DIEBOLD FOUNDATION, INC., Transferee, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
Docket No. 12-3225-cv.
United States Court of Appeals, Second Circuit.
Argued: April 15, 2013. Decided: Nov. 14, 2013.
739 F.3d 172
Second, as we observe in our accompanying opinion, reassignment is an ordinary tool used by our judicial system to maintain and promote the appearance of impartiality across the federal courts.15 We recognize that it is frustrating to work extensively on a case that is later reassigned, and that reassignment, even if only based on an appearance of partiality, is a displeasing occurrence for any district judge, particularly for a long-serving and distinguished one such as Judge Scheindlin, but we are confident that these matters will be ably handled, without any arguable appearance of partiality, by another of her capable colleagues.
CONCLUSION
For the foregoing reasons, we DENY Judge Scheindlin‘s motion to appear in this Court in support of retaining authority over these cases.
parties to raise the issues at an appropriate point in the proceedings without being forced to address them in the context of an unseemly dispute among judges.
Respectfully,
Burt Neuborne
(Counsel of Record)
Norman Dorsen
Arthur R. Miller
Judith Resnik
Frederick A.O. Schwarz
Amici Counsel to the District Judge
cc: all interested counsel
A. Duane Webber (Phillip J. Taylor, Summer M. Austin, Mireille R. Zuckerman, Baker & McKenzie LLP, Washington, DC, Jaclyn Pampel, Baker & McKenzie LLP, Chicago, IL, on the brief), Baker & McKenzie LLP, Washington, DC, for Petitioner-Appellee.
Before: POOLER, DRONEY, Circuit Judges, SEIBEL,* District Judge.
POOLER, Circuit Judge:
The Commissioner of Internal Revenue (“Commissioner“) appeals the decision of the United States Tax Court (Joseph Robert Goeke, J.) holding that the Diebold Foundation, Inc. (“Diebold“), could not be held liable as a transferee of a transferee under
BACKGROUND
I.
This case involves shareholders who owned stock in a C Corporation (“C Corp“), which in turn held appreciated property. Upon the disposition of appreciated property, taxpayers generally owe tax on the property‘s built-in gain—that is, the difference between the amount realized from the disposition of the property and its adjusted basis.
When shareholders who own stock in a C Corp that in turn holds appreciated property wish to dispose of the C Corp, they can do so through one of two transactions: an asset sale or a stock sale. In an asset sale, the shareholders cause the C Corp to sell the appreciated property (triggering the built-in gain tax), and then distribute the remaining proceeds to the shareholders.1 In a stock sale, the shareholders sell the C Corp stock to a third party. The C Corp continues to own the appreciated assets and the built-in gain tax is not triggered. In other words, in an asset sale, because C Corps are treated as separate legal entities for tax purposes, subject to corporate tax (independent of any capital gain taxes assessed against the earning shareholders), a C Corp‘s sale of its assets imposes an additional tax liability. While the C Corp, and not the shareholders, pays this tax liability, such payment nonetheless reduces the amount of cash available for distribution to those shareholders.
In the case of a stock sale, the assets remain owned by the C Corp and the tax on the built-in gain is not triggered. Buyers would generally prefer to purchase the assets directly and receive a new basis equal to the purchase price, thus eliminating the built-in gain. Sellers generally disfavor the sale of assets because of the attendant tax liability and would prefer to sell the stock and move the tax liability on to the purchaser. However, the seller‘s preferred transaction merely pushes the tax liability down the line; at any point when the shareholders of the C Corp—including new owners who purchased the shares in a stock sale—wish to sell the assets, the built-in gain tax will be triggered. Because of this accompanying tax liability, a stock sale will generally merit a lower sale price than an asset sale.
“Midco transactions” or “intermediary transactions” are structured to allow the parties to have it both ways: letting the seller engage in a stock sale and the buyer engage in an asset purchase. In such a
II.
