restricted Fund equal
to his allocable share of the Roddy Coke stock. Other require-
ments under the Tenants in Common Agreement were that the Roddys
were each responsible for paying the income taxes attributable to
their portions of the Fund and that each Roddy’s allocable por-
tion was alienable.
With these Agreements in place, the Bank distributed Eugen-
ia’s stock, and the Roddys sold the stock to Coca-Cola Enterpri-
ses for about $33 million. None of these proceeds were returned
to the Estate; the Roddys did put $20 million of the proceeds
into the Restricted Fund. The Bank then filed the Estate’s Form
706, valuing the 1,714 shares of Roddy Coke at $14,052,638.
This meant that, whether through inheritance or via the
agreements they had signed years earlier with Coca-Cola Enterpri-
ses, the Roddys had received the entire value of the Roddy Coke
stock. The stock was thus not considered part of the residuary
proceeds of Eugenia’s estate. This resulted in each of the four
charities’ receiving a mere $6,695,774, much less than each would
have received if Eugenia had just sold her stock back in 1993 and
held on to what would have been left after taxes.
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E. The Charities Sue
One could predict litigation. From the Charities’ perspec-
tive, what the Roddys did to Eugenia--from the redemption of the
Williams Trust stock (giving their Voting Trust majority control
of Roddy Coke) to the payment to the Roddys of a control premium
to the Right of First Refusal Agreement that stripped Eugenia of
the power to sell her stock to anyone but Coca-Cola Enterprises--
all looked like a massive violation of the various duties that
various Roddys owed Eugenia, all aimed at getting as much of the
Roddy Coke stock’s value for themselves. From the Roddys’ per-
spective, that’s more or less correct--but with the very large
reservation that they didn’t think they were violating any duties
they owed her. Instead, they were fulfilling what they saw as
her desire that the Roddy family--not the IRS and not the Chari-
ties--realize the ultimate value of nearly a century’s worth of
work that their families had put into Roddy Coke when she died.
The Charities prepared for war. They wanted the much
greater profit from the actual sale of the stock, rather than
what was left of the payments which Eugenia had received under
the Right of First Refusal Agreement. They demanded that the
Bank, as executor of the Estate, sue on their behalf. An
administratrix ad litem, Anna Hinds, was appointed. She then
sued William Jess Mitchell and the Roddys, demanding that all
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proceeds from the sale of Eugenia’s stock be given to the
Charities.
The original suit listed several causes of action; an
amended complaint added another for constructive sale.
Defendant Cause of Action Result
William Jess Mitchell Breach of duty as Resolved by the
attorney-in-fact for settlement
Eugenia F. Williams
J.P. Roddy, III Breach of duty as Chancery Court
Mary Ellen Roddy co-trustees of the ruled for the
Mitchell David Hitt Williams Roddys
Thomas Roddy Trust
William Jess Mitchell Constructive fraud Resolved by the
J.P. Roddy, III as Eugenia F. settlement
Mary Ellen Roddy Williams’ attorney-
Mitchell in-fact and as
Thomas Roddy trustees
Breach of duties as
majority
shareholders
Civil conspiracy
Fraudulent
concealment and non-
disclosure
Conspiracy to
conceal and non-
disclosure
Intentional
interference with
inheritance
Conversion
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Intentional Dismissed by
interference with Chancery Court
inheritance (this is
the only action in
which the Charities
themselves were
plaintiffs)
William Jess Mitchell Constructive sale Added by an
J.P. Roddy, III amended complaint,
Mary Ellen Roddy then resolved by
Mitchell the settlement.
Thomas Roddy
First Tennessee Bank
The Fourth Generation
Roddys (added to
impose a
constructive trust)
The Estate argued that the stock had been constructively
sold before Eugenia’s death because, if the stock had been sold
before her death, the proceeds would have become a part of Eu-
genia’s residuary Estate, much to the Charities’ advantage. The
administratrix ad litem even moved for partial summary judgment
using this theory. The parties argued fervently over the mo-
tion’s merits, but then settled before the Chancery Court ruled.
