106 T.C. No. 8
UNITED STATES TAX COURT
SHELDON R. AND PHYLLIS MILENBACH, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 28514-92, 1571-93, Filed March 28, 1996. 1572-93, 1573-93, 1574-93, 12129-94.
1 Cases of the following petitioners are consolidated herewith: Los Angeles Raiders, a California Limited Partnership, Allen Davis, Tax Matters Partner, docket No. 1571-93; Los Angeles Raiders, a California Limited Partnership, Allen Davis, Tax Matters Partner, docket No. 1572-93; Los Angeles Raiders, a California Limited Partnership, Allen Davis, Tax Matters Partner, docket No. 1573-93; Los Angeles Raiders, a California Limited Partnership, Allen Davis, Tax Matters Partner, docket No. 1574-93; and Los Angeles Raiders, a California Limited Partnership, A.D. Football, Inc., Tax Matters Partner, docket No. 12129-94. -2-
P’s were partners of the Raiders, a professional football team that received municipal funds repayable only from specific sources of revenue. The partnership also received funds from settlement of a lawsuit brought by the City of Oakland. 1. Held: Amounts received from the Los Angeles Memorial Coliseum Commission as “loans”, to be repaid from revenue received from luxury suites, are taxable when received, because the obligation to repay was not unconditional. 2. Held, further, damages received from the City of Oakland were not allocated to goodwill or franchise value and are thus taxable. 3. Held, further, income from discharge of indebtedness resulted when the agreement to build a stadium in the City of Irwindale became unenforceable. Bad debt issue also resolved.
Barrie Engel, for petitioners.
David W. Sorensen and Paul L. Dixon, for respondent.
COHEN, Judge: Respondent determined deficiencies in
Sheldon R. and Phyllis Milenbach’s Federal income taxes as
follows:
Docket No. 28514-92 Year Deficiency
1980 $2,749 1981 1,822 1982 4,499
Respondent issued notices of Final Partnership Administrative
Adjustments (FPAA’s) determining adjustments to partnership items
as follows: -3-
Docket Adjustments Other Number Year Ended to Ordinary Income Adjustments1
1573-93 12/31/83 $ 1,239,528 $ 57,386 1574-93 12/31/84 4,990,534 35,505 1571-93 12/31/85 787,108 60,442 1572-93 12/31/86 1,149,513 121,759 12129-94 12/31/87 10,029,373 100,871 12129-94 12/31/88 11,616,054 51,973 12129-94 12/31/89 11,064,920 (300) 1 The “Other Adjustments” related to respondent’s determination of adjustments in the allowable depreciation and amortization deductions in each year.
After concessions by the parties in two stipulations of
settled issues and a concession on brief by petitioners, the
issues remaining for decision are: (1) Whether $6.7 million
received from the Los Angeles Memorial Coliseum Commission during
the period 1982 through 1986 constituted taxable income to the
Los Angeles Raiders; (2) whether settlement payments received
during 1988 and 1989 from the City of Oakland constituted taxable
income to the Los Angeles Raiders; (3) whether $10 million
received from the City of Irwindale constituted taxable income to
the Los Angeles Raiders in 1987, 1988, or 1989; and (4) whether
the Los Angeles Raiders were entitled to a bad debt deduction in
1986.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. The use of the term “loan” in the Findings of Fact is -4-
for convenience and is not conclusive as to characterization for
tax purposes.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Sheldon R. and Phyllis Milenbach resided in Oakland,
California, at the time their petition was filed. Sheldon R.
Milenbach was a limited partner of the Los Angeles Raiders (the
Raiders) during 1980 through 1982. Allen Davis is the tax
matters partner for 1983 through 1986. A.D. Football, Inc., is
the tax matters partner for 1987, 1988, and 1989.
The Raiders own and operate a professional football club and
hold a franchise in and are a member of the National Football
League (NFL). During the years in issue, the Raiders' principal
places of business were Oakland, California, and Los Angeles,
California, respectively. For many years prior to 1980, the
Raiders played their professional football games at the Oakland-
Alameda County Coliseum (Oakland Coliseum) in Oakland,
California. The Raiders’ lease of the Oakland Coliseum expired
at the close of the 1979 NFL season.
Los Angeles Coliseum Agreement
During 1979, the Raiders undertook negotiations with the
management of the Oakland Coliseum to amend and extend the term
of the then-about-to-expire lease. The Raiders were also
negotiating with the Los Angeles Memorial Coliseum Commission -5-
(LAMCC) for a lease to play home games in the Los Angeles
Memorial Coliseum (LA Coliseum). On March 1, 1980, the Raiders
entered into a memorandum of agreement (1980 MOA) with the LAMCC.
This agreement provided for a $16.5-million loan to the Raiders.
Repayment was to be made in 30 equal annual payments with
interest at 7 percent. Under the terms of the 1980 MOA, the
Raiders were allowed to construct luxury suites (suites) that
they would own. The Raiders agreed to begin playing their home
games in the LA Coliseum at the start of the 1980 NFL season.
When the Raiders’ move to Los Angeles was announced, the
City of Oakland (Oakland) filed an action against the Raiders in
eminent domain seeking to condemn for public use the Raiders’ NFL
franchise, business, and physical assets. Oakland obtained a
temporary restraining order, and subsequently a preliminary
injunction, prohibiting the Raiders from relocating the team and
playing their home games anywhere but the Oakland Coliseum.
