United States District Court, M.D. North Carolina
For HERBERT ALLEN ANDREW, JAMES P. APLINGTON, JACK C. DIXON, ESTATE OF BENJAMIN F. FORTUNE, KENNETH W. FRASER, LOUIS P. GODWIN, N. CLAYTON LEE, ALBERT S. LINEBERRY, ESTATE OF FRED L. PROCTOR, SAMUEL A. SUE, PORTER B. THOMPSON, KENNETH E. TUTTEROW, ESTATE OF O. FRANK YORK, COMMUNITY FOUNDATION OF GREATER GREENSBORO, INC., Plaintiffs: BENJAMIN R. NORMAN, LEAD ATTORNEY, BROOKS PIERCE MCLENDON HUMPHREY & LEONARD, GREENSBORO, NC; JOHN S. BUFORD, BROOKS PIERCE MCLENDON HUMPHREY & LEONARD, LLP, GREENSBORO, NC; HOWARD L. WILLIAMS, BROOKS PIERCE MCLENDON HUMPHREY & LEONARD, GREENSBORO, NC.
For UNITED STATES OF AMERICA, Defendant: THOMAS J. JAWORSKI, LEAD ATTORNEY, BRITTNEY N. CAMPBELL, U.S. DEPARTMENT OF JUSTICE, WASHINGTON, DC; LAWRENCE P. BLASKOPF, DEPARTMENT OF JUSTICE - TAX DIVISION, WASHINGTON, DC.
MEMORANDUM OPINION AND ORDER
Catherine C. Eagles, UNITED STATES DISTRICT JUDGE.
The plaintiffs filed this lawsuit against the United States seeking a refund of taxes and penalties assessed against them as transferees of GNC Investors Club, Inc. ( See Doc. 1.) The case came on for a bench trial on November 17, 2014. Having considered the documentary evidence and testimony, the Court finds that the plaintiffs have proven that there is no basis under North Carolina law for holding them liable as transferees for GNC's unpaid taxes.
The parties stipulated to many of the facts, ( see Doc. 36-1), and these stipulations are incorporated in the Court's findings by reference. The Court's remaining findings are based either on undisputed evidence or on its evaluation of the admissible evidence and its determination about the credibility of and appropriate weight to be given to the testimony of the various witnesses and the various exhibits. The plaintiffs' trial exhibits will be referenced as " PTX" and the defendant's trial exhibits as " DTX." Because many of the defendant's exhibits have multiple pages and documents, the Court has often used the number found on the bottom left of the page, i.e., DTX 15.0043, to specifically identify the location of the referenced evidence. The Court has not attempted to cite all of the evidence available to support its findings.
The Court makes the following findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a).
GNC Investors Club, Inc., (" GNC" ) was incorporated as a " C" corporation in 1957 and engaged in the business of (1) acquiring, holding, and selling securities and holding cash and cash equivalents; and (2) conducting meetings and educating its members about the stock market. (Doc. 36-1 at ¶ 1, 2; Testimony of H.A. Andrew.) GNC's shareholders met monthly to conduct the corporation's business and for social purposes. (DTX 15.0036-15.0069.) In 2000, the plaintiffs or their predecessors in interest collectively owned 16 of the 24 outstanding GNC shares, and each share represented one vote. (Doc. 36-1 at ¶ ¶ 4, 5.)
In the spring of 2000, GNC began to consider alternative business models. (Doc. 36 at ¶ 7.) The shareholders' goal was to avoid the double taxation resulting from its C-corporation status and to reduce the buy-in price for new members. (DTX 15.0036-15.0037; Testimony of P. Thompson, H.A. Andrew; Doc. 97-2 at 16-17.) After considering and rejecting the possibility of converting to an LLC in March of 2000, (DTX 15.0001-15.0035, 15.0051; Testimony of W.K. Fraser), the shareholders began considering dissolution in the late summer and early fall of 2000. (Doc. 36-1 at ¶ ¶ 7-8; DTX 15.0042-15.0048.)
Michael Haley, then-president of GNC and an astute businessman, formed a Dissolution Task Force (" Dissolution Committee" ) composed of himself, Clayton Lee, W. Kenneth Fraser, and Porter Thompson. (Doc. 36-1 at ¶ 9; see also Testimony of W.K. Fraser, P. Thompson, H.A. Andrew, J. Aplington.) GNC invited Lewis Ritchie, a KPMG tax advisor, to several meetings to discuss the tax consequences of dissolution. (DTX 15.0045-15.0047.) In September 2000, the shareholders voted to pursue dissolution and reorganization as an LLC, and GNC hired local attorney Sharon Allen to assist. (DTX 15.0051.) The shareholders expected the dissolution and reorganization to be completed in December of 2000. (DTX 15.0053.) Each shareholder knew that if this was done, the corporation would have to pay taxes on the gains from the sale of GNC's stock and that each shareholder would have to pay taxes on the cash proceeds distributed to him after dissolution. (DTX 15.0053; DTX 22.0075; Testimony of S. Allen.)