The settlement left the Charities with $20 million, all payable
from the Restricted Fund set up under the Estate Distribution
Agreement that the Roddy beneficiaries had negotiated with the
Executor. Although all the defendants named in the various cau-
ses of action received the benefit of the settlement, the settle-
ment money came only from the Restricted Fund.
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F. The Notice of Deficiency
While the state-court suit was being fought, the Commission-
er began looking at the Estate’s tax return, and in April 2002 he
sent a notice of deficiency, determining that the Estate owed
$596,086. The primary source of the alleged deficiency was an
understatement of $927,999 in the value of the Roddy Coke stock.
After litigation got underway, the Commissioner actually conceded
this issue--the parties now agree on a value of $12 million for
that stock--but the Estate began a counteroffensive by claiming a
refund under section 6512(b)(1)2 of the lesser amount of the va-
lue of the shares or the settlement proceeds distributed to the
Charities. The Estate’s claim arises from the undisputed fact
that the Charities got more than the roughly $6 million each that
the Estate reported on the Form 706. The Estate argues that this
additional money is nothing more than a share of the sale price
of Eugenia’s stock to Coca-Cola Enterprises. The Commissioner
argues that any extra money that the Charities got is attribut-
able not to the shares, but to the settlement of the state-court
litigation. He argues that any increase in the charitable deduc-
tion merely matches the value--which the Estate left off its re-
turn--of that litigation.
2
All section references are to the Internal Revenue Code,
and the Rule reference is to the Tax Court Rules of Practice and
Procedure.
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The Commissioner also moved to amend his answer before
trial. In his proposed amendment, the Commissioner specifically
denied that the Estate was entitled to any deduction based on the
distribution of the Hinds v. Mitchell settlement proceeds, and
alleged that the value of that litigation may have exceeded the
amount of settlement. He asserted a revised deficiency of
$11,659,891.
The Commissioner later retreated, and agreed that he was not
seeking to impose an additional tax liability on the Estate based
on the value of the litigation asset, but only arguing that the
Estate was not entitled to an overpayment refund because any
increased charitable deduction would be neutralized by an in-
crease in the value of the gross estate. The Commissioner is
arguing, in other words, that the cause of action the Estate had
against the Roddys is not the same thing as the shares of stock
that--however encumbered by side agreements--Eugenia still owned
on the day she died. We granted the Commissioner’s motion to
amend his answer, but only as a clarification of his position
that the settlement proceeds did not give rise to an increase in
the Estate’s charitable deduction.
Trial was held in Knoxville, where Eugenia died and the
Executor has its principal place of business.
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OPINION
We begin by noting how curious the Estate’s argument must
look to a nonlawyer: Its own return listed the stock as a tax-
able asset that was to be distributed to the Roddys. Eugenia’s
name was (at least metaphorically--there’s no indication the
stock was held in street name and it wouldn’t matter if it was)
on the shares. And when the Executor distributed the shares to
the Roddys, they sold them to Coca-Cola Enterprises--what could
they possibly be selling other than shares of stock?
So how can the Estate possibly argue that the settlement
proceeds are somehow legally the same thing as those shares of
stock?
The Estate’s argument might appear to be either nearly fri-
volous or remarkably subtle. Its essential point is nonintui-
tive--an assertion that the Roddys had effectively sold the stock
before they actually received it--and that, appearances to the
contrary, Eugenia did not, as a matter of law, own the stock when
she died.
To decide whether this argument is nothing more than fizz
requires us to begin with a brief explanation of how courts ana-
lyze the taxability of proceeds from settlements of litigation.
This is a venerable problem--dating back at least to Lyeth v.