At approximately the same time the Oakland suit was filed,
the NFL filed suit against the Raiders seeking enforcement of the
NFL constitution and bylaws. The NFL claimed the Raiders were
required to obtain the necessary votes of the other NFL members
before the team could be relocated. The NFL obtained a temporary
restraining order, and subsequently a preliminary injunction,
prohibiting the Raiders from relocating the team and playing
their home games anywhere but the Oakland Coliseum. -6-
Due to the Oakland injunction and the NFL injunction, the
Raiders played their 1980 and 1981 home games at the Oakland
Coliseum pursuant to individually negotiated 1-year extensions of
the previous lease. The Oakland injunction was dissolved on
June 9, 1980; reinstated on January 3, 1983; and ultimately
dissolved on August 10, 1984. The NFL injunction was dissolved
on May 21, 1982. The 1980 MOA was never implemented.
On July 5, 1982, the Raiders entered into a memorandum of
agreement (1982 MOA) with the LAMCC. The 1982 MOA provided that
the Raiders would begin playing their home games at the LA
Coliseum in 1982 and that the LAMCC would loan the Raiders
$6.7 million, at 10-percent interest, to be advanced as follows:
$675,000 per year for the first 4 years and $4 million no more
than 5 years from July 5, 1982. The $4-million advance was to
come from one or more sources, including potential damages from
an antitrust suit against the NFL or from rental payments from
the 1984 Summer Olympic Games. The loan was to be repaid with
12 percent of net receipts from operations of suites to be
constructed by the Raiders at the LA Coliseum. As to the
construction of the suites, the 1982 MOA provided:
4. The Partnership [Raiders] shall construct or cause to be constructed the following:
(a) In the Coliseum - approximately 150 private suites, together with all appurtenant and related improvements; * * *
* * * * * * * -7-
Construction of such improvements shall commence as soon as practicable as determined by the Partnership in its reasonable discretion, having in mind pending and potential litigation involving the parties hereto, or either of them, financial considerations, and other considerations reasonably deemed important or significant to the Partnership. * * * [Emphasis added.]
Beginning with the 1982 NFL season and throughout the years
in issue, the Raiders played their home games at the LA Coliseum.
The Raiders and the LAMCC did not enter into a formal lease (1984
lease) until December 8, 1984. The 1984 lease was made
effective, however, as of the beginning of the 1982 NFL season.
The 1984 lease included provisions for the $6.7-million loan to
the Raiders on essentially the same terms as the 1982 MOA and
contained a repayment provision that was essentially the same as
the 1982 MOA repayment provision, i.e., 12 percent of net
revenues from operations of suites to be constructed by the
Raiders. All physical improvements to the LA Coliseum and the
surrounding premises, i.e., the practice facilities, were to
revert to the LAMCC upon the termination of the lease. As to the
construction of the suites, the 1984 lease provided:
7.05 Construction of the Suites and the Press Box Improvements shall commence as soon as practicable as determined by the Lessee [Raiders] in its reasonable discretion, having in mind pending and potential litigation involving the parties hereto, or either of them, financial considerations, and other considerations reasonably deemed important or significant to the Lessee. Lessee shall use its best efforts to begin and complete Suite construction as soon as possible and upon completion subject to the terms hereof, to use its best efforts to rent, lease, license, grant or otherwise deal with the same so as to -8-
maximize their use and obtain the reasonable rental value thereof. The plans and specification for the Press Box Improvements and Suites and the timing and manner of all construction at the Stadium must be approved by Lessor, which approval will not be unreasonably withheld or delayed. * * * [Emphasis added.]
The 1980 MOA, the 1982 MOA, and the 1984 lease were the
result of arm’s-length bargaining between the Raiders and the
LAMCC.
The $6.7-million loan was represented by a promissory note
dated November 30, 1984, the terms of which were as provided in
the 1982 MOA and the 1984 lease. The Raiders were to commence
repayment of the $6.7-million loan 3 years after the completion
of construction of the suites. The loan was nonrecourse against
the Raiders, secured solely by the improvements to be made. The
$6.7-million loan was funded with a $4-million advance in 1984
and by the following credits against the rent due from the
Raiders:
Year Amount
1982 $ 442,401 1983 665,690 1984 675,000 1985 675,000 1986 241,909 Total $2,700,000
During these years, the Raiders took corresponding deductions for
their rent expense.
Due to the concern of the Los Angeles Olympic Committee over
the timing of construction, plans to construct the suites prior -9-
to the 1984 Summer Olympics were abandoned. In 1985 and 1986,
the Raiders worked with architects and contractors on the design
and planning of the suites. The construction of the suites began
in early 1987 but was halted on or about February 18, 1987.
Construction was stopped due to a dispute between the Raiders and
the LAMCC over the obligations of the LAMCC to perform certain
improvements to the LA Coliseum.
The Raiders made no payments on the LAMCC loan. The Raiders
did not construct the suites at the LA Coliseum.
The LAMCC did not seek repayment of the $6.7 million until
after the Raiders signed a memorandum of agreement with the City
of Irwindale (Irwindale MOA), discussed infra. The LAMCC filed a
lawsuit against the Raiders on September 30, 1987, claiming that
the Raiders were in breach of their lease and demanding repayment
of the $6.7 million. In the Raiders’ answer to the LAMCC
complaint, the Raiders alleged:
That Raiders has not constructed the suites or the press box improvements referred to in the lease agreement because, by reason of considerations reasonably deemed important and significant to Raiders, including plaintiff’s [LAMCC’s] breach of its commitment to modernize and reconfigure the stadium as hereinafter alleged, Raiders was never under any obligation to construct the suites or press box improvements, and, Raiders has not obtained a building permit or the surety bonds referred to in the lease agreement * * * [Emphasis added.]
