NOT ALL RECAPITALIZATIONS ARE TAX-FREE

Code Section 368(a)(1)(E) generally allows a corporation to rejigger its debt and equity structure and then swap old interests for new interests with its stock and security holders, with no gain or loss to the current owners. A recent Legal Advice by Field Attorneys demonstrates an important limit to such E reorganization nonrecognition treatment.

To qualify for nonrecognition treatment, the old stock and securities that are exchanged for recapitalized stock and securities must have the same value. Kohler, TC Memo 2006-152. In the Legal Advice, the IRS determined that the stock surrendered by the stockholder had little or no value, and that the new stock issued in the reorganization did have value. Thus, nonrecognition treatment did not apply and the stockholder had to recognize gain on the transaction.

Thus, taxpayers need to keep in mind that an E reorganization is not an open door to any type of exchanges of stock and securities arising in a reorganization setting – an equal exchange of value requirement still applies (even though in many cases that is easily satisfied via a pro rata exchange of all existing equity and security interests for the newly issued interests).

Legal Advice Issued by Field Attorneys 20131601F

SPOUSE WAS NOT REQUIRED TO CHALLENGE A VOIDABLE PRENUPTIAL AGREEMENT DURING THE MARRIAGE

A recent appellate court decision supporting a challenge to a prenuptial agreement addresses two interesting concepts.

The divorce court recognized that a prenuptial agreement was voidable by the wife due to coercion at the time of signing. Since the wife had learned from her attorney shortly after the marriage that the agreement could be voidable, the divorce court went on to rule that by the time of divorce six years later, the concepts of ratification and laches (i.e., inequitable delay) prevented the wife from making a challenge at the time of divorce. Thus, the court in effect was requiring the wife to bring a challenge to the prenuptial agreement during marriage, instead of waiting until divorce.

The appellate court reversed the divorce court, and allowed the wife to challenge the prenuptial agreement. The appellate court could locate no authority inside or outside of Florida that requires a spouse to challenge a marital agreement during the term of the marriage, since forcing spouses to bring an action during marriage is just bad policy. More particularly, the court provided:

The parties concede that no case in Florida, nor any case in any other jurisdiction, has held that the equitable defenses of ratification and laches apply to validate a voidable prenuptial agreement on the basis that the disadvantaged spouse did not take some form of legal action during the parties' intact marriage to challenge the agreement. Other jurisdictions have declined to apply ratification and laches because it would be contrary to public policy to force a spouse who wanted to challenge the enforceability of a prenuptial agreement to do so prior to the dissolution of the marriage by death or divorce. See In re Estate of Hollett, 834 A.2d 348, 353 (N.H. 2003) (declining to consider “the wife's delay in challenging the agreement as substantive evidence of the agreement's voluntariness or ratification”); In re Flannery's Estate, 173 A. 303, 304 (Pa. 1934) (holding that laches did not bar a wife from challenging the prenuptial agreement during marriage and noting that in litigation between spouses “presumptions or estoppels by lapse of time, ordinarily, do not affect the rights of the wife”); Baker v. Baker, 142 S.W.2d 737, 748 (Tenn. Ct. App. 1940) (explaining that it would go against public policy to require a spouse to challenge a prenuptial agreement during marriage); Kellar v. Estate of Kellar, 291 P.3d 906, 918 (Wash. Ct. App. 2012) (refusing to apply the doctrines of ratification and laches because “considering a wife's delay in challenging a prenuptial agreement as evidence of ratification would penalize the wife for choosing not to disrupt her marriage”) review denied, 312 P.3d 652 (Wash. 2013).

The second interesting aspect of the case was the lesson it gives in how NOT to do a prenuptial agreement. In preparing these agreements, I am often asked, “How close to the wedding can the prenuptial agreement be signed?” There is no black and white answer to that question – but clearly the night before the wedding presents a big problem. The timetable in this case was:

a. Husband presents first draft to wife one month before the wedding.

b. Wife meets with her attorney 11 days before the wedding. The attorney advises her not to sign the agreement, and says she will speak to the husband’s attorney.

c. Wife does not speak any more with her attorney, but goes out to Las Vegas a few days before the wedding. She picks up her husband at 11 p.m. at the airport, he gives her a revised agreement, and sends her out to find a notary and to sign the agreement which has some changes from the prior version. She finds a notary and signs at 2 a.m. without reading the agreement, and then marries later that day.

Apparently, 2 a.m. on the day of the wedding is a bit too late.

SUSAN LEE FLAHERTY, Appellant, v. JERALD CHARLES FLAHERTY, Appellee. 2nd District. Case No. 2D12-3192. Opinion filed December 20, 2013

FATIGUE, DISTRESS, AND SECOND THOUGHTS NOT ENOUGH TO VOID A MEDIATED SETTLEMENT AGREEMENT [FLORIDA]

Most will and trust disputes in Florida involve at least one mediation attempt – either by order of the trial court or agreement of the parties. Such mediations usually begin in the morning, and often do not wind-up until the evening or wee hours of the morning.