Double D Ranch, Inc., (“Double D“), a personal holding company, taxed as a C Corp,
By 1999, Mrs. Diebold and her three children were “anxious” for her to begin making cash gifts to them, but the Marital Trust was insufficiently liquid for her to make such gifts. The other trustees, Power of Bessemer and Bisset, explained to Mrs. Diebold that the best way to make such gifts would be to sell the shares of Double D. Power knew that liquidating the assets of Double D would incur the substantial tax consequences discussed above because of the low tax basis of the assets. Power discussed with “a whole network of people, for months,” whether there “were potential purchase[r]s for a corporation like Double D.” Power engaged senior staff members at Bessemer as well as lawyers in other trust companies, identifying the illiquidity of the trust and the attendant tax consequences as “a problem,” and asking, “What‘s the possible solution? How do we sell this?” Among those with whom Power consulted was Richard Leder, an attorney at Chadbourne & Parke and Bessemer‘s “principal outside tax counsel.” Identifying the steep tax liability inherent in the assets held by Double D, Leder testified, “it was generally known ... in that profession that there were ... some people, who for whatever reason, whatever their tax activities are, were able to make very favorable offers to sellers with stock with appreciated assets ... with the corporation having appreciated assets.” Leder directed Power to one of these “people” in the form of Harry Zelnick of River Run Financial Advisors, LLC (“River Run“). Power also sought out Stephen A. Baxley, a managing director at Bessemer, who referred him to Craig Hoffman at Fortrend International LLC (“Fortrend“).
The trustees of the Marital Trust and the Directors of Diebold New York each decided that their respective entity would sell all of its Double D stock. Power was primarily responsible for implementing the decision to sell Double D. On May 26, 1999, Power, Baxley, Leder, and two other attorneys, acting as representatives of the Shareholders, met with Zelnick of River Run and Ari Bergmann, a principal at Sentinel Advisors, LLC (“Sentinel“), a small investment banking firm specializing in “structuring economic transactions to solve specific corporate or estate or accounting issues.” At this meeting, the Shareholder representatives, Zelnick, and Bergmann discussed methods for valuing Double D‘s AHP stock and alternatives for
Several days after the meeting with River Run and Sentinel, the Shareholder representatives met with Craig Hoffman and Howard Teig of Fortrend to discuss the sale of Double D. According to Leder, tax attorney to the Bessemer Trust, he was familiar with Fortrend because he “had represented a seller of stock in another transaction where the buyer had arranged to have [Fortrend] participate in the purchase.” Fortrend provided Bessemer with a firm profile that detailed its strategy entitled the “Buy Stock/Sell Assets Transaction.” Identifying the tax liabilities endemic to selling a corporation with appreciated assets, Fortrend presented its expertise as follows: “We are working with various clients who may be willing to buy the stock from the seller and then cause the target corporation to sell its net assets to the ultimate buyer. These clients have certain tax attributes that enable them to absorb the tax gain inherent in the assets.”
The Shareholder representatives chose to pursue the transaction with Sentinel instead of with Fortrend, and Sentinel sent them an initial term sheet, laying out the preliminary details of the transaction, on June 8, 1999. Sentinel intended to use a newly formed entity, Shap Acquisition Corporation II (“Shap II“), specifically created to carry out the transaction. Power informed the Shareholders that Sentinel would purchase all of the shares of Double D, from both the Marital Trust and from Diebold New York, for a price that “works out to 97% of the market value of the Corporation‘s assets.” Had the Shareholders sold the assets directly, the tax liability would have caused the Shareholders to realize an amount that worked out to approximately 74.5% of the assets’ market value, a clear reduction from that negotiated with Shap II. On June 10, 1999, Mrs. Diebold approved of the sale and directed Power to go forward with it. On June 17, 1999, Shap II and the Shareholders executed a letter of intent and term sheet specifying that Shap II would purchase all issued and outstanding Double D Stock for cash in an amount equal to the value of Double D‘s assets minus a discount of 4.5% of the built-in gain.4
Sentinel intended to purchase the Double D stock through Shap II with financing from Rabobank. Even prior to taking ownership of the Double D stock, Sentinel planned on having Shap II immediately sell Double D‘s securities portfolio, as it intended to use the proceeds of that sale to repay the loan from Rabobank. Rabobank provided financing on the condition that Shap II enter into a fixed price contract to sell the securities, with the purchase price to be paid directly to Rabobank, pursuant to an irrevocable payment instruction. Rabobank understood that the loan would be outstanding for “not more” than five business days, as that was the “longest settlement period” for the securities to be liquidated. Sentinel determined that the securities would be sold to Morgan Stanley.
