During a negotiation with the Service about a case pending in Tax Court, when does the discussion cross the line from tentative agreement to binding agreement? It is very rare that the government will be bound by something other than a statement to the Court. As with most instances of line drawing, describing the things that clearly fall on either side of the line comes much easier than finding the actual crossing point. This post does not seek to discuss the settlement process in federal tax cases generally. For an excellent and in depth article on that process from a broader perspective look at the article “Settling with the IRS: The Importance of Procedure” by Ronald Stein, 2005 Tax Notes Today 123-33 (June 28, 2005).
Clearly Binding Agreements
The poster child for cases clearly creating a binding agreement is the case of Dorchester Industries Inc. v. Commissioner. The Dorchester case should have notoriety because it served as the springboard for the Service offshore effort which has so successfully identified offshore accounts. If you want more background on the case and how it led to the volunteer offshore program through which the IRS has collected billions of dollars over the past decade, you can read my article about the agent who worked the Dorchester case. Instead, the case is best known for the antics of the owner of the business after apparently reaching an agreement and the Tax Court’s response to those antics.
The taxpayer engaged in complicated offshore transactions. The examination went on for about eight years. The parties obtained a special trial session from the Tax Court because they anticipated a several week trial. On the eve of trial, the parties reached an agreement to resolve the case. The agreement principally involved a concession by the taxpayer. The parties went before the Court and told the Court they had reached a basis for settlement. The Court accepted their representation and gladly cancelled the special trial session. The Court ordered the parties to file a decision document within 30 days. The Government computed the correct tax based on the agreement of the parties and sent the decision document to petitioner. Petitioner’s owner refused to sign the decision document, or allow its counsel to do so, and the case went back before the Court. The Service moved to enforce the agreement by entry of a decision and the Court granted the motion. In doing so, Judge Halpern used strong language about the binding nature of a settlement agreement and that the settlement agreement served as a contract between the parties which the Court could enforce.
The opinion sets out the facts leading up to the agreement reported to the Court in great detail. It does not simply enter the decision without comment, but sets the scene by providing the actions of the parties prior to the moment of reporting the settlement to the Court. The factual background in Dorchester, and in any case seeking to enforce a settlement, has significance on the decision of the Court to enforce a broken agreement between the parties. The Court held an evidentiary hearing on the issues leading up to the report of settlement. The opinion recounts in great detail all of the discussions leading up to, and including, the report to the Court that the parties had reached a basis for settlement and no longer needed the scheduled special trial session. The Court then examined the actions of the parties in deciding whether these actions added up to an enforceable contract. It found:
A settlement is a contract and, consequently, general principles of contract law determine whether a settlement has been reached. A prerequisite to the formation of a contract is an objective manifestation of mutual assent to its essential terms. Mutual assent generally requires an offer and an acceptance. “An offer is the manifestation of willingness to enter into a bargain, so made as to justify another person in understanding that his assent to that bargain is invited and will conclude it.” 1 Restatement, Contracts 2d, sec. 24 (1981).
In a tax case, it “is not necessary that the parties execute a closing agreement under section 7121 in order to settle a case pending before this Court, but, rather, a settlement agreement may be reached through offer and acceptance made by letter, or even in the absence of a writing.” Settlement offers made and accepted by letters are enforced as binding agreements.
The Tax Court went on to say that “A valid settlement, once reached, cannot be repudiated by either party; and after parties have entered into a binding settlement agreement, the actual merits of the settled controversy are without consequence.”
If you attend a Tax Court calendar call, you will almost always see several cases in which the Government offers to the Court a signed stipulation of settled issues or a signed decision document with only faxed signatures. Occasionally, you will see the parties stand in front of the judge and orally explain the basis for settlement issue by issue. If signed documents get submitted to the Court by the Chief Counsel attorney, it is common that the taxpayers or their representative do not even appear. The Court accepts these documents or the oral statements of agreed issues and orders the parties to submit a signed decision document within 30 or 60 days. The Court also removes that case from the trial calendar by doing this and relieves the parties of the necessity of trial even though they have not perfectly completed the case at that point. This normal action at a trial calendar sets up almost precisely the circumstances that existed in Dorchester. If either party later tries to back out of the settlement after making that representation to the Court and after the postponement of the trial as a result of the representation, the Court will, in almost all cases, enforce the settlement reflected in the document lodged with the Court at calendar call or in the statements made by the parties. Exceptions to the enforcement of the settlement will generally only occur if a party can show a misunderstanding of the agreement or some false statement in the formation of the agreement. Several cases address these situations:
Other Eve of Trial Cases Where the Court Enforces Settlement
Clark v. Commissioner – Judge Haines faced a case similar to Dorchester with petitioners who sought to avoid having an oral statement of settlement as well as a written stipulation of settled issues become binding. Because the parties anticipated a lengthy trial, they requested and received a special trial session in San Francisco as had the petitioners in Dorchester. Before the scheduled trial date, taxpayers and counsel agreed to settlement. The parties informed the Court of the settlement in a conference call, causing the court to cancel the scheduled trial session. The parties then filed a stipulation of settled issues with the Court. The attorney for the Office of Chief Counsel sent decision documents to petitioners’ counsel. Petitioners said they disagreed with the computations but never explained why. Petitioners found some additional evidence that would have allowed them to obtain a better settlement had they found it before the filing of the stipulation of settled issues. The court found they were bound, stating that, “This Court has declined to set aside a settlement duly executed by the parties and filed with the Court in the absence of fraud, mutual mistake, or other similar ground.” Here, the petitioners found at least two issues they wanted to contest after they agreed to the settlement. First, they found an application for extension of time to file. During the settlement negotiations, the Service had stated it would concede a penalty if petitioners produced this document. Second, they noticed a duplication of rental income in the notice of deficiency. Based on these items found after they stated the basis for settlement, petitioners sought to unwind the settlement. At least they offered a concrete basis for their request, but the court rejected their request stating, “If petitioners made a mistake in agreeing to the settlement, respondent contends, and the Court agrees, it was not mutual but unilateral. This Court has previously held that a party may be bound by its agreement although it has made a unilateral mistake in the calculation of a deficiency. Petitioners have not shown that respondent committed fraud or otherwise improperly induced petitioners to agree to the offer.”
