The Morning Star Packing Compa v. Cir

• Court: Court of Appeals for the Ninth Circuit
• Decided: December 19, 2024
• Docket: 21-71191
• Status: Unpublished

Opinion

NOT FOR PUBLICATION FILED UNITED STATES COURT OF APPEALS DEC 19 2024 MOLLY C. DWYER, CLERK U.S. COURT OF APPEALS FOR THE NINTH CIRCUIT

THE MORNING STAR PACKING No. 21-71191 COMPANY, L.P.; THE MORNING STAR COMPANY, Tax Matters Partner, Tax Ct. No. 5013-15

Petitioners-Appellants, MEMORANDUM* v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

THE MORNING STAR PACKING No. 21-71192 COMPANY, L.P.; THE MORNING STAR COMPANY, Tax Matters Partner, Tax Ct. No. 16684-16

Petitioners-Appellants,

v.

LIBERTY PACKING COMPANY, LLC; No. 21-71193 THE MORNING STAR COMPANY, Tax

* This disposition is not appropriate for publication and is not precedent except as provided by Ninth Circuit Rule 36-3. Matters Partner, Tax Ct. No. 5015-15

LIBERTY PACKING COMPANY, LLC; No. 21-71194 THE MORNING STAR COMPANY, Tax Matters Partner, Tax Ct. No. 16842-16

Appeal from a Decision of the United States Tax Court

Argued and Submitted November 19, 2024 San Jose, California

Before: GRABER, FRIEDLAND, and BUMATAY, Circuit Judges. Dissent by Judge BUMATAY.

The Morning Star Packing Company, L.P. and Liberty Packing Company,

LLC (collectively, Morning Star) appeal the Tax Court’s decision affirming the

Commissioner of Internal Revenue’s determination that Morning Star’s anticipated

2 expenses for reconditioning failed to satisfy the “fact of liability” prong of the “all

events” test. We review de novo whether a taxpayer has satisfied the “all events”

test, Gold Coast Hotel & Casino v. United States, 158 F.3d 484, 487 (9th Cir.

1998), and affirm.

Under the “all events” test, a liability is incurred, and can be recognized for

tax purposes, when “all events have occurred which determine the fact of liability

and the amount of such liability can be determined with reasonable accuracy.”

I.R.C. § 461(h)(4); see also Treas. Reg. § 1.461-1(a)(2). To satisfy the “fact of

liability” prong of the “all events” test, “the liability must be fixed, absolute, and

unconditional.” Gold Coast, 158 F.3d at 487 (internal citation omitted). “[T]he

timing of the moment in which liability [i]s fixed is essential.” Challenge Publ’ns,

Inc. v. Comm’r, 845 F.2d 1541, 1544 (9th Cir. 1988). A taxpayer may not “deduct

an estimate of an anticipated expense, no matter how statistically certain, if it is

based on events that have not occurred by the close of the taxable year.” United

States v. Gen. Dynamics Corp., 481 U.S. 239, 243–44 (1987).

Morning Star contends that the final production run of the harvest season

fixes a liability to recondition its facilities, relying primarily on its financing

agreements as the source of that obligation. We disagree.

To determine whether Morning Star’s financing agreements require Morning

Star to recondition its equipment, we refer “to contract law principles.” Giant

3 Eagle, Inc. v. Comm’r, 822 F.3d 666, 673 (3d Cir. 2016); see also Challenge

Publ’ns, 845 F.2d at 1544 (looking to the plain meaning of contract terms to

determine the taxpayer’s obligations). We therefore must “ascertain the intent of

the parties from the language of their agreement[s].” Johnston v. Comm’r, 461

F.3d 1162, 1165 (9th Cir. 2006). “Unless a different intention is manifested,” we

interpret the agreements’ language in accordance with its “generally prevailing

meaning.” Id. (quoting Restatement (Second) of Conts. § 202(3) (Am. L. Inst.

1981)).1

Morning Star’s financing agreements do not expressly require it to

recondition its equipment. But Morning Star contends that an obligation can be

inferred from the agreements’ requirement that Morning Star keep its business

property in “good condition and repair, reasonable wear and tear excepted,” “good

operating order and repair, normal wear and tear excepted,” and “good working

order and condition, ordinary wear and tear excepted.” The agreements do not

1 Some of Morning Star’s agreements state that New York law applies, while others are governed by California law. Neither party argues that the analysis hinges on the nuances of state law and, under both New York and California law, courts similarly interpret contract provisions in accordance with their plain meaning. See Ellington v. EMI Music, Inc., 21 N.E.3d 1000, 1003 (N.Y. 2014) (“The words and phrases used by the parties must, as in all cases involving contract interpretation, be given their plain meaning.” (citation and internal quotation marks omitted)); Santisas v. Goodin, 951 P.2d 399, 405 (Cal. 1998) (“The clear and explicit meaning of these provisions, interpreted in their ordinary and popular sense, unless used by the parties in a technical sense or a special meaning is given to them by usage, controls judicial interpretation.” (cleaned up)).