While it is not clear that the Shareholders knew the details behind Sentinel‘s financing plan, the Shareholder representatives did indeed have notice that Shap II planned to sell Double D‘s securities to Morgan Stanley, based upon the draft of the stock purchase agreement drawn up to execute the stock sale between the Marital Trust and Diebold New York, on the one hand, and Shap II, on the other, which (1) indicated that certain limitations within the agreement would not apply to sale arrangements Shap II already had with Morgan Stanley, (2) held the selling shareholders liable for any costs incurred upon termination in “connection with arrangements for the sale of the Securities by [Double D] following the Closing,” and (3) indicated that the agreement‘s prohibition on assignments of rights would not apply to Shap II assigning its rights “to Morgan Stanley as collateral security for [Shap II‘s] obligation to deliver the Securities to Morgan Stanley following the closing for purposes of resale.” These specific provisions were altered by the Shareholders’
After these negotiations, Shap II and the Shareholders executed their stock purchase agreement on June 25, 1999, setting a closing date of July 1, 1999. The agreement also required Shap II to cause Double D to execute an option agreement on the Connecticut farm “immediately” after the closing. This agreement was structured as one between Double D and Toplands Farm, Dudley Diebold‘s entity, giving Toplands the option to purchase the farm for $6.3 million. Also on June 25, Shap II and Morgan Stanley entered into a contract wherein Shap II agreed to sell the securities held by Double D to Morgan Stanley after the closing date. This agreement mandated the use of the exact same valuation method for the securities as did the agreement between Shap II and the selling Shareholders. The agreement between Morgan Stanley and Shap II was slated to be executed on July 1, 1999—the same day for which the closing between Shap II and the shareholders was originally scheduled.
On June 30, 1999, Dudley Diebold, acting as manager of Toplands Farm, executed the option agreement to purchase Double D‘s Connecticut real estate. The agreement, which was to then be executed by Double D “immediately” after the closing, gave Toplands Farm the right to purchase through July 31, 1999. At the same time, Dudley Diebold executed an occupancy agreement that set forth terms allowing Toplands Farm to take possession of the property on July 1, 1999, including requirements that it maintain liability insurance and take responsibility for all utilities and taxes beginning on that date.
The closing between Shap II and Double D was delayed from July 1, 1999, to July 2, 1999. As the closing did not occur as originally scheduled, Shap II could not transfer the securities to Morgan Stanley on July 1, as mandated by the agreement between Shap II and Morgan Stanley. By its terms, Shap II‘s agreement with Morgan Stanley obligated Shap II to deliver equivalent securities or their cash equivalent to Morgan Stanley in the event the Double D transaction did not occur on July 1, 1999. As it turned out, however, Morgan Stanley did not require this from Shap II. Power contacted Tim Morris, the head of Bessemer‘s investment department, who contacted John Mack, a very senior officer at Morgan Stanley. Following Morris‘s call to Mack, Morgan Stanley “backed off” from demanding securities or their cash equivalent from Shap II. Shap II and Double D then closed, a day delayed from the originally set date. Morgan Stanley “backed off” by agreeing to change its settlement date with Shap II to July 6, 1999, the first business day after the July 2, 1999 closing date. Thus, the two agreements—one between Double D and Shap II and the other between Shap II and Morgan Stanley—were both amended to change their closing dates and the date on
On July 2, 1999, both parties to the stock sale of Double D took steps to carry out the transaction. The selling Shareholders opened an account at Rabobank for the receipt of Double D‘s cash holdings. The Marital Trust, Diebold New York, and Bessemer executed an agreement with Rabobank in which the bank agreed to waive any of its possible set-off rights against the account. Under such an agreement, Rabobank could not apply any of the money from that account to satisfy Shap II‘s obligation to pay its loan to the bank. Also on July 2, in executing the closing, Rabobank credited over $297 million to Shap II‘s account per the loan agreement, and Shap II paid $297 million to the Shareholders, with further adjustments to be paid shortly thereafter. The Shareholders transferred their stock shares to Shap II, and Bessemer wired Double D‘s cash holdings from the account at Bessemer to the newly created account at Rabobank.