Hoey, 305 U.S. 188, 196 (1938)--and the general rule may be sim-
ply stated: If the proceeds of a settlement represent something
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that would have been taxable, such as lost wages, then they are
taxable. Id. However, if the proceeds of a settlement represent
something that is not taxable, such as a personal-injury award,
the proceeds are not taxable. Id.
The Estate’s position becomes more plausible if one ap-
proaches it through some simple hypotheticals. Imagine someone
who owns only a pearl of great price, which she intends to leave
to charity when she dies. Imagine that she dies, and the charity
gets the pearl. It can sell the pearl or keep it--and if it
sells the pearl, it keeps the proceeds.
Now imagine that our hypothetical decedent wills the pearl
to two charities. It’s most likely that the executor would sell
the pearl and divide the proceeds between the two charities.
With the step-up in basis at death (and, since it’s a hypotheti-
cal, no post mortem increase in value), these cash proceeds would
be treated by the IRS the same way as the distribution of the
pearl itself--no income tax, and the charities get the value of
the pearl.
Let’s add a complication. A third party learns of the pearl
and, rather than sell all that he has to buy it, steals it in-
stead. The decedent dies. Her estate sues the thief for conver-
sion damages or return of the pearl. How should the estate re-
port this? Theft doesn’t grant good title, but the thief has the
pearl. The answer, we think, is that it doesn’t really matter.
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The estate could list the pearl as the asset. Then, if the law-
suit against the thief leads to the pearl’s return, the estate
can distribute the pearl or, if the estate wins damages, can
distribute those damages to its hypothetical charitable legatees.
Lyeth v. Hoey teaches us to treat any settlement proceeds as if
they were what they are substitutes for--in our hypothetical--the
pearl. The right to damages would in some sense be the same as
the pearl of great price or, at the very least, not an additional
asset of the estate.
Add another twist: The thief turns out to be clever. In-
stead of coming in the night to steal the pearl, he comes in the
bright light of day with a cleverly designed paste pearl which he
substitutes for the real one. The decedent dies. We can see no
reason why the results of the last hypothetical don’t again
apply: The estate could list the real pearl as an asset, but
would really have only a right of action against the thief for
damages or return of the pearl. In the end, again, the right to
damages would be treated the same as the pearl of great price
--not as an additional asset of the estate.
And one last hypothetical: The hypothetical decedent’s
hypothetical estate doesn’t realize at first that all it had was
paste, so it lists the pearl on its return as if it were the
pearl of great price. If our hypothetical decedent left the
pearl not to charities but to friends, the estate might pay tax
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on the value of the pearl. But then the estate realizes that the
pearl of great price is missing. The thief has long since sold
it. The estate would still have only a right of action against
the thief for conversion or restitution. Any damages would again
be taxed the same as if the pearl itself were returned. But if
the estate won only money, rather than the return of the pearl,
the specific bequest of the pearl would be defeated.3
We return to the real world, only to face a complication
absent from our hypotheticals--the Roddys, far from being
thieves, were the objects of Eugenia’s affection. She wanted
them to receive the stock-of-great-price and said so in her will.
But the problem here is that the Roddys may have so encumbered
that stock with restrictions and diminished it in value that Eu-
genia’s estate might have been left with something that was--if
not a paste pearl--not really the same as the stock Eugenia had
before the Roddys’ deal with Coca-Cola Enterprises back in 1993.
And that is the Estate’s argument here. It is claiming a
refund because it originally paid taxes on the Estate’s Roddy
Coke stock as if it all went to the Roddys instead of treating it
as having been constructively sold years before.
3
The estate-law term for this is “ademption by extinc-
tion,” defined as the “‘doing of some act with regard to the
subject-matter which interferes with the operation of the will.’”
University of the South v. Klank, 984 S.W.2d 602, 604 (Tenn.
1999) (quoting Am. Trust & Banking Co. v. Balfour, 198 S.W. 70,
71 (Tenn. 1917)).