Stamm International Corporation v. Commissioner – The parties requested a special trial calendar because of the anticipated length of the trial. Before the special trial calendar, the parties contacted the Court to state that a basis of settlement was reached and this caused the cancellation of the special trial calendar. Shortly thereafter, the parties filed a memorandum of settled issues. After filing the memorandum, respondent began to see the downside of its agreement:
During a meeting on February 12, 1987, among respondent’s counsel, a revenue agent, and petitioner’s accountant, the applicability of section 959 to the calculation of the correct amount of the deficiencies was raised. Prior to this meeting, respondent’s counsel had not taken account of section 959, which, for reasons discussed below, would reduce the total amount to be paid by petitioner to approximately $1.1 or $1.25 million. Petitioner’s attorneys had discussed among themselves the effect of section 959 on the computation prior to execution of the settlement agreement, and they had been aware that respondent’s counsel was not giving effect to that section. They had not, however, discussed section 959 with respondent’s counsel or otherwise called attention to his apparent error.
As a result of realizing the failure to take into account the impact of section 959, which reduced the anticipated liability by 70%, the Service sought to reopen the settlement discussions. Petitioner refused and asked that the Court enforce the settlement. Because petitioner knew of the impact of section 959 on the settlement, the Court found that this impact was a unilateral mistake. It refused to negate the settlement based on the failure of one party to understand the computational consequences of the deal. The parties described the settlement with great specificity in their memorandum of settlement to the Court. The Court found that the settlement was not ambiguous.
At the hearing on whether to enforce the settlement, the Service argued that the agreement should be set aside 1) based on the unilateral mistake of his counsel which was known by petitioner’s counsel and 2) because the agreement did not mention the application of 959. Service did not argue that the agreement was not authorized or binding, but rather that, as a matter of contract law, it should be relieved of the agreement. The Service cited to no authority that the Court should relieve it of the settlement based on the mistake of fact. There was misleading silence by petitioner’s counsel but no overt misrepresentation.
The court notes that in Saigh v. Commissioner and other cases it unwound a settlement where “excusable damaging silence” upon a false or true representation of the other party, even one innocently made, is recognized as a ground for relief from a settlement stip. Here, the silence was the not equivalent of a misrepresentation because petitioner’s counsel had no duty to explain the Code to respondent. The Service cited Adams v. Commissioner for the position that the “primary consideration in determining whether a settlement stipulation should be set aside is whether such action is necessary to prevent manifest injustice… The determination, however, takes into account the injury to the opposing party and the inconvenience to the Court, as well as possible injustice to the moving party.” The Court points out that if a computational surprise in the amount of the deficiency by itself were a basis for overturning an agreement, petitioners [or respondent] would make this motion all the time once they received the computations and could see the tax consequences of the issue settlement. The Court also felt that a party had a very high burden to undo a settlement in the posture of this case unlike the Adams case, which involved a pre-trial motion. The case points to the need for a party, if money is the driving force – which will almost always be the case for petitioners, to calculate the dollar impact of a settlement before agreeing to the issues in a settlement stipulation filed with the Court.
The Court then looked at what the agreement meant and how to interpret it in the context of the 959 argument. If the agreement was unclear, a trial of the matter might be inevitable, even where the agreement might have otherwise been binding. The Court found that the agreement was ambiguous and indefinite; however, looking at the Code as a whole in this section, the Court concluded that the most logical reading of the agreement is to view it as allowing the application of 959 in the absence of a clear statement to the contrary. It appreciated that the Code was complex and understood the failure of respondent’s counsel to appreciate how it would work but, nonetheless, felt that the agreement included related adjustments such as the one in 959. So, the Court enforced the settlement agreement allowing petitioner to reduce the tax owed by including the 959 adjustments in the computation. Because the document providing the Court with the settlement agreement would have been reviewed by the party within the Service authorized to settle the case, the argument of lack of approval at the appropriate level was unavailable to the Service and was never made.
The Stamm case demonstrates that if either party pulls out of an eve-of-trial settlement, the Court will enforce the settlement. In submitting the settlement document to the Court, the Service will necessarily have obtained the necessary approval level for settlement. So, that argument will never really provide an effective basis for pulling out of a settlement communicated to the Tax Court.