On the same day, Double D instructed Bank of New York to transfer the securities in Double D‘s account to Morgan Stanley on July 6, 1999. This was an irrevocable transfer agreement—between Bessemer, Double D, and Shap II—to transfer custody of Double D‘s assets to Shap II‘s Morgan Stanley account and “to not honor any other request or instruction which would cause Bessemer to be unable to make such a transfer.” Shap II also directed Morgan Stanley to transfer over $258 million into its loan account at Rabobank on July 6 and irrevocably instructed Rabobank to pre-pay its loan obligation with any amounts transferred into that account.
On July 6, 1999, Bessemer and Bank of New York delivered the securities in Double D‘s accounts to Shap II‘s Morgan Stanley accounts. As to these transferred securities, which represented approximately 97% of the total value of Double D‘s securities, Morgan Stanley recorded a trade date of July 2, 1999, and, with the exception of one security, a settlement date of July 6, 1999. Also on July 6, Morgan Stanley wired over $297 million from Shap II‘s Morgan Stanley account to Shap II‘s loan account at Rabobank, and Bessemer wired the funds transferred by Shap II pursuant to the closing to the Marital Trust and Diebold New York, in proportion to the amount of stock in Double D each owned. On July 9 and 12, 1999, Shap II paid the Shareholders the additional purchase price adjustments, bringing the total amount paid by Shap II to approximately $309 million. Bessemer distributed these funds to the Marital Trust and Diebold New York on July 12. Bessemer made an additional distribution of $15.7 million to the selling Shareholders on November 8, 1999.
Also pursuant to the closing on July 2, the option agreement regarding the sale of the Connecticut real estate was executed. Toplands Farm paid $1,000 for the option to purchase. Subsequently, Toplands Farm made a down payment to Shap II for the farm on July 28, 1999, and paid the purchase price in full on August 27, 1999.
The transaction described above had the form of a Midco transaction with Shap II in the role of the Midco. The Shareholders sold the Double D stock for approximately $309 million in cash. Morgan Stanley and Toplands Farm purchased, respectively, Double D‘s securities and real property. Shap II received approximately $319 million from the asset sale. Because it claimed losses sufficient to offset the built-in gain, it did not pay any tax on this
Pursuant to a dissolution, effective on January 29, 2001, Diebold New York distributed all of its assets in equal shares to three foundations, each one headed by one of the adult Diebold children: the Diebold Foundation (“Diebold“), Appellee in the instant case, the Salus Mundi Foundation, and the Ceres Foundation. These transfers, of approximately $33 million each, were not made in exchange for any property or to satisfy an existing debt. On March 26 and April 15, 2004, Bessemer distributed an additional $5.6 million from the escrow account used for the sale of Double D to the Marital Trust and to each of the successor foundations of Diebold New York.
III.
The parties to this Midco transaction all filed tax returns. The Shareholders filed timely returns reflecting their sale of Double D stock. Double D filed a corporate return for a short taxable year, beginning July 1, 1999, and ending July 2, 1999, and dissolved. Double D‘s asset sales were not included in this return. On its tax return for the taxable year ending June 30, 2000, Shap II filed a consolidated return with Double D, on which it reported all of Double D‘s built-in gain from its asset sales. On this return, Shap II claimed sufficient losses to offset the gain, resulting in no net tax liability.5
On March 10, 2006, the IRS issued a notice of deficiency against Double D, determining a deficiency of income tax, penalties, and interest of approximately $100 million for its July 2, 1999 taxable year. The deficiency resulted from the IRS‘s determination that the Shareholders sale of Double D stock was, in substance, actually an asset sale followed by a liquidating distribution to the Shareholders. Double D did not contest this assessment, but the IRS was unable to find any Double D assets from which to collect the liability.
Deciding that any additional efforts to collect from Double D would be futile, the Commissioner attempted to collect from the Shareholders as transferees of Double D. Section 6901 of the Internal Revenue Code authorizes the assessment of liability against both (a) transferees of a taxpayer who owes income tax and (b) transferees of transferees.
DISCUSSION
I.