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The Commissioner argues that the stock was never sold till
after Eugenia died, and so the settlement proceeds must instead
have been proceeds of an asset--the Estate’s tort action against
the Roddys--that wasn’t listed on the original return. If the
Commissioner is correct, the settlement proceeds would still be
part of the residual estate and still go to the Charities, but
because the litigation asset was not listed on the return, it
would not have been accounted for in the original estate tax paid
and the Estate would not be entitled to a refund now.
The parties battle on two fronts. The first is the effect
of the Roddys’ Estate Distribution Agreement with the Executor on
the characterization of the settlement proceeds. The Commission-
er says the terms of that Agreement show that the Roddys had such
unfettered control over the stock as to prove that they really
owned it. The Estate argues that the Restricted Fund was, well,
restricted--and so proves nothing.
The second front is how to interpret the Settlement Agree-
ment itself, together with the negotiations leading to it. And
to characterize settlement proceeds for tax purposes:
we must look to various factors, including
the allegations in the State court pleadings,
the evidence adduced at trial, a written
settlement agreement, and the intent of the
payer.
Threlkeld v. Commissioner, 87 T.C. 1294, 1306 (1986), affd. 848
F.2d 81 (6th Cir. 1988).
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A. The Estate Distribution Agreement and Restricted Fund
The Estate Distribution Agreement was a compromise between
the Executor and the Roddys. Both the Commissioner and the Es-
tate agree that the Restricted Fund that the Agreement created
was subject to constraints, but it was also a creative solution
to another problem: It was clear that the Estate’s tax liability
would be due before the resolution of any potential claims the
Charities or the Estate had against the Roddys. A simple distri-
bution of the shares to the Roddys would have left the Bank open
to potential liability to the Charities. But if the Bank com-
pletely refused to distribute the shares to the Roddys, it could
have been violating its duty to the Roddys as beneficiaries under
the will. And, most importantly in our view, it would have
possibly been stripping off much of the value of the shares--
salable as they were at a high price under the Conditional Agree-
ment between the Roddys and Coca-Cola Enterprises.
The testimony of Keith Keisling (an officer of First Tennes-
see Bank) and Jim Roddy (which we specifically find credible on
this point), as well as the Estate Distribution Agreement itself,
made clear the parties’ intent. Keisling testified that the
Estate Distribution Agreement was a mechanism for the Executor
both to ensure that the taxes would be paid and to avoid any
liability to the Charities, which were already expressing con-
cerns over the disposition of the stock. Jim Roddy similarly
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testified that the Estate Distribution Agreement was necessary
because:
We needed to pay Estate taxes on this asset
that was going to come to us, and we did an
agreement with the trustees whereby we would
sell the stock into a tenants in common
restricted account. In the event that the
shares didn’t belong to us, we would return
it back to the Estate, but at this time, you
know, the determination was that the shares
would go to us and we would treat it that
way.
The Estate Distribution Agreement also contains a provision
that the restrictions on the Restricted Fund--and thus the Estate
Distribution Agreement itself--would terminate upon the earliest
of: the release by the Executor of any claims on the shares’ va-
lue; the issuance of a final (nonappealable) court order regard-
ing the disposition of the shares; or April 2, 2003. This indi-
cates that the Estate Distribution Agreement was not an outright
distribution to the Roddys, but something resembling the res in
an interpleader. It is as if the parties to a dispute about the
ownership of a load of bananas reasonably agree between them-
selves to sell the fruit before it spoils, and continue their
fight over the proceeds. See also, e.g., U.C.C. sec. 2-704(2)
(1998).
The Commissioner argues that the Roddys held sufficient
control over the Restricted Fund to make it the Roddys’ property.