4 define those terms. But the plain meaning of “wear and tear” is the “[d]eterioration

caused by ordinary use.” Wear and tear, Black’s Law Dictionary, 12 ed. 2024.2

Morning Star does not dispute that its facilities’ deterioration is caused by the

ordinary use of its equipment, i.e., to process tomatoes. Thus, although Morning

Star may decide to recondition its equipment to prepare for another production

cycle, its financing agreements do not obligate Morning Star to do so under the

plain meaning of the wear and tear exceptions.3

Our interpretation also makes practical sense. If Morning Star’s lenders

needed to repossess the equipment, there is no evidence that lenders would care

whether Morning Star reconditioned the equipment; as Morning Star conceded at

oral argument, the equipment would at least need to be sterilized again after

repossession anyway. By contrast, Morning Star’s interpretation strains credulity.

2 Both New York and California courts have applied similar definitions of “wear and tear.” See Superhost Hotels Inc. v. Selective Ins. Co. of Am., 75 N.Y.S.3d 124, 126 (N.Y. App. Div. 2018) (“The dictionary definition of ‘wear and tear’ is the loss, injury, or stress to which something is subjected by or in the course of use.” (some internal quotation marks omitted)); Kanner v. Globe Bottling Co., 78 Cal. Rptr. 25, 29 (Ct. App. 1969) (holding that damage that “was attributable to the usual practice and custom of [a commercial lessee] in carrying out its business . . . constituted ‘ordinary wear and tear’”). 3 Given our interpretation of the agreements, the Tax Court did not abuse its discretion in denying Morning Star’s motions to reconsider and to reopen the record to add three complete copies of its security agreements, all of which contained identical terms regarding maintenance obligations (or lack thereof) as the agreement already in the record. See Nor-Cal Adjusters v. Comm’r, 503 F.2d 359, 363 (9th Cir. 1974); Parkinson v. Comm’r, 647 F.2d 875, 876 (9th Cir. 1981).

5 Under its interpretation, Morning Star would be in breach of its agreements for

most of the year while it waited to recondition its equipment until right before the

next production cycle—which neither Morning Star nor any of its contracting

partners has ever said is the case.

Morning Star presses that because its “facilities require between $16.7

million and $21 million in reconditioning costs to restore the facilities to the same

operating capability as prior to the start of production,” the equipment must be “in

a state of disrepair beyond mere ‘ordinary wear and tear.’” But the mere total of

Morning Star’s reconditioning costs does not suggest that its equipment is in

disrepair beyond ordinary wear and tear. Indeed, Morning Star acknowledged at

oral argument that if another truck of tomatoes arrived at its facilities right after its

last production run before production shut down for the season, it could process

those tomatoes without reconditioning. Reconditioning is therefore necessary to

prepare for the next production cycle, not to repair inoperative equipment.

Morning Star also argues that its contracts with customers suggest that it has

a fixed liability for reconditioning, but those contracts are similarly unhelpful to

Morning Star. Morning Star concedes that those contracts do “not directly require

the reconditioning costs.” Instead, Morning Star contends that its commitments to

customers provide “a high degree of certainty that the reconditioning costs would

in fact be completed.” But a high likelihood is not the same as a certain obligation.

6 Morning Star is making “a mere estimate of liability” based on its predicted future

tomato sales, which does not create a fixed liability under the “all events” test.

Gen. Dynamics, 481 U.S. at 244. Morning Star’s customer contracts therefore do

not support its position.

Because Morning Star does not satisfy the “fact of liability” prong, we need

not reach the parties’ arguments regarding other parts of the “all events” test.

AFFIRMED.

7 FILED DEC 19 2024 The Morning Star Packing Co., L.P. v. Commissioner of Internal Revenue, No. 21- MOLLY C. DWYER, CLERK 71191+ U.S. COURT OF APPEALS BUMATAY, Circuit Judge, dissenting:

The Internal Revenue Service (“IRS”) has a shocking view of taxpayers’

money. According to the IRS’s counsel at oral argument, any disagreement on when

a tax payment is due constitutes “an interest-free loan from the government” to the

taxpayer. That’s completely wrong. Simply, the income of everyday Americans is

not government property. Taxpayers do not keep their hard-earned income by the

grace of the IRS. It’s the people’s money. And so, if there is a good-faith

disagreement on how our complicated tax laws operate, the IRS doesn’t get the

presumption that the money is theirs at the time it wants it. But then, this view

explains much of what has transpired in this case.

The Morning Star Packing Company and Liberty Packing Company

(collectively “Morning Star”) are two of the largest tomato paste producers in the

United States. During its 100-day season, Morning Star runs its production facilities

at maximum capacity and operates its equipment 24 hours a day. When the season

finishes in October, its equipment is so worn out that it needs extensive

reconditioning—to the tune of up to $21 million annually. For efficiency, Morning

Star services its equipment shortly before the start of the next year’s season. But it

deducts the cost of doing so from its income in the previous year, the year in which

the equipment was worn out and the expense actually incurred. If that all sounds

1 routine, that’s because it should. In fact, Morning Star has used this method since

its founding. And the IRS had endorsed this practice—it audited Morning Star in

the early 1990s and concluded that this practice was acceptable. But now, after

allowing Morning Star’s deductions for years, the IRS changes its mind and demands

that Morning Star alter how it recognizes the reconditioning costs.