The lawsuit was settled on September 11, 1990, with the parties
entering into a mutual release. -10-
Respondent, in the notice of deficiency for 1982 and in the
FPAA’s for 1983, 1984, 1985, and 1986, disallowed the Raiders’
rent deductions because the rent was not currently payable and
was considered part of the “loan” from the LAMCC. In the
alternative, if the rent deductions were allowed, respondent
determined that the amount advanced under the “loan” was
includable in gross income. For 1984, respondent determined that
the additional $4-million advance was includable in the Raiders’
gross income.
City of Oakland Lawsuit Settlement
The lawsuit filed by Oakland to keep the Raiders from moving
to Los Angeles was pending for several years and ultimately was
decided in favor of the Raiders. As part of that eminent domain
lawsuit, the Raiders filed a notice of claim for damages (notice
of claim) and a Supplemental Brief in Support of Right to Seek
Damages in the Present Action (supplemental brief). The notice
of claim sought damages for Oakland’s denial of the Raiders’
“free and untrammeled possession and use of the property sought
to be condemned and thereby preempted Raiders’ full possessory
right to the enjoyment and use of the Raiders’ property”. The
Raiders also claimed that Oakland had interfered with the
Raiders’ free use and enjoyment, thus taking property without
compensation. The notice of claim enumerated several ways, in a
nonexclusive list, in which Oakland had caused the Raiders to
suffer damages, including lost revenue and increased expense, -11-
during the 2 years that the Raiders were enjoined from playing
their games in Los Angeles: (1) The expense of continued
operation of a summer training camp in Santa Rosa, California;
(2) the prevention of the establishment of a Southern California
training facility; (3) the necessity of leasing and maintaining a
practice field in both Alameda County and Los Angeles County;
(4) the prevention of the construction of suites in the LA
Coliseum, resulting in millions of dollars in lost revenue;
(5) the reduced attendance at home games at the LA Coliseum;
(6) the decrease in season ticket sales; (7) the loss of radio
revenue; and (8) the expenses associated with housing,
relocation, and transportation of the Raiders personnel. In the
supplemental brief, the Raiders based their argument for recovery
on Cal. Civ. Proc. Code sec. 1268.620 (West 1982).
On February 23, 1987, the Raiders filed a complaint in
inverse condemnation against Oakland for damages arising out of
the eminent domain action alleging that:
[Oakland] denied the Raiders the free and untrammeled possession and use of the property sought to be condemned and thereby preempted Raiders’ full possessory right to the enjoyment and use of the Raiders property; interference with Raiders free use and enjoyment also constituted a taking of an interest in Raiders’ property for which Raiders have not been compensated.
As of July 28, 1986, the Raiders claimed that the damages
sustained and yet to be sustained totaled in excess of
$26 million. -12-
At some time before April 1988, the Raiders completed an
82-page damage study that alleged total losses of $25,083,146.99
as a result of the Oakland suit. This study indicates that the
Raiders suffered the following damages: (1) Lost Olympic
committee contract revenue; (2) lost attendance income; (3) lost
food and beverage income; (4) lost merchandise income; (5) lost
game program income; (6) lost Oakland practice field revenue;
(7) lost suite income; (8) lost radio income; (9) lost per diem;
(10) lost Santa Rosa air travel revenue; and (11) lost Oakland
office rent.
On May 6, 1987, the notice of claim in the eminent domain
action and the complaint in inverse condemnation were
consolidated. On November 10, 1988, the Raiders and Oakland
settled the lawsuit. The settlement provided for $4 million plus
interest to be paid in $1-million (plus interest) installments
over 4 years. The settlement agreement recited that the
agreement was entered into by the parties for the “purpose of
settling disputed claims involving the restoration of lost
franchise value and does not constitute an admission of liability
of any party.”
In the FPAA’s for 1988 and 1989, respondent determined that
$600,000 ($1 million less $400,000 attorney's fees) in each year
constituted taxable income. -13-
City of Irwindale Agreement
On August 20, 1987, the Raiders and the City of Irwindale
(Irwindale) entered into the Irwindale MOA. The Irwindale MOA
provided that Irwindale would loan the Raiders $115 million to be
used in the construction of a stadium in Irwindale where the
Raiders would play their home games beginning with the 1992 NFL
season. Irwindale and the Raiders estimated that revenue during
the first year of the stadium’s operation would reach
approximately $24 million. The Raiders opened an Irwindale
office staffed with five to six people in 1987, and the office
remained open until some time in 1992.
On or about August 19, 1987, Irwindale advanced the Raiders
$10 million against the $115-million loan. The Raiders, in turn,
signed and delivered a $115-million nonrecourse promissory note
secured by a deed of trust. The note provided that the repayment
of the principal and interest was to be made exclusively from
stadium net revenue. In addition to the $10-million advance, the
Irwindale MOA required an additional $10 million:
to be placed in an escrow interest-bearing account within seven (7) days on behalf of the Raiders and the entire $10,000,000.00 plus interest will be paid to the Raiders upon 1) passage of the G.O. [general obligation] Bond Issue on November 3, 1987; and 2) assurance of mutually acceptable parking facilities prior to November 3, 1987.
Irwindale never deposited the additional $10 million in an escrow
account. -14-
Obstacles in the performance of the terms of the agreement
were contemplated by the Irwindale MOA, in the following
provisions:
8.5 If any obstacle is imposed by third parties (such as litigation, legislation, or failure to cooperate) it is agreed that both parties pledge good faith cooperation to overcome any such obstacle. However, these obstacles will not be construed as a tolling event for the project itself, nor will it be construed as a reason to refund any exchange of monies, nor will it be construed as a forfeiture. It is further agreed, that both parties will move forward with the project and mutually work to resolving the problem. * * *
8.6 Any third party obstacle will not excuse either party from proceeding with the project except to the extent ordered by court, e.g. an injunction.