Many factors support this argument: The Roddys had discretion--
with the Estate’s permission as cosigner--to invest the proceeds
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in cash or any readily marketable securities, “the sole property
of the Roddy Beneficiaries;” the Roddys were allowed to make
withdrawals from the Fund to pay taxes related to income from the
Fund if the Fund’s income exceeded 4 percent; and the Roddys ack-
nowledged in the Agreement that the sale of the stock would re-
sult in tax consequences to them. The Commissioner also argues
that if the Roddys did own the Restricted Fund, the settlement
payment was made from the Roddys’ own property, indicating it was
actually the settlement of a tort claim. We don’t think any of
this makes much difference--the Estate’s theory is that the
Roddys’ payment back to the Estate was the equivalent of return-
ing proceeds from the sale of the stock, not additional compensa-
tion for other torts committed against Eugenia, and the source of
the funds used for the payment makes no difference to that char-
acterization.
The Estate points to the significant restrictions on distri-
butions from the Restricted Fund as evidence that the sale pro-
ceeds never actually accrued to the Roddys. The Estate contends
that, though meandering, the path the money took led to the same
destination it would have reached if Eugenia had sold the stock
and the Charities received the money as residuary beneficiaries.
The Estate does highlight one fact about the settlement’s
having been paid out of the Restricted Fund--because the Third
Generation Roddys had disclaimed any interest in the shares, that
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payment from the Restricted Fund was a direct loss only to the
Fourth Generation Roddys. And the Fourth Generation Roddys did
not have the same duties to Eugenia as the Third Generation
Roddys.
We therefore find that the Restricted Fund was created as a
receptacle for the proceeds of the stock until any legal issues
between the Roddys and the Estate could be resolved and the stock
or its proceeds could be properly distributed. We hold that its
terms do not affect our characterization of the settlement pro-
ceeds as either compensation for torts or other wrongs committed
by the Roddys, or as restitution for a constructive sale of Eu-
genia’s stock before she died.
B. Characterization of the Settlement in Hinds v. Mitchell
We next turn to a direct analysis of the settlement proceeds
from the state-court litigation. The Estate urges us to begin
and end with the language of the Settlement Agreement. That
Agreement is quite clear:
Whereas, Hinds and the Residuary Beneficia-
ries contend in the Litigation that the spe-
cific bequest of the [shares] was, as a mat-
ter of law, adeemed and/or the said shares
were constructively sold, and thus the
[shares or their value] actually passed or
should have passed to the Residuary Benefici-
aries.
This was the only cause of action specifically named in the
Settlement Agreement.
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The Commissioner argues that we shouldn’t rely on the Agree-
ment’s text. He asserts that the Agreement was written in collu-
sion between the Roddys and the Charities once they realized that
pinning the settlement proceeds to the constructive-sale theory
could lead to a significant refund claim redounding to the bene-
fit of the Charities as residuary legatees and letting them ease
up on the Roddys in negotiating the settlement. He argues that
the parties in Hinds v. Mitchell had every incentive to tailor
their settlement in a manner that would minimize ultimate tax
liability and thus maximize their available funds. The Commis-
sioner’s strongest argument is to point out that the parties in
Hinds v. Mitchell were adverse to each other only as to the
state-law causes of action. When it came to the settlement’s tax
consequences, the parties and their attorneys understood (and we
so find) that any funds kept from the IRS would increase the
amount they could divide among themselves. This is not a new
problem. In Bagley v. Commissioner, 105 T.C. 396, 400-01 (1995),
affd. 121 F.3d 393 (8th Cir. 1997), we analyzed a settlement
between the two parties to a tort action involving tortious
interference with present employment, tortious interference with
future employment, libel, and invasion of privacy. Under the
settlement, the defendant paid $1.5 million to Bagley, the plain-
tiff, to settle all claims. Id. at 403. The defendant’s inter-
ests were minimizing cost, avoiding publicity, eliminating the
-29-
risk of punitive damages, retrieving some corporate documents,
and obtaining a full release. We analyzed the problem of alloca-
ting damages in that case by placing the facts in Bagley in a
range bounded by Robinson v. Commissioner, 102 T.C. 116 (1994),
affd. in part and revd. in part 70 F.3d 34 (5th Cir. 1995), and
McKay v. Commissioner, 102 T.C. 465 (1994), vacated without pub-
lished opinion 84 F.3d 433 (5th Cir. 1996). We began by acknow-
ledging that the allocation of a settlement by the parties is
“generally binding for tax purposes to the extent that the agree-
ment is entered into by the parties in an adversarial context at
arm’s length and in good faith.” Bagley, 105 T.C. 407. In
Robinson, however, the allocation didn’t control because it “was
uncontested, non-adversarial, and entirely tax-motivated, and did
not accurately reflect the underlying claims.” Id. at 407. By
contrast, in McKay the settlement had been made by “hostile par-
ties who were in an adversarial position with respect to the al-
locations to be made in the settlement.” Id.
