TAXPAYER ESTOPPED FROM RELITIGATING IN TAX COURT ISSUES ALREADY DECIDED IN STATE COURT.

TAXPAYER ESTOPPED FROM RELITIGATING IN TAX COURT ISSUES ALREADY DECIDED IN STATE COURT.

Brothers John and Richard Bertoli were principal shareholders in SYS Industries Inc., a family-owned holding company, which held a majority interest in Door Openings Corp. (DOC), a publicly held corporation. John managed DOC. While Richard was president of Executive Securities Corp. (ESC)., a securities brokerage firm, he had apparently fraudulently misused clients' funds, leading to ESC's financial collapse. In 1975, a district court liquidated ESC and appointed Cameron MacRae III as trustee. On behalf of ESC, MacRae filed suit against Richard, John, SYS, and DOC, asserting that, three months after the ESC shut down, Richard had fraudulently transferred personal and corporate assets beyond the reach of creditors, whose claims exceeded $2 million. John was named as a defendant in three capacities: individually; as custodian for Richard's minor children; and as the sole general partner of Rutherford Construction Co. (RCC), the limited partnership established specifically to receive ESC's assets upon liquidation. Prior to trial, John was released as a defendant in his individual capacity. The trial court found that Richard had defrauded ESC's creditors and shareholders by transferring personal assets and DOC's assets to RCC. DOC's business was transferred to a newly formed corporation that was wholly owned by RCC. One section of the court's opinion, devoted to "'John's Fraud,'" clearly established that John had helped his brother perpetrate the fraud. To justify their actions, John and Richard claimed that the transfers from ESC to RCC were supported by adequate consideration, namely a $112,037 promissory note payable to DOC, which RCC eventually assumed. The brothers also claimed that RCC or John had assumed $412,200 of outstanding convertible debentures issued by DOC, plus accrued interest. The trial court held that the debenture assumption was not a genuine debt, because neither RCC nor John intended to honor the assumption. John appealed. The state appeals court agreed with John's contention that the lower court's decision only reached him in his capacity as custodian and as the person in control of RCC and DOC. But, the court concluded that "there was no fatal infirmity in the trial court's judgment since the limitation on [his] activities would be identical whether the judgment were worded to enjoin him individually or as custodian." Next, John filed for chapter 11 bankruptcy protection on behalf of RCC. In the bankruptcy proceedings, John alleged that RCC was responsible for satisfying the rights of the debenture holders when it assumed DOC's outstanding debentures. MacRae filed a motion to dismiss, asserting that John had filed the petition to avoid execution of the trial court's restraining order. The court granted the motion, concluding that under res judicata the restraining order should be treated as a final judgment and that John had filed the bankruptcy petition in bad faith. Concurrently, John also filed a chapter 11 petition on behalf of Richard's estate, seeking to establish that John had some enforceable rights as an individual to the property in Richard's estate. The trustee of the estate filed a motion to dismiss based on res judicata and collateral estoppel, which was denied. A U.S. district court later reversed the bankruptcy court, and the Third Circuit affirmed. Because of a restraining order issued by the trial court, John decided to write down the book value of RCC's assets from $641,425 to zero as of December 31, 1983. As a result, John and his wife claimed that RCC suffered substantial losses in 1983, and carried the resulting loss deductions forward to their 1984-87 tax returns. (Only the 1986 and 1987 years remained open and at issue.) The IRS disallowed the losses, and, in the Tax Court, moved for partial summary judgment based on issues decided by the state appeals court. Tax Court Senior Judge Arthur L. Nims III has held, first, that a state court adjudication may, in appropriate circumstances, bind parties in a federal action. Judge Nims rejected John's contention that significant differences existed between the issues raised in the state proceedings and those raised before the Tax Court. The court held that John was collaterally estopped from denying that he was a party in the state court action, finding that he had a full and fair opportunity to litigate the same issues in state court. But, Judge Nims held that he was not collaterally estopped from asserting that RCC was a partnership for federal tax purposes, finding insufficient proof that RCC was a sham to support estoppel. However, Judge Nims did hold that John was estopped from asserting that RCC was created for business purposes. The court held that John was estopped from asserting that the alleged debenture assumption by RCC and him represented genuine indebtedness, having already had an opportunity to litigate this issue. But, the Tax Court concluded that he was not estopped from arguing that the note he issued, and RCC assumed, represented genuine indebtedness, because the trial court had not decided this issue. Next, Judge Nims held that John was not collaterally estopped from asserting that he owned an interest in RCC, because the trial court's discussion on this issue was simply dicta. But, Judge Nims held that he was estopped from asserting that the transfer of DOC's assets was in the ordinary course of business or that the transfers were supported by adequate consideration.