Taxpayers who, like Morning Star, use the accrual method of accounting are

allowed to “deduct expenses in the year which they are incurred, regardless of when

paid.” Gold Coast Hotel & Casino v. United States, 158 F.3d 484, 487 (9th Cir.

1998). To determine whether expenses are incurred, we apply the “all events” test.

See 26 U.S.C. § 461(h)(4). This test operates on the principle that “although

expenses may be deductible before they become due and payable, liability must first

be firmly established.” United States v. General Dynamics Corp., 481 U.S. 239, 243

(1987). And it is satisfied “with respect to any item if all events have occurred which

determine the fact of liability and the amount of such liability can be determined

with reasonable accuracy.” 26 U.S.C. § 461(h)(4). We are only concerned with the

“fact of liability” prong here.

The “fact of liability” requirement is satisfied when the liability is “fixed,

absolute, and unconditional.” Gold Coast, 158 F.3d at 487 (simplified). So this case

turns on whether Morning Star’s reconditioning expenses were fixed, absolute, and

2 unconditional when each year’s production run ended. They were. And two cases

are instructive here.

First, there’s United States v. Hughes Properties, Inc., 476 U.S. 593 (1986).

In that case, the Supreme Court determined that a casino operator could deduct

money guaranteed for payment on a progressive slot machine even though it hadn’t

been won by a gambler at the end of the year. Hughes, 476 U.S. at 595–96, 601–02.

As the Court explained, “the last play of the machine before the end of the fiscal

year” created the liability because “that play fixed the jackpot amount irrevocably”

under Nevada law, which prevented the casino from reducing the “payoff without

paying the jackpot.” Id. at 601–03. And because the liability was fixed, hypothetical

situations like the casino going out of business, entering bankruptcy, or having

customers stop gambling were irrelevant. Id. at 601. Such risk “exists for every

business that uses an accrual method, and it does not prevent accrual” because “[t]he

existence of an absolute liability is necessary; absolute certainty that it will be

discharged by payment is not.” Id. at 606 (simplified).

Second, there’s Gold Coast Hotel. There, we concluded that a casino could

deduct the value of redeemable points for the year in which a casino member

accumulated the minimum amount needed to redeem a prize, regardless of when the

points were used. See 158 F.3d at 485–89. We explained that the “liability to redeem

accumulated slot points is fixed and unconditional under state law once a slot club

3 members accumulates 1,200 points” and that “the fact a club member may choose

not to redeem his/her points immediately does not render Gold Coast’s otherwise

fixed liability conditional.” Id. at 488.

These cases stand for a straightforward principle—when liability is legally

certain, the taxpayer may deduct it from their income in the tax year in which the

liability became fixed. And the law doesn’t require the taxpayer to prove the fixed

obligation to a metaphysical certitude.

Morning Star’s liability was fixed at the end of each season’s production run.

First, a series of loan agreements requires Morning Star to maintain its equipment

“in good condition and repair, reasonable wear and tear excepted” and prevent it

from being “negligent in its care and use.” Second, a set of credit agreements directs

Morning Star to “keep all property useful and necessary in its business in good

working order and condition, ordinary wear and tear excepted” and precludes it from

defaulting on other contracts, including the first set of loan agreements. Third, a

series of agreements with its customers mandates that Morning Star provide massive

amounts of processed tomatoes over the course of several years. To comply with

these legal obligations, Morning Star must recondition its equipment at the end of

the tomato processing season.

Without restoring, rebuilding, and sterilizing the equipment after the season,

Morning Star wouldn’t be able to use the equipment again. Failing to recondition

4 the equipment would thus make Morning Star in default of its loan, credit, and

customer agreements. Non-useable equipment means it falls out of “good

condition,” diminishes its value, and precludes Morning Star from complying with

its tomato processing obligations. For example, I imagine that Morning Star’s

lenders would balk at loaning the company significant sums of money (well over

$100 million) and then having Morning Star inflict $20 million of damage to its

collateral without a duty to repair. So the last production run is a direct analogue to

the “last play” in Hughes or accumulation of 1,200 points in Gold Coast.

The majority errs by concluding that the reconditioning was “ordinary wear

and tear.” Whatever “ordinary wear and tear” means, it cannot mean damaging the

equipment to the sum of $21 million in repairs. “Ordinary wear and tear” is when

your bathroom’s tiles fade, a tire tread gets worn down, or when a door handle

becomes loose. It is not catastrophic damage that requires millions to repair.

Claiming that a recurring, $21 million expense is “ordinary wear and tear” doesn’t

pass the straight-face test.

I respectfully dissent.