In an appeal from the Tax Court, it is without dispute in this Circuit that we review legal conclusions de novo and findings of fact for clear error. Robinson Knife Mfg. Co. v. Comm‘r, 600 F.3d 121, 124 (2d Cir. 2010). While we have previously held the standard of review for mixed questions of law and fact to be one for clear error, see Wright v. Comm‘r, 571 F.3d 215, 219 (2d Cir. 2009), all Courts of Appeals are to “review the decisions of the Tax Court ... in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury.”
The standard that mixed questions of law and fact are reviewed under a clearly erroneous standard when we review a decision of the Tax Court was established in this Circuit‘s jurisprudence in Bausch & Lomb Inc. v. Comm‘r, 933 F.2d 1084, 1088 (2d Cir. 1991). Bausch & Lomb imported the standard from the Seventh Circuit, which, in Eli Lilly & Co. v. Comm‘r, 856 F.2d 855, 861 (7th Cir. 1988), held the clearly erroneous standard to be applicable. Eli Lilly in turn relied upon another Seventh Circuit case, Standard Office Bldg. Corp. v. United States, 819 F.2d 1371, 1374 (7th Cir. 1987), a tax case on review from the district court. None of these decisions mention
Quoting Eli Lilly approvingly, in Bausch & Lomb, this Court indicated, “We are unaware of any decision discussing the standard that governs appellate review of a Tax Court‘s [determination].” Bausch & Lomb, 933 F.2d at 1088 (quoting Eli Lilly, 856 F.2d at 860-61). It was certainly the case that no decision at that time discussed the standard for such appellate review, but the statute which governs our Court‘s review of Tax Court decisions set out a mandatory standard, tied to the level of review in appeals on review from a district court.
We now conclude that this standard of review was adopted in error.7 As all Article III courts, with the exception of the Supreme Court, are solely creatures of statute, see
II.
Title 26, Section 6901 of the United States States Code provides that the IRS may assess tax against the transferee of assets
The Supreme Court has long held that this section “neither creates nor defines a substantive liability but provides merely a new procedure by which the Government may collect taxes.” Comm‘r v. Stern, 357 U.S. 39, 42 (1958) (discussing the predecessor transferee liability statute under the Internal Revenue Code of 1939,
The Commissioner urges that these two prongs are not independent—that a court must first make a determination as to whether the party in question is a transferee, looking to the federal tax law doctrine of “substance over form” to recharacterize the transaction, and that if a court recharacterizes the transaction, when it proceeds to the second prong to make the determination of state law liability, it must assess liability with respect to the recharacterized transaction. Under this formulation, the order in which the two prongs are assessed is critical to the determination of the case. In contrast, Diebold argues that the two prongs of
The Tax Court accepted Diebold‘s understanding of the two-prong framework and stated that “[t]he law of the State where the transfer occurred ... controls the characterization of the transaction.” Under the NYUFCA, a party seeking to recharacterize a transaction must show that the transferee had “actual or constructive knowledge of the entire scheme that renders [its] exchange with the debtor
A.
The First and the Fourth Circuits have both recently addressed the relationship between the transferee prong and the liability prong of
In Stern, the Supreme Court recognized that the predecessor statute to
In the instant case, if there was not a “conveyance” under the NYUFCA, a de-
B.
The NYUFCA defines a “conveyance” as “every payment of money, assignment, release, transfer, lease, mortgage or pledge of tangible or intangible property, and also the creation of any lien or incumbrance.”