The Tax Court has held that a state court adjudication may, in appropriate circumstances, bind parties in a federal action, and that the instant taxpayer is estopped from relitigating before the Tax Court issues that were already decided in state court.

Brothers John and Richard Bertoli were principal shareholders in SYS Industries Inc., a family-owned holding company, which held a majority interest in Door Openings Corp. (DOC), a publicly held corporation. John managed DOC. While Richard was president of Executive Securities Corp. (ESC)., a securities brokerage firm, he had apparently fraudulently misused clients' funds, leading to ESC's financial collapse. In 1975, a district court liquidated ESC and appointed Cameron MacRae III as trustee. On behalf of ESC, MacRae filed suit against Richard, John, SYS, and DOC, asserting that, three months after the ESC shut down, Richard had fraudulently transferred personal and corporate assets beyond the reach of creditors, whose claims exceeded $2 million. John was named as a defendant in three capacities: individually; as custodian for Richard's minor children; and as the sole general partner of Rutherford Construction Co. (RCC), the limited partnership established specifically to receive ESC's assets upon liquidation. Prior to trial, John was released as a defendant in his individual capacity. The trial court found that Richard had defrauded ESC's creditors and shareholders by transferring personal assets and DOC's assets to RCC. DOC's business was transferred to a newly formed corporation that was wholly owned by RCC. One section of the court's opinion, devoted to "'John's Fraud,'" clearly established that John had helped his brother perpetrate the fraud. To justify their actions, John and Richard claimed that the transfers from ESC to RCC were supported by adequate consideration, namely a $112,037 promissory note payable to DOC, which RCC eventually assumed. The brothers also claimed that RCC or John had assumed $412,200 of outstanding convertible debentures issued by DOC, plus accrued interest. The trial court held that the debenture assumption was not a genuine debt, because neither RCC nor John intended to honor the assumption. John appealed. The state appeals court agreed with John's contention that the lower court's decision only reached him in his capacity as custodian and as the person in control of RCC and DOC. But, the court concluded that "there was no fatal infirmity in the trial court's judgment since the limitation on [his] activities would be identical whether the judgment were worded to enjoin him individually or as custodian." Next, John filed for chapter 11 bankruptcy protection on behalf of RCC. In the bankruptcy proceedings, John alleged that RCC was responsible for satisfying the rights of the debenture holders when it assumed DOC's outstanding debentures. MacRae filed a motion to dismiss, asserting that John had filed the petition to avoid execution of the trial court's restraining order. The court granted the motion, concluding that under res judicata the restraining order should be treated as a final judgment and that John had filed the bankruptcy petition in bad faith. Concurrently, John also filed a chapter 11 petition on behalf of Richard's estate, seeking to establish that John had some enforceable rights as an individual to the property in Richard's estate. The trustee of the estate filed a motion to dismiss based on res judicata and collateral estoppel, which was denied. A U.S. district court later reversed the bankruptcy court, and the Third Circuit affirmed. Because of a restraining order issued by the trial court, John decided to write down the book value of RCC's assets from $641,425 to zero as of December 31, 1983. As a result, John and his wife claimed that RCC suffered substantial losses in 1983, and carried the resulting loss deductions forward to their 1984-87 tax returns. (Only the 1986 and 1987 years remained open and at issue.) The IRS disallowed the losses, and, in the Tax Court, moved for partial summary judgment based on issues decided by the state appeals court. Tax Court Senior Judge Arthur L. Nims III has held, first, that a state court adjudication may, in appropriate circumstances, bind parties in a federal action. Judge Nims rejected John's contention that significant differences existed between the issues raised in the state proceedings and those raised before the Tax Court. The court held that John was collaterally estopped from denying that he was a party in the state court action, finding that he had a full and fair opportunity to litigate the same issues in state court. But, Judge Nims held that he was not collaterally estopped from asserting that RCC was a partnership for federal tax purposes, finding insufficient proof that RCC was a sham to support estoppel. However, Judge Nims did hold that John was estopped from asserting that RCC was created for business purposes. The court held that John was estopped from asserting that the alleged debenture assumption by RCC and him represented genuine indebtedness, having already had an opportunity to litigate this issue. But, the Tax Court concluded that he was not estopped from arguing that the note he issued, and RCC assumed, represented genuine indebtedness, because the trial court had not decided this issue. Next, Judge Nims held that John was not collaterally estopped from asserting that he owned an interest in RCC, because the trial court's discussion on this issue was simply dicta. But, Judge Nims held that he was estopped from asserting that the transfer of DOC's assets was in the ordinary course of business or that the transfers were supported by adequate consideration.

Search Connectors

Retrieving Documents With a Tax Analysts’ Citation:

Field Restricted Searching:

TAXPAYER ESTOPPED FROM RELITIGATING IN TAX COURT ISSUES ALREADY DECIDED IN STATE COURT.