Sections 8.5 and 8.6 did not apply to Irwindale’s obligation to
place $10 million in escrow. If Irwindale failed to fulfill its
obligations under the agreement by November 4, 1987, and that
failure was not due to third-party obstacles, the Raiders were to
be relieved of all obligations under the Irwindale MOA and were
entitled to retain $20 million, without a repayment obligation,
as consideration for the execution of the Irwindale MOA.
On September 8, 1987, the first of two lawsuits was filed to
prevent the transaction contemplated by the Irwindale MOA. A
preliminary injunction that was issued on September 30, 1987, and
ultimately a preemptory writ of mandate that was issued on
March 29, 1988, prevented further performance under the Irwindale
MOA until an environmental impact report was made concerning the
project. Under the terms of the Irwindale MOA, Irwindale was -15-
required to prepare any required environmental impact studies.
The second lawsuit was filed on October 16, 1987, and sought to
require the Raiders to return the initial $10-million advance to
Irwindale.
In an amended answer dated March 21, 1988, the Raiders
alleged: “the City of Irwindale * * * [has] paid the Raiders
$10 million pursuant to that Agreement [Irwindale MOA], and that
the Raiders are entitled to retain that money whether or not the
stadium is built.” In a Memorandum of Points and Authorities
(the memorandum) filed in response to a Motion for Summary
Judgment, Irwindale alleged: “regardless of what happens, the
Raiders are permitted to keep the $10,000,000”.
The environmental impact report was completed on January 12,
1989, and the preemptory writ of mandate was discharged on
February 17, 1989. During the time the preemptory writ of
mandate was in effect, circumstances relating to the Irwindale
MOA changed as follows: (1) Bond interest rates increased from
9 percent to more than 11 percent; (2) Los Angeles County refused
to lease Irwindale land adjacent to the proposed site to be used
for parking; (3) a second site for the stadium was required to be
selected; and (4) another environmental impact report was
required for the second site. In September 1988, the California
legislature passed a bill that prohibited Irwindale from using
general obligation bonds to construct a stadium that Irwindale
would then turn over to any private company, such as the Raiders; -16-
this law precluded Irwindale from complying with the terms of the
Irwindale MOA.
The Raiders continued to discuss various options with
Irwindale through 1990. Because general obligation bonds were no
longer an option, the later Irwindale proposals dealt mainly with
financing options. Financing alternatives included an employee
stock option plan, which was problematic due to the numerous
members of the Raiders’ front office staff who were covered by
the NFL retirement plan, and junk bonds, which the Raiders
rejected. A larger development plan that would have included a
stadium and other Raiders' facilities was also rejected by the
Raiders. One of the problems facing the Raiders in many of the
proposals was the NFL debt limitation that prevented the pledge
of the Raiders' franchise as security.
The Irwindale staff that worked on the negotiations with the
Raiders changed throughout the negotiations. On November 6,
1989, the Raiders notified Irwindale that Irwindale had not
fulfilled its commitments under the Irwindale MOA. By mid- to
late December 1989, one of the Irwindale lead negotiators
declared that the parties were back where they had started
2 years earlier. At that point, the Raiders were anticipating
approximately 4 to 6 months before a transaction could be
completed. As part of this new transaction, the Raiders would
have been expected to ensure a greater stream of revenue,
approximately $19 million per year, to repay the loan. During -17-
the first quarter of 1990, the Raiders sought a more specific
proposal from Irwindale, but none was forthcoming.
Between 1987 and 1989, the Raiders were also engaged in
negotiations with other venues for possible stadium construction
and relocation. The lawsuits arising out of the Irwindale MOA
were settled in October 1992. The Raiders were not required to
repay the initial $10 million received from Irwindale.
Bad Debt Deduction
The Raiders, for some time prior to their move to Los
Angeles, had contracted with Bob Speck Productions (Speck) for
the television and radio broadcast rights to certain games.
Speck sold the commercial time during these broadcasts to various
advertisers. By a letter dated April 9, 1986, Speck was granted
the rights to produce Raiders' broadcasts for the 1986, 1987, and
1988 NFL seasons.
Speck entered into a contract with DCA Marketing and
Promotional Services, Inc. (DCA), on May 28, 1986, that
transferred certain of Speck’s rights to produce Raiders'
broadcasts for 1986. The Raiders were not a party to this
contract. Payments due under the Speck/DCA agreement were to be
made directly to the Raiders, however.
At the end of 1986, Speck still owed $200,000 on the
agreement for the 1985 broadcast rights. Of the amounts due for
the 1986 broadcasts, $750,000 was not paid. Final payments under -18-
the agreement for the 1986 season were not due, however, until
the spring of 1987.
Jeffrey Birren (Birren), in-house counsel for the Raiders,
was involved in attempting to collect from Speck during 1986.
Birren met face to face with Speck several times during 1986 to
discuss collection. Speck, in a letter dated November 20, 1987,
disputed the amount of the remaining balance owed for the 1985
season, but Speck agreed that some amount was still owed on the
1985 contract and that approximately $200,000 was still owed on
the 1986 contract. In a letter dated December 7, 1987, the
Raiders indicated that they were still seeking collection of the
remaining balance that Speck owed from the 1985 and 1986 seasons.
The Raiders and Speck continued to do business until sometime
after 1990.
The Raiders deducted $400,000 ($200,000 due from Speck for
the 1985 agreement and $200,000 of the $750,000 due from Speck
for the 1986 agreement) as a bad debt deduction on their 1986
Federal income tax return. Respondent, in the FPAA for 1986,
disallowed the deduction because the Raiders had not established
that the debt had become worthless during 1986.