“It is well established that multilateral transactions may under appropriate circumstances be ‘collapsed’ and treated as phases of a single transaction for analysis under the UFCA.” HBE Leasing, 48 F.3d at 635 (citing Orr v. Kinderhill Corp., 991 F.2d 31, 35-36 (2d Cir. 1993)). HBE Leasing describes a “paradigmatic scheme” under this collapsing doctrine as one in which one transferee gives fair value to the debtor in exchange for the debtor‘s property, and the debtor then gratuitously transfers the proceeds of the first exchange to a second transferee. The first transferee thereby receives the debtor‘s property, and the second transferee receives the consideration, while the debtor retains nothing. Id. Such a transaction can be collapsed if two elements are met. “First, in accordance with the foregoing paradigm, the consideration received from the first transferee must be reconveyed by the [party owing the liability] for less than fair consideration or with an actual intent to defraud creditors.” Id. “Second, ... the transferee in the leg of the transaction sought to be voided must have actual or constructive knowledge of the entire scheme that renders her exchange with the debtor fraudulent.” Id.8 Here, it is clear that the first element is met. Though the transaction in the instant case has an additional wrinkle—namely, an additional party who serves as the conduit
While under an application of
Therefore, we must now assess whether the Shareholders had actual or constructive knowledge of the entire scheme. The Tax Court concluded they did not. This assessment is a mixed question of law and fact, assessing whether based upon the facts as determined by the Tax Court, the Shareholders had constructive or actual knowledge as a matter of law. Therefore, we review de novo the Tax Court‘s determination that the Shareholders did not have constructive knowledge, but review for clear error the factual findings that underpin the determination.
Concluding that a party had constructive knowledge does not require a showing that the party had actual knowledge of a scheme; rather, it is sufficient if, based upon the surrounding circumstances, they “should have known” about the entire scheme. HBE Leasing, 48 F.3d at 636 (internal quotation marks omitted). Constructive knowledge in this context also includes “inquiry knowledge“—that is, where transferees “were aware of circumstances that should have led them to inquire further into the circumstances of the transaction, but ... failed to make such inquiry.” Id. As we noted in HBE Leasing, “[t]here is some ambiguity as to the precise test for constructive knowledge,” id. at 636, in that some cases require “the knowledge that ordinary diligence would have elicited,” see United States v. Orozco-Prada, 636 F. Supp. 1537, 1543 (S.D.N.Y. 1986), aff‘d, 847 F.2d 836 (table) (2d Cir. 1988), and other cases have required a “more active avoidance of the truth.” HBE Leasing, 48 F.3d at 636 (citing Schmitt v. Morgan, 98 A.D.2d 934, 471 N.Y.S.2d 365, 367 (3d Dep‘t 1983)). However, even as we acknowledge this ambiguity in New York law, we need not reach the issue of which test to apply, because the facts here demonstrate both a failure of ordinary diligence and active avoidance of the truth.
The facts in this case rested upon a substantial number of stipulated facts and submissions which together evince constructive knowledge under either standard. As correctly recognized by the Tax Court, assessing whether constructive knowledge existed in this case requires examining all of the circumstances to conclude whether
The Tax Court did not sufficiently address the totality of the circumstances from all of the facts, which that court had already laid out itself. The constructive knowledge inquiry does not begin, in this instance, solely with the agreement between Shap II and Double D. Rather, it is of great import that the Shareholders recognized the “problem” of the tax liability arising from the built-in gains on the assets held by Double D. The Shareholders specifically sought out parties that could help them avoid the tax liability inherent in a C Corp holding appreciated assets. They viewed slideshow and other presentations from three different firms—River Run, Sentinel, and Fortrend—that purported to deal with such problems. While the Tax Court is correct in noting that I.R.S. Notice 2001-16 was not yet issued at the time of the instant transactions, this is not determinative on the question of constructive knowledge. The parties to this transaction were extremely sophisticated actors, deploying a stable of tax attorneys from two different firms in order to limit their tax liabilities. One of these attorneys testified, identifying the steep tax liability inherent in the assets held by Double D, that “it was generally known ... in that profession that there were ... some people, who for whatever reason, whatever their tax activities are, were able to make very favorable offers to sellers with stock with appreciated assets ... with the corporation having appreciated assets.” While not every taxpayer in the country could have been presumed to have knowledge about the existence of such Midco transactions prior to the IRS issuance of Notice 2001-16, it is plain from the facts found by the Tax Court that these particular actors did. Considering their sophistication, their negotiations with multiple partners to structure the deal, their recognition of the fact that the amount of money they would ultimately receive for an asset or stock sale would be reduced based on the need to pay the C Corp tax liability, and the huge amount of money involved, among other things, it is obvious that the parties knew, or at least should have known but for active avoidance, that the entire scheme was fraudulent and would have left Double D unable to pay its tax liability.