In Bagley, we reasoned the facts were not like those in
McKay, where the taxpayer lacked the “freedom to structure the
settlement on his own,” whereas in Bagley the parties had been
“jointly participating in the drafting of the agreement.” Id. at
408. This led us to conclude that the settlement documents were
not controlling. Yet Bagley was also unlike Robinson, because
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totally tax-motivated collusion was missing, too. The answer was
somewhere in between:
Based on these facts, we conclude that some
of the $1.5 million is properly allocable to
punitive damages. However, we do not agree
with the amount [the Commissioner] allocated.
The parties were negotiating for an amount in
lieu of the overall amount petitioner might
recover if the case went to trial. They were
considering the risk of trial, as well as
items unrelated to the money that petitioner
might recover, such as the return of the
Bagley documents and the confidentiality of
the settlement.
Id. at 410. We proceeded to list the various factors important
to Bagley’s former employer, including the avoidance of punitive
damages.
We begin here with what the witnesses in the present case
said their motivations were. Doris Allen, an attorney who repre-
sented two of the Third Generation Roddys and their families,
testified with some credibility that from the Roddys’ perspec-
tive, the sole ground for settlement was the constructive-sale
theory, and they would not have settled on any other theory. She
also credibly testified that she thought at the time that the
strongest legal theory in the litigation was the constructive-
sale issue. Jim Roddy, a Fourth Generation Roddy, testified that
the only theory the defendants thought might succeed was the
constructive-sale theory.
Two attorneys for the Charities also testified, and both
credibly confirmed that the constructive-sale theory had been at
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least a factor in the settlement. David Black, who had represen-
ted the American Printing House For the Blind and then the admi-
nistratrix ad litem, testified that “the most straightforward”
cause of action for the administratrix to prevail on would have
been the constructive-sale theory. This was due at least in part
to the lack of a need for any “proof of intent” or “establishment
of bad acts.” Black also testified, however, that litigation
would have been ready to proceed on any of the causes of action
listed in the complaint. Even as the Commissioner’s witness,
Black testified on direct examination that the plaintiffs in the
Hinds case were prepared to go forward on all counts which they
believed viable after discovery. This would, of course, have
included the constructive-sale theory.
Taking that testimony into account, we find that settling
the constructive-sale theory was the dominant, but not exclusive,
motivation of the Roddys. This finding is also supported by the
evidence that, at an early point in the administration of the
Estate, both the Executor and the Charities had concerns about
the propriety of the 1993 transactions and their potential to
give rise to both constructive-sale and breach-of-fiduciary-duty
causes of action. Indeed, the Bank was worried enough to seek
legal advice on both these issues and supported the appointment
of an administratix ad litem to pursue both.
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We also acknowledge the strength of the Commissioner’s
argument that the constructive-sale and various breach-of-
fiduciary-duty causes of action were intertwined. The Third
Generation Roddys, and especially William Jess Mitchell, owed a
number of duties to Eugenia in various capacities--as her
attorney-in-fact, as trustees of the Williams Trust, and as
officers and directors of Roddy Coke and Johnson City Coke. And
the Estate’s original complaint alleged that the Roddys breached
these duties in 1993 by securing for themselves the ability to
sell both their own and eventually Eugenia’s stock to Coca-Cola
Enterprises while receiving a control premium--a premium so large
that it deprived Eugenia of full value from the deal.