OPINION
Gross income, as used in the Internal Revenue Code, includes
all income from whatever source derived, sec. 61(a), encompassing
all “accessions to wealth, clearly realized, and over which the -19-
taxpayers have complete dominion.” Commissioner v. Glenshaw
Glass Co., 348 U.S. 426, 431 (1955). Generally, proceeds of a
loan do not constitute income to a borrower because the benefit
is offset by an obligation to repay. United States v. Rochelle,
384 F.2d 748, 751 (5th Cir. 1967); Arlen v. Commissioner, 48 T.C.
640, 648-649 (1967); see Vaughan v. Commissioner, T.C. Memo.
1994-8. Whether a particular transaction actually constitutes a
loan, however, is to be determined upon consideration of all of
the facts. Fisher v. Commissioner, 54 T.C. 905, 909 (1970).
Petitioners argue that the $6.7 million received from the
LAMCC was a loan and, therefore, not taxable income. Respondent
contends that the Raiders did not have an unconditional
obligation to repay the $6.7 million, and, thus, the Raiders had
taxable income upon receipt of the funds.
Petitioners cite Commissioner v. Indianapolis Power & Light
Co., 493 U.S. 203 (1990), in support of their argument that the
$6.7 million represented a valid debt that was not includable in
the Raiders' taxable income. In that case the Supreme Court
addressed the issue of whether deposits required to assure
payment of future bills for electric service were taxable to the
power company. The Supreme Court analyzed the control and
dominion that the power company enjoyed over the deposits in
determining that the deposits did not constitute taxable income
at the time deposited. -20-
IPL hardly enjoyed “complete dominion” over the customer deposits entrusted to it. Rather, these deposits were acquired subject to an express “obligation to repay,” either at the time service was terminated or at the time a customer established good credit. So long as the customer fulfills his legal obligation to make timely payments, his deposit ultimately is to be refunded, and both the timing and method of that refund are largely within the control of the customer. [Id. at 209.]
The Supreme Court’s reasoning does not support petitioners’
position. Under the terms of the 1982 MOA, the Raiders, the
borrower, controlled whether or not repayment of the $6.7 million
would be triggered. In contrast, in Commissioner v. Indianapolis
Power & Light Co., supra, the customer, i.e., the lender,
controlled whether or not the deposit was returned by making
timely payments of the utility bills. The Raiders, unlike the
power company, were not subject to an express obligation to repay
within the lender’s control.
The Raiders had the discretion to determine if and when the
suites would be constructed, as demonstrated by the terms of the
1982 MOA and the 1984 lease. Although both documents limited the
Raiders’ discretion by a standard of reasonableness, the
agreements gave the Raiders great latitude in the timing of
construction.
Where the performance of a party’s obligations under a
contract is subject to such party’s unlimited discretion, the
duties ostensibly imposed upon that party are illusory for income
tax purposes. See Schulz v. Commissioner, 686 F.2d 490, 494 (7th -21-
Cir. 1982), affg. T.C. Memo. 1980-568; Alterman Foods, Inc. v.
United States, 505 F.2d 873, 879 (5th Cir. 1974); Saunders v.
United States, 450 F.2d 1047, 1050 (9th Cir. 1971). While the
Raiders may well have intended to construct the suites, in the
context of the agreement, any obligation to construct the suites
was illusory.
Petitioners point out that the Raiders, under the terms of
the agreement, were to “begin and complete * * * construction as
soon as possible”; the timing of construction, however, was still
to be determined by the Raiders, in their reasonable discretion.
Planning for the suites was undertaken in 1985 and 1986 and
actual construction began and was halted in February 1987. While
construction was stopped due to a dispute between the Raiders and
the LAMCC, the Raiders at this time were contemplating their move
to Irwindale, which was represented by a formal agreement in
August 1987.
Repayment of the $6.7 million was to commence 3 years after
the construction of the suites, and repayment was to be solely
from the net revenues from suite operations. If the Raiders did
not construct the suites, which was the case, there would be no
suite revenues to use for repayment. No default or alternative
payment provision was included in the 1982 MOA, the 1984 lease,
or the promissory note. The nonrecourse promissory note was
secured only by the improvements, i.e., the suites. When the -22-
Raiders did not construct the suites, the LAMCC was without a
source for repayment.
Respondent points out that courts, including this Court,
have recognized the concept that, to be a valid debt for tax
purposes, there must exist an unconditional obligation to repay.
See, e.g., Midkiff v. Commissioner, 96 T.C. 724, 734-735 (1991),
affd. sub nom. Naguchi v. Commissioner, 992 F.2d 226 (9th Cir.
1993) (quoting Howlett v. Commissioner, 56 T.C. 951, 960 (1971)
(“Indebtedness is ‘an existing, unconditional, and legally
enforceable obligation for the payment of a principal sum.’”)).
The Raiders’ obligation to repay the LAMCC was both conditional
and contingent in these cases. Because the Raiders had the
ability to control the repayment, the Raiders’ dominion and
control over the funds at the time they received them was
sufficient to require their inclusion in the Raiders’ gross
income.
No evidence was presented to indicate that the LAMCC sought
to enforce the Raiders’ agreement to build the suites prior to
the Raiders’ announcement of their intention to move to Irwindale
in late 1987. Petitioners presented testimony of representatives
of both the Raiders and the LAMCC, purportedly to show the intent
to repay and to enforce repayment. The testimony is ambiguous
and is contradicted in many respects by documentary exhibits.