If a settlement is reached, smart mediators will attempt to have the parties negotiate and sign a binding settlement agreement before they leave. This is because if litigants have to time think about a settlement after leaving the mediation, they will often change heir minds and the settlement will evaporate. Thus, at the end of the mediation, litigants are often both physically and emotionally exhausted.

In a recent Florida case, the trial court allowed one of the parties to a will contest to escape from a mediated settlement agreement. The party claimed she was coerced into signing the mediation agreement after the mediator allegedly denied her request to take the agreement home over the weekend to study it.

The trial court noted:

The Court believes that the request for additional time to review was not given the priority or emphasis it should have because Ms. Linda Pierce was fatigued and emotionally distraught from the extensive mediation efforts. However, it is clear that Ms. Linda Pierce, after taking one night to reflect and review the terms of the Agreement, immediately went to the office of the mediator on Saturday morning and hand delivered a note requesting that the Agreement be rescinded. Ms. Linda Pierce also met with her attorney early the next Monday morning and instructed him to file a Motion to Vacate the Settlement Agreement. When Mr. Cummings suggested he could not file such a motion as it would put him in a position of a conflict of interest, Ms. Linda Pierce asked him to draft the Motion, which she then filed pro se.

The trial court concluded that Ms. Pierce had not “freely, knowingly and intelligently entered into the agreement.”

The appellate court reversed the trial court and ordered the settlement agreement to be enforced. To void the agreement, the presence of fraud, misrepresentation, coercion, or overreaching is needed. Fatigue, distress, and second thoughts are not enough.

The appellate court noted that emotion is not grounds to set aside an agreement, since courts recognize that it is normal for parties in these matters to be emotionally upset. Further, the parties were ably represented by counsel experienced in probate law, and the parties reviewed and corrected several drafts of the agreement over the course of the mediation. While the challenging party may have at one point made a request to review the agreement over the weekend, the fact that at the end of the day she had read and signed the agreement without requesting additional time for review was evidence of lack of coercion.

TAMRA E. PIERCE, Appellant, v. LINDA MARIE PIERCE IN RE: ESTATE OF CECILIE REDLINGER PIERCE, DECEASED, Appellee. 1st District. Case No. 1D13-1546. Opinion filed December 10, 2013

IRS TAX OVERPAYMENT AND UNDERPAYMENT INTEREST RATES–1st QUARTER 2014

CONTINUING WRITS OF GARNISHMENT AGAINST DISCRETIONARY TRUSTS–HOW FAR DOES IT GO? [FLORIDA]

In the recent 2nd DCA case of Berlinger v. Casselberry, the court allowed a continuing writ of garnishment against distributions to be made to a beneficiary of what appears to be a discretionary trust, for unpaid alimony obligations of the beneficiary. This opinion resolves (at least within the 2nd DCA) some statutory questions regarding continuing writs of garnishment, but raises others.

The continuing writ is not a surprise here, since it is specifically contemplated by Fla.Stats. Section 736.0503(3) that provides special limitations on creditor protection and spendthrift trusts for unpaid support and maintenance obligations. Fla.Stats. Section 736.0503(3) is a codification of Bacardi, 463 So.2d 218 (1985), which voided the application of spendthrift provisions of trusts for similar marital obligations. Since 736.0503(3) is expressly subject to 736.0504 by its language, the issue remained whether 736.0504 prohibits garnishment in the circumstances of a discretionary trust. 736.0504 limits creditor rights against discretionary trusts. Thus, an argument exists that 736.0504 overrides 736.0503(3) when a discretionary trust exists. The Berlinger court ruled that a writ of attachment can still apply, notwithstanding the existence of a discretionary trust under 736.0504 and the reference to it in 736.0503(3).

The Berlinger decision relies in part on Bacardi. Since Bacardi predated the establishment of Florida’s trust code in Chapter 736, and indeed was codified into 736.0503(3), its continued application perhaps can be questioned. By relying on Bacardi in part, the 2nd DCA indicates it still applies separate and apart from Chapter 736.

The interesting question here is whether Berlinger can be read to say that a continuing writ of garnishment can be obtained by other creditors NOT described in 736.0503(3) when a discretionary trust is involved. The opinion does not rule this out, and perhaps can be read to broadly say that continuing writs of garnishment are not prohibited in any circumstances against discretionary trusts by 736.0504. Or does the special language of 736.0503(3) and the public policy of Bacardi justify a continuing writ of garnishment only in the circumstances described in 736.0503(3)? Here is the key language of the opinion:

"According to section 736.0504(2), a former spouse may not compel a distribution that is subject to the trustee's discretion or attach or otherwise reach the interest, if any, which the beneficiary may have. The section does not expressly prohibit a former spouse from obtaining a writ of garnishment against discretionary disbursements made by a trustee exercising its discretion. As a result, it makes no difference that the instant trusts are discretionary. Casselberry is not seeking an order compelling a distribution that is subject to the trustee's discretion or attaching the beneficiary's interest."

BRUCE D. BERLINGER, Appellant, v. ROBERTA SUE CASSELBERRY, Appellee. Case No. 2D12-6470. District Court of Appeal of Florida, Second District. Opinion filed November 27, 2013