The Shareholder representatives also had a sophisticated understanding of the structure of the entire transaction, a fact that courts consider when determining whether to collapse a transaction and impose liability on an entity. See HBE Leasing, 48 F.3d at 635-36 (“The case law has been aptly summarized in the following terms: ‘In deciding whether to collapse the transaction and impose liability on particular defendants, the courts have looked frequently to the knowledge of the defendants of the structure of the entire transaction and to whether its components were part of a single scheme.‘” (quoting In re Best Products Co., 168 B.R. 35, 57-58 (Bankr. S.D.N.Y. 1994)) (emphasis added)). The Shareholder representatives plainly knew that Shap II was a brand new entity that was created for the sole purpose of purchasing Double D stock. They further had notice, by means of the draft stock purchase agreement, that Shap II intended to sell Double D‘s securities to Morgan Stanley, and by means of the option agreement, Shap II intended to sell the Con-
The delay of the original closing date by one day, and the Shareholders’ representatives’ corresponding intervention between Shap II and Morgan Stanley, make the conclusion of their “active avoidance of the truth” inescapable. By asking Morgan Stanley to “back off” and give Shap II extra time to provide the Double D securities so that the transactions would not be upended, the Shareholders demonstrated not only their knowledge of the structure of the entire transaction, but their understanding that Shap II did not have the assets to meet its obligation to buy equivalent shares on the open market for delivery to Morgan Stanley or pay Morgan Stanley an equivalent sum in cash. This understanding, combined with the Shareholders’ knowledge that Shap II had just come into existence for the purposes of the transaction, was more than sufficient to demonstrate an awareness that Shap II was a shell that did not have legitimate offsetting losses or deductions to cancel out the huge built-in gain it would incur upon the sale of the Double D securities.
Taken together, these circumstances should have caused the Shareholder representatives to inquire further into the supposed tax attributes that allegedly would have allowed Shap II to absorb the tax liability of which the Shareholders had intimate knowledge and which indeed was the very reason they structured this deal in the first instance. To conclude that these circumstances did not constitute constructive knowledge would do away with the distinction between actual and constructive knowledge, and, at times, the Tax Court‘s opinion seems to directly make this mistake. The facts in this case strongly suggest that the parties actually knew that tax liability would be illegitimately avoided, and in any event, as a matter of law, plainly demonstrate that the parties “should have known” that this was a fraudulent scheme, designed to let both buyer of the assets and seller of the stock avoid the tax liability inherent in a C Corp holding appreciated assets and leave the former shell of the corporation, now held by a Midco, without assets to satisfy that liability.
Based on the myriad circumstances discussed above of which they were aware, the Shareholders had a duty to inquire further into the circumstances of the transaction. HBE Leasing, 48 F.3d at 636. The term in the stock purchase agreement allocating liability for the taxes to Shap II and Double D is insufficient to relieve the Shareholders of their duty to inquire. This is because the knowledge requirement for collapsing a transaction was designed to “protect[] innocent creditors or purchasers for value.” Id. It was not designed to allow parties to shield themselves, when having knowledge of the scheme, by simply using a stock agreement to disclaim any responsibility. To accept this rule would be to undermine the very concept of constructive knowledge, as it would allow an incantation of assignment of tax liability to magically relieve the parties of their duty to inquire based on all of the circumstances which they were aware. To relieve parties of this duty, when the surrounding circumstances indicate that they should further inquire, would be to bless the willful blindness the constructive knowledge test was designed
As we have concluded that the Shareholders’ conduct evinces constructive knowledge in this case, we collapse the series of transactions and find that there was a conveyance under the NYUFCA. In collapsing the transactions, we conclude that, in substance, Double D sold its assets and made a liquidating distribution to its Shareholders, which left Double D insolvent—that is, “the present fair salable value of [its] assets [wa]s less than the amount ... required to pay [its] probable liability on [its] existing debts as they bec[a]me absolute and matured.”
III.
Because the Tax Court determined that there was no state law liability, it did not consider the other questions determinative to the outcome here. We thus remand to the Tax Court to determine in the first instance: (1) whether Diebold New York is a transferee under
CONCLUSION
For the reasons stated above, the judgment of the Tax Court is hereby VACATED, and the case is REMANDED to the Tax Court for further proceedings consistent with this opinion.