The objective manifestations of intent in this instance are more
persuasive to us. -23-
Due to the contingent nature of the Raiders’ obligation, an
unconditional and enforceable debt did not exist for tax purposes
at the times that the $4 million advance and the rent credits
were received by the Raiders from the LAMCC. Thus, we sustain
respondent’s determination that the Raiders had income in 1982,
1983, 1984, 1985, and 1986 equal to the amount of the rent
credits, and that, in 1984, the Raiders had an additional
$4 million in income from the advance made in 1984.
City of Qakland Lawsuit Settlement
Petitioners bear the burden of proving that the damages
received from Oakland in settlement of the Raiders’ claims were
not includable in taxable income. Rule 142(a); H. Liebes & Co.
v. Commissioner, 90 F.2d 932 (9th Cir. 1937), affg. 34 B.T.A. 677
(1936). Petitioners argue that the damages received were to
compensate the Raiders for damage to goodwill, and, thus, as a
return of capital, they would not be included in the Raiders’
gross income. Respondent contends that the damages were to
compensate the Raiders for lost profits, and, therefore, the
Raiders would be required to include the settlement amounts
received in 1988 and 1989 in gross income.
The parties generally agree on the legal principles that
govern the determination of this issue. “‘[W]hether a claim is
resolved through litigation or settlement, the nature of the
underlying action determines the tax consequences of the
resolution of the claim.’” Getty v. Commissioner, 913 F.2d 1486, -24-
1490 (9th Cir. 1990), revg. 91 T.C. 160 (1988) (quoting Tribune
Pub. Co. v. United States, 836 F.2d 1176, 1177 (9th Cir. 1988)).
In characterizing the settlement payment for tax purposes, we
ask: “‘In lieu of what were the damages awarded?’” Tribune Pub.
Co. v. United States, supra (quoting Raytheon Prod. Corp. v.
Commissioner, 144 F.2d 110, 113 (1st Cir. 1944), affg. 1 T.C. 952
(1943)).
Petitioners have focused on the purpose referred to in the
settlement agreement (“settling disputed claims involving the
restoration of lost franchise value”) as the basis of their
argument that the damages were for injury to goodwill. While the
stated purpose of the settlement agreement is to be considered,
courts “employ a broad approach in determining the true nature
and basis of a party’s claim.” Getty v. Commissioner, supra at
1491.
The parties in these cases have introduced several items of
evidence to show the true nature of the claim involved. The
notice of claim filed by the Raiders with Oakland states: “the
plaintiff [Oakland] has denied to defendant Raiders the free and
untrammeled possession and use of the property sought to be
condemned, viz, Raiders’ franchise in the National Football
League and has thereby itself preempted Raiders’ full possessory
rights”. The notice of claim enumerated the ways in which
Oakland had caused the Raiders to suffer damages, including lost
revenue and increased expense. -25-
The Raiders’ basis for recovery in their supplemental brief
was Cal. Civ. Proc. Code sec. 1268.620 (West 1982), which allows
property owners to recover for economic injuries suffered as a
result of the pendency of eminent domain proceedings that are
abandoned or fail. Cal. Civ. Proc. Code sec. 1268.620 (West
1982) provides in part:
If, after the defendant moves from property in compliance with an order or agreement for possession or in reasonable contemplation of its taking by the plaintiff, the proceeding is dismissed with regard to that property for any reason or there is a final judgment that the plaintiff cannot acquire that property, the court shall:
* * * * * * *
(b) Make such provision as shall be just for the payment of all damages proximately caused by the proceeding and its dismissal as to that property. [Emphasis added.]
This section allows for the recovery of all damages, not just
injury to goodwill, caused by the eminent domain proceeding.
The complaint in inverse condemnation, incorporating the
notice of claim and setting forth the inverse condemnation cause
of action, reiterated the damages stated in the notice of claim.
The November 10, 1988, agreement also settled the Raiders’
inverse condemnation claim. Inverse condemnation is not a cause
of harm, but is merely a theory or remedy for vindication of a
property owner’s cause of action against a public entity for
damage to his property. City of Mill Valley v. Transamerica Ins.
Co., 98 Cal. App. 3d 595, 600, 159 Cal. Rptr. 634, 637 (1979). -26-
The portions of an 82-page damage study produced by the
Raiders prior to April 1988 received in evidence indicate at
least 10 categories of lost revenue and increased expense
suffered by the Raiders as a result of the Oakland lawsuit. The
total loss shown by the report was $25,083,146.99.
Finally, we look to the settlement agreement entered into on
November 10, 1988. The agreement states in part: “The execution
of this Settlement Agreement by the parties is done for the
purpose of settling disputed claims involving the restoration of
lost franchise value and does not constitute an admission of
liability of any party.” Emphasis added.
In Armstrong Knitting Mills v. Commissioner, 19 B.T.A. 318
(1930), the Board of Tax Appeals considered a situation similar
to the one involved here. In Armstrong Knitting Mills, two
lawsuits, one for breach of contract and one for tortious
interference with the taxpayer’s business, were consolidated and
settled. The taxpayer did not include the settlement amount in
income but did disclose the settlement on its return. The
taxpayer contended that the settlement was for injury to
goodwill, and the Commissioner argued that the settlement was for
lost profits. The Board of Tax Appeals stated:
The amount in question was paid to the petitioner in compromise and settlement of two suits, and there is no evidence to indicate in what proportion the amount could be allocated between the actions. Also, there is no evidence to establish the specific purpose for which the money was paid, other than that it was paid as a lump sum in compromise and settlement of the -27-
litigation. Whether the amount represented damages for wrongful injury to the petitioner’s good will, or whether it represented damages for loss of profits, or indeed whether the amount was simply paid by the defendants to avoid further expense and harassment resulting from long continued litigation, does not definitely appear.