But we must also acknowledge that all those involved thought
that the constructive-sale theory suffered from far fewer weak-
nesses than any of the tort theories. Proposed finding 49 in the
Estate’s opening brief states that “the executor’s attorneys ad-
vised [the Charities] that the executor would not prevail in any
such litigation [i.e., the tort litigation],” and proposed find-
ing 55 states, “In October and November 1998, the residuary bene-
ficiaries raised concerns to the petitioner’s personal represen-
tative (executor) involving the bequest of the [Roddy Coke] stock
to the Roddy family.” While the Commissioner objects to both of
these, he does not offer any specific rebuttal, and we find them
to be proved.
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The most important weakness of the various tort theories was
that the Roddys had a plausible argument that the 1993 transac-
tions were fundamentally fair to Eugenia in that the Right of
First Refusal payments and the other payments she received
constituted an acceptable alternative to paying a large capital-
gains tax and seeing what was left of the proceeds go to the
Charities. They could point to the similar deal they negotiated
with the Roddy patriarch, J.P. Roddy, Sr.
Eugenia was, moreover, never formally judged incompetent.
There was credible testimony that the Roddys and their lawyers
strongly believed that absent a finding that Eugenia was incompe-
tent, any action based on a breach-of-duty theory would have been
subject to a statute-of-limitations defense. Indeed, the Es-
tate’s attorneys originally rejected the idea of pursuing the
breach claim in part because of this.
We also find on the basis of the credible evidence in the
record4 that the parties thought that trial of the fiduciary-duty
causes of action might lead to a judgment that the stock or pro-
ceeds from its sale must be disgorged. See Freeman v. Martin,
181 S.W.2d 745, 746 (Tenn. 1944). This means that even the
4
We use phrases like “credible evidence” in discussing
state law because our focus in allocating the settlement proceeds
is not on what the law is (obviously a legal, not a factual,
question), but on what the parties and their lawyers thought the
law was when agreeing to the settlement.
-34-
settlement value of the tort causes of action had a hefty
restitutionary component.
And, finally, we note that the economic burden of the
settlement fell entirely on the members of the Tenants in Common
Agreement--the Fourth Generation Roddys, who were named defen-
dants only in the amended complaint’s cause of action for con-
structive sale. We find this very significant, because it shows
that all the damages paid under the Settlement Agreement were
being paid by only some of the Roddys, who presumably had an
incentive not to bear the costs of the settlement entirely on
their own without good reason.
Nevertheless, even the Fourth Generation Roddys were Roddys,
and so (if possessed of any filial affection) they would benefit
at least intangibly from the releases of their elders in the
Third Generation from all the causes of action in which those
Roddys were the named defendants. Even J.P. Roddy, Jr.’s estate
was released from any liability, and he had had the primary obli-
gations to Eugenia for some of the years involved.
Weighing these various factors is not something we can do
with great precision. But persuaded especially by where the
economic burden of the settlement lay, and the parties’ reason-
able estimation of the probabilities of success on the different
causes of action, we find that 90 percent of the settlement
proceeds is allocable to the constructive-sale theory, with the
-35-
remainder allocable to the tort theories (or, more precisely, the
damages-other-than-monetary-equivalent-of-the-stock theories).
Thus, 90 percent of the settlement proceeds should be considered
to be only a return of the value of the stock to the Estate and
not compensation for any profits or income to Eugenia.
Petitioner having agreed to a refund of the lesser of this
amount or the stipulated value of the shares, and to reflect the
parties’ various other concessions and stipulations,
Decision will be entered under
Rule 155.