In October 2000, Mr. Lee saw Thomas Watkins, a reputable local attorney with over 30 years of experience in the purchase and sale of companies, at a social event. (Doc. 36-1 at ¶ 10; see also Testimony of T. Watkins.) During their conversation, the topic of investment clubs came up, and Mr. Watkins told Mr. Lee that he might know of an alternative to dissolution. (Doc. 36-1 at ¶ 10; Testimony of T. Watkins.) Mr. Watkins had received several solicitations from MidCoast Credit Corporation (" MidCoast" ) that communicated MidCoast's interest in acquiring the stock of C corporations and paying its shareholders a premium in excess of the amount they would otherwise receive from liquidation. (DTX 24.0667-24.0668.) Mr. Watkins reached out to MidCoast, and MidCoast expressed an interest to Mr. Watkins in purchasing an investment club's stock. (Testimony of T. Watkins.) Mr. Watkins then conveyed MidCoast's interest to Mr. Lee, and Mr. Lee authorized Mr. Watkins to share GNC's information with MidCoast. (Testimony of T. Watkins; DTX 16.0009.) MidCoast retained Mr. Watkins to represent it in negotiations with GNC. (DTX 24.0693-24.0694; Testimony of T. Watkins.)
MidCoast sent a letter of intent to Mr. Watkins on October 17, 2000, stating terms for a deal to buy 100% of GNC's stock. (DTX 16.0009-16.0012; Testimony of T. Watkins.) MidCoast proposed that it or its designee would acquire the GNC shareholders' stock as an alternative to the shareholders liquidating GNC. (Doc. 36-1 at ¶ 11; DTX 16.0009-16.0012.) MidCoast required that GNC liquidate its stock portfolio before the closing date. (DTX 16.0009-16.0010.) MidCoast provided a schedule showing that the GNC shareholders would receive more money from selling GNC's stock to MidCoast than from liquidation, taking into account the tax consequences. (Doc. 36-1 at ¶ 12; DTX 16.0013; Testimony of T. Watkins.) Specifically, MidCoast represented that the shareholders would collectively receive $401,325 more in proceeds from the stock sale to MidCoast than if they liquidated
GNC; this constituted a premium of approximately 10%. (DTX 16.0013; Testimony of T. Watkins.)
The same day Mr. Watkins received the letter of intent from MidCoast, he met with the Dissolution Committee members and communicated MidCoast's proposal to them. (Testimony of T. Watkins; see also DTX 16.0090.) At a shareholder meeting that night, the shareholders considered and accepted MidCoast's proposal. (DTX 15.0054.)
After accepting MidCoast's proposal, the Dissolution Committee checked MidCoast's business references. (DTX 15.0064.) Jack Dixon, a GNC shareholder and partner at KPMG, informed the Committee that his company had some dealings with MidCoast in the past, and a Committee member checked with Dun & Bradstreet and reported that MidCoast was a viable company. (Doc. 97-3 at 27-28; see also DTX 15.0064.) On October 20, 2000, the Committee reported to the other shareholders that the MidCoast references were favorable and that GNC would move forward with negotiating a stock purchase agreement with MidCoast. (DTX 15.0064.) On November 3, 6, and 7, 2000, GNC liquidated its publicly traded stock and received a total of $4,955,000. (Doc. 36-1 at ¶ 13.) Ms. Allen represented GNC and its shareholders in connection with the sale to MidCoast. (Testimony of S. Allen.)
Through November 2000, GNC and MidCoast finalized arrangements for the transaction. MidCoast arranged for Battery Street, Inc., a newly formed corporation, to acquire GNC's stock. (Doc. 36-1 at ¶ 14.) Mr. Watkins continued to represent MidCoast, (DTX 24.0693-24.0694; Testimony of T. Watkins), and also represented Battery Street. (Testimony of T. Watkins.) The shareholders, through Ms. Allen, reviewed Battery Street's certificate of incorporation and confirmed that it was an existing company. (Testimony of S. Allen.) The shareholders made no additional inquiries about MidCoast or Battery Street because Battery Street planned to pay cash and because they trusted Mr. Haley's ability to review the arrangement with Battery Street and Mr. Watkin's business reputation. (Testimony of S. Allen, W.K. Fraser, P. Thompson, H.A. Andrew.)