However, upon examination of the declarations in the two actions referred to, we are unable to conclude that the plaintiff there was seeking damages only for alleged injury to its goodwill. * * * [Id. at 321.]
While petitioners are not required to prove that the
settlement proceeds are clearly classifiable as what they claim
them to be, petitioners must show by a preponderance of the
evidence the merits of their claim that the settlement was
received for damage to goodwill. Getty v. Commissioner, 913 F.2d
at 1492; Rockwell v. Commissioner, 512 F.2d 882, 885 (9th Cir.
1975), affg. T.C. Memo. 1972-133. The preponderance of the
evidence here shows that the damages that the Raiders sought were
for lost profits. The 82-page damage study referred to the
damages incurred as lost revenue and lost income. The notice of
claim, which also listed alleged damages, referred to extra
expenses incurred and lost revenues. The Raiders have failed to
provide us with a basis upon which to estimate any portion of the
settlement that relates to damage to goodwill. See Bresler v.
Commissioner, 65 T.C. 182, 188 (1975) (estimation that a portion
of antitrust settlement was for injury to goodwill possible when
evidence showed business had failed as a result of the actions
from which the lawsuit arose). Therefore, respondent’s -28-
determination that the settlement proceeds received in 1988 and
1989 are includable in gross income will be sustained.
Respondent contends that a valid debt did not exist with
regard to the Irwindale MOA. Respondent asserts that the Raiders
had no obligation to repay the initial $10-million advance unless
Irwindale was successful in funding the remainder of the loan by
certain deadlines. Furthermore, respondent points to the
provision for repayment solely from a percentage of the profits
from the stadium as further evidence that the obligation to repay
was conditional.
Under the terms of the Irwindale MOA, the Raiders did not
control whether or not the $10 million would be repaid.
Irwindale was required under the Irwindale MOA to provide sites
for the stadium and other Raiders' facilities and to provide full
funding of the loan. Otherwise, the Raiders would be relieved of
their obligation to repay the initial advance. Unlike the LAMCC
loan, the advance was not under the Raiders' complete dominion
and control at the time the Raiders received the $10 million.
See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
If Irwindale had provided the additional $105 million to the
Raiders, under the terms of the Irwindale MOA, those funds would
have been used to construct the stadium and other Raiders'
facilities in Irwindale, as well as to facilitate the move of the
Raiders' personnel to Irwindale. Respondent’s argument that the -29-
advance did not constitute a loan because the repayment was to
come solely from the stadium net revenues is not persuasive.
Respondent argues that there is no evidence that the stadium, if
built, would have generated sufficient income to repay the
$10 million. Estimates during the Irwindale negotiations,
however, indicated that revenues during the first year of the
stadium’s operation would be approximately $24 million.
Alternatively, respondent argues that petitioners had income
in 1987, 1988, or 1989, as a result of the Raiders' being
discharged of their obligation to repay Irwindale. Petitioners
contend that the Raiders’ obligation to repay was not discharged
in 1987, 1988, or 1989 because the Raiders and Irwindale
continued in their negotiations until at least 1990,
contemplating the repayment of the initial $10-million advance.
In general, gross income includes all income from whatever
source derived, including income from the discharge of
indebtedness. Sec. 61(a)(12). The gain to the debtor from such
discharge is the resultant freeing up of his assets that he would
otherwise have been required to use to pay the debt. See United
States v. Kirby Lumber Co., 284 U.S. 1 (1931).
Respondent has alleged several events that she claims
constitute a discharge of the Raiders’ obligation to repay in
1987, 1988, or 1989. -30-
Respondent argues that, if the $10 million was received as a
loan on August 19, 1987, the obligation to repay was immediately
terminated by the terms of the agreement on August 20, 1987.
This argument appears to be merely a reprise of the argument that
we have rejected above, i.e., that the “contingency” of repayment
(the full financing of the transaction) discharged the obligation
to repay. Respondent also argues that Irwindale’s failure to
deposit $10 million in escrow within 7 days of the signing of the
agreement (by August 27, 1987) terminated the Raiders’ obligation
to repay.
Petitioners argue that the escrow requirement was waived to
the extent that the timing of the second $10-million advance was
delayed. Allen Davis and Birren testified at trial, without
contradiction, that the escrow requirement had been waived by the
Raiders in the hope that the stadium deal would work. Their
testimony further shows that the Raiders intended to move to
Irwindale, and the waiver of the escrow deposit was a logical
response by the Raiders to facilitate the deal.
Respondent argues that Irwindale’s failure to prepare and
file the environmental impact report and to pass the general
obligation bond issue by November 4, 1987, terminated the
Raiders’ obligation to repay. The preliminary injunction that
was issued on September 30, 1987, prohibited the transfer of any
funds held in trust and participation in the bond measure -31-
election until the environmental impact report was performed.
Although the terms of the Irwindale MOA required Irwindale to
complete the environmental impact study, the injunction
prohibited the Raiders and Irwindale from continuing in the
implementation of the Irwindale MOA. By the terms of the
Irwindale MOA, third-party obstacles, such as the preliminary
injunction, did not excuse performance; therefore, the Raiders’
obligation to repay the loan was not discharged in 1987.
Respondent argues that, by their statements in pleadings
filed in the lawsuits designed to stop this project, the Raiders
and Irwindale admitted that the Raiders were entitled to retain
the $10 million without obligation. In the amended answer dated
March 21, 1988, the Raiders alleged that the Raiders were
entitled to retain that money whether or not the stadium was
built. Irwindale conceded the right of the Raiders to keep the
$10 million “regardless of what happen[ed]”.
