In Uncategorized on 12/16/2013 at 17:46

That’s the story of Larry E. Austin and Belinda Austin, lead-off hitters in 141 T. C. 18, filed 12/16/13, but the executors and administrators (and spouse) of Arthur E. Kechijian, late of North Carolina, are along for the ride in Judge Lauber’s sleigh.

Larry and the late Arthur were bad-debt stripminers, although apparently better than Mid-Coast Financial of infamous memory. Anyway, Larry and the late Arthur 351’d their respective portfolios of toxic paper into a Sub S, entitling them to much stock (which was stowed in an ESOP that qualified under Section 401(a)), provided they served their four years before the mast at the Sub S.

If they were discharged “for cause”, in this case failing to perform their duties faithfully and diligently after 15 days’ notice to get on the stick during year three, they would be deemed to have sold their shares for 50% of book, rather than the 100% they’d get if they stuck to it.

Larry and the late Arthur claim substantial risk of forfeiture under Section 83. Nope, says IRS, read the regulations:  Section 1.83-3(c)(2) says possible termination because of committing a crime or “for cause” is not a substantial risk.

This is a motion for partial summary judgment because IRS has other arguments, but they involve disputed facts, so no summary judgment for them.

Judge Lauber goes back to when IRS wrote those regulations. IRS admitted it was all facts and circumstances (Sir Ed Elgar, where are you?), but the clear words are “for cause”, and that’s what Larry and the late Arthur said in their stock deal papers.

Now the classic “earnout” (stay to play or you get no pay) is defined in Section 1.83-3(c)(4), Example (1) of the regulations. And both Hank Black of dictionary fame and the Restatement of the Law, Employment agree that the parties can write their employment agreements with a wide-sweeping definition of reasons (causes) for discharge.

Judge Lauber finds the original 1971 version of the regulation didn’t mention discharge for cause, and the phrase was added to the final version as a result of two cases (cited in the opinion), both of which arose out of busted 401(a)s and both of which gave dishonesty as grounds for discharge.

IRS characterized the addition of the “discharged for cause” language to “commission of a crime” as a “less significant” change, notwithstanding the New York State Bar Association’s comment that “the Regulations should not attempt to create presumptions or draw lines, except in the clearest situations (such as forfeiture conditioned only on committing a crime), because to do so is to make a rule of law where none was authorized by Congress.” 2013 T. C. 18, at p. 17.

And calm down, NYSBA membership department; I love ya. I’ll pay my dues before year-end.

Judge Lauber: “The text and evolution of section 1.83-3(c)(2) indicate that the term ‘discharged for cause,’ as used therein, does not necessarily have the same scope that parties to a particular contract may have given this term in their negotiations. Rather, as used in the regulation, ‘discharged for cause’ refers to termination for serious misconduct that is roughly comparable–in its severity and in the unlikelihood of its occurrence–to criminal misconduct.” 141 T. C. 18, at p. 20.

Then, too, the phrase “for cause” may be narrower in regulation than in contract. The phrase in the regulation is known by the company it keeps, namely, crime. As the high-priced lawyers say, “noscitur a sociis”–a Latin phrase meaning “it is known by its associates”. For more about this canon of construction than you want to know, see 141 T. C. 18, at pp. 22-23, footnote 6.

And under State law, contracts are interpreted to effectuate the intent of the parties. The intent was that Larry and the late Arthur labor heart and soul for the greater good of their corporation, and if not, no goodies.

Judge Lauber: “Notwithstanding section 7(B)’s [of their stock deal] appearance in a contractual provision addressing termination ‘for cause,’ the employee activity specified in section 7(B) falls outside the scope of discharge ‘for cause or for committing a crime’ within the meaning of section 1.83-3(c)(2), Income Tax Regs. That is so because an employee’s inability or disinclination to work for the agreed-upon term of his employment contract is not a ‘remote’ event that is unlikely to occur. Even more clearly, that is so because a conclusion that section 1.83-3(c)(2) precludes an earnout restriction from creating a ‘substantial risk of forfeiture’ would make that subparagraph of the regulation inconsistent with the statute.” 141 T. C. 18, at pp. 27-28 (Citations omitted).

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