By letter dated November 22, 2000, Ms. Allen informed Mr. Watkins that GNC had an estimated federal tax liability of $1,208,690, of which $30,000 had been paid, from the sale of GNC's publicly traded stock. (Doc. 36-1 at ¶ 15.) Also during this time, several GNC shareholders donated their shares to various foundations. (Testimony of M. Angulo, W. Sanders; Doc. 97-2 at 30-31.) Among these were gifts of three shares to a plaintiff, the Community Foundation of Greater Greensboro, Inc. (DTX 21.0003-21.0009; Testimony of W. Sanders.)
On November 27, 2000, one day before the closing, Southeast Acquisition Partners (" SEAP" ) offered to lend Battery Street $3,818,000 to purchase GNC, conditioned upon Battery Street's repayment within 24 hours. ( See Doc. 36-1 at ¶ 17 (referencing Doc. 36-1 at 9-10); see also DTX 23.0558-23.0560.) None of the shareholders knew the terms of SEAP's loan offer or of how Battery Street would come up with the money to buy GNC's stock. (Testimony of W.K. Fraser, P. Thompson, H.A. Andrew, J. Aplington.)
On November 28, 2000, the GNC shareholders and Battery Street signed a Stock Purchase Agreement (the " Agreement" ),
which required the shareholders to sell and Battery Street to buy all shares of GNC for $3,818,000. (Doc. 36-1 at ¶ 16.) At that time, GNC's sole assets were two bank accounts--a Wachovia account and a Paine Webber account--that contained cash in the total amount of $4,932,676. (Doc. 36-1 at ¶ ¶ 18, 21.) The Agreement required Battery Street to cause GNC to pay its state and federal taxes for the tax year ending on April 30, 2001, including GNC's " Specified Tax Liability" and all taxes, penalties, and interest GNC was required to pay after the closing date. (PTX 111.) Schedule 3.2(h) of the Agreement outlined GNC's Specified Tax Liability as: " (1) federal taxes on 2000 taxable income of $1,210,811.00, and (2) state and local taxes on 2000 taxable income of $267,790.00." (PTX 111.)
Ms. Allen made copies of the Agreement and Battery Street's corporate documents available for the shareholders to review at closing. (Testimony of S. Allen, P. Thompson, H.A. Andrew.) Mr. Haley reviewed Battery Street's certificate of existence, but no other shareholder asked to review the documents. (Testimony of S. Allen.) At closing, each shareholder executed a signature page to the Agreement after " scanning" the document or without reading it. (Testimony of P. Thompson, H.A. Andrew.)
Also on November 28, 2000, Battery Street wired the purchase price of $3,818,000 to Ms. Allen's trust account. (Doc. 36-1 at ¶ 20.) Once Ms. Allen received this money from Battery Street, GNC wired $4,928,752 from its Wachovia account to a new Golden Gate Bank account set up by Battery Street in GNC's name. (Doc. 36-1 at ¶ 21.) GNC also wrote a $3,924 check to Battery Street from its Paine Webber account. (Doc. 36-1 at ¶ 21.) These amounts represented the total assets of GNC. (Doc. 36-1 at ¶ 21.) GNC also transferred all outstanding stock certificates to Battery Street. (Doc. 36-1 at ¶ 21.)
On November 30, 2000, Ms. Allen distributed the sale proceeds to the former shareholders in amounts ranging from $31,775 to $478,500. ( See Doc. 36-1 at ¶ 22.) After the closing, the GNC shareholders had no contact with MidCoast or
Battery Street. ( See Testimony of W.K. Fraser, P. Thompson, H.A. Andrew.)
GNC filed a tax return for the year 2000 that showed it did not owe any tax. (DTX 17.0011.) On December 28, 2004, the IRS issued a statutory Notice of Deficiency to GNC for the tax year ending April 30, 2001. (Doc. 36-1 at ¶ 23; DTX 17.0004.) The deficiency found GNC liable for $1,286,686 in unpaid taxes and an accuracy-related penalty of $514,573.20. (Doc. 36-1 at ¶ 23; DTX 17.0004.) On September 2, 2005, GNC and the IRS entered into a stipulation providing that GNC owed $1,158,132 in unpaid taxes and a $231,626 penalty. (Doc. 36-1 at ¶ 24; DTX 17.0041-17.0042.) The IRS was unable to collect the tax or the penalty from GNC. ( See Testimony of M. Thompson, C. Ferebee.)
On or about September 30, 2008, the IRS proposed assessments against the plaintiffs as transferees of GNC. (Doc. 36-1 at ¶ 25.) On or about July 29, 2009, the plaintiffs collectively paid the IRS in full for the alleged deficiency ($1,158,132 in unpaid taxes and ...