Legislation enacted in September 1988, by its terms,
prohibited the implementation of the Irwindale MOA. Although
negotiations continued after September 1988, those negotiations
were not conducted under the Irwindale MOA. At trial, Birren
admitted that the legislation precluded Irwindale from complying
with the terms of the MOA. General obligation bonds could not be
issued to construct a stadium that Irwindale would then turn over
to any private company, such as the Raiders. The parties to the -32-
Irwindale MOA and the Irwindale MOA, by its own terms, did not
contemplate any type of financing other than general obligation
bonds, as shown by the negotiation problems that arose after the
legislation was passed. None of the alternative financing
proposals was acceptable to the parties.
Under the terms of the Irwindale MOA, Irwindale and the
Raiders pledged to work in good faith to overcome any third-party
obstacle. Although the Raiders and Irwindale continued to
negotiate toward an agreement, they were not bound by the terms
of the Irwindale MOA that could not at that time be legally
implemented. The Raiders were relieved of their obligation to
repay the initial $10-million advance in 1988 and thus must
recognize discharge of indebtedness income in that year.
Because we have determined that the Raiders had income
during 1988 resulting from discharge of indebtedness, we do not
address respondent’s alternative argument that petitioners had
income arising from the Raiders' being discharged of indebtedness
during 1989.
Section 166(a) provides that a taxpayer may deduct any debt
that becomes wholly or partially worthless within the taxable
year. The parties do not dispute the existence of a bona fide
debt between the Raiders and Speck, but, instead, they disagree
as to whether any portion of the Speck debt became worthless
during 1986. -33-
Petitioners bear the burden of proving that the Speck debt
became worthless within the 1986 taxable year. Rule 142(a);
Rockwell v. Commissioner, 512 F.2d 882 (9th Cir. 1975), affg.
T.C. Memo. 1972-133; Crown v. Commissioner, 77 T.C. 582, 598
(1981). Specifically, petitioners must prove that the debt had
value at the beginning of the taxable year and that it became
worthless during that year. Estate of Mann v. United States, 731
F.2d 267, 275 (5th Cir. 1984); American Offshore, Inc. v.
Commissioner, 97 T.C. 579, 593 (1991).
There is no standard test or formula for determining
worthlessness within a given taxable year. Crown v.
Commissioner, supra at 598. The determination depends upon the
particular facts and circumstances of the case. Generally,
however, the year of the worthlessness is fixed by identifiable
events that form the basis of reasonable grounds for abandoning
any hope of recovery. United States v. S. S. White Dental
Manufacturing Co., 274 U.S. 398 (1927); American Offshore, Inc.
v. Commissioner, supra at 593; Crown v. Commissioner, supra at
598; Dallmeyer v. Commissioner, 14 T.C. 1282, 1292 (1950).
Worthlessness is determined primarily by objective standards.
American Offshore, Inc. v. Commissioner, supra at 594; Perry v.
Commissioner, 22 T.C. 968, 973 (1954).
The amounts due from Speck under the 1985 agreement were
overdue, but the fact that accounts are overdue, standing alone,
does not warrant deducting them as worthless. See Shippen v. -34-
Commissioner, 30 T.C. 716, 727 (1958), revd. and remanded on
other grounds 274 F.2d 860 (5th Cir. 1960); Eastern New Jersey
Power Co. v. Commissioner, 37 B.T.A. 1037, 1040 (1938); Chicago
Ry. Equip. Co. v. Commissioner, 4 B.T.A. 452, 459 (1926). The
payments due under the 1986 agreement were not due, however,
until the spring of 1987. The Raiders’ collection efforts in
1986 consisted mainly of Birren's speaking with Bob Speck on
several occasions about the debt's being overdue. In
November 1987, Speck acknowledged that money was still owed under
the 1985 and 1986 agreements and stated his intent to pay the
remaining balance before the end of 1987. The Raiders sought
collection of the total amounts owed by Speck until at least
December 1987.
While Birren’s testimony indicated that Speck’s advertisers
had been slow in paying in 1986, Birren did not indicate that
Speck’s advertisers did not or were not going to pay. Birren
also stated that DCA had not paid pursuant to its agreement with
Speck. The subjective opinion of Birren alone that Speck’s debt
was uncollectible is insufficient to prove worthlessness. See
Fox v. Commissioner, 50 T.C. 813, 822 (1968); Newman v.
Commissioner, T.C. Memo. 1982-61.
On brief, petitioners argue that “The regulations do not
require the filing of a suit for collection as a condition to the
bad debt deduction”, but petitioners ignore the remaining portion -35-
of the pertinent regulation. Sec. 1.166-2(b), Income Tax Regs.,
provides:
(b) Legal action not required. Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for purposes of the deduction under section 166.
Petitioners did not produce any evidence at trial that would
indicate that, if the Raiders had instituted collection
proceedings, the result would not have been the satisfaction of
execution on the judgment.
The Raiders continued to do business with Speck until
sometime after 1990. While the mere continuation of business
with Speck is not determinative of the debt’s worth, it is a
factor to be considered. See, e.g., Record Wide Distrib., Inc.
v. Commissioner, T.C. Memo. 1981-12, affd. 682 F.2d 204 (8th Cir.
1982).
Petitioners have failed to show any identifiable event that
would have formed the basis for reasonably abandoning any hope of
recovery of $400,000 of the Speck debt in 1986. Respondent’s
disallowance of the bad debt deductions is sustained.
To reflect the foregoing and concessions of the parties,
Decisions will be entered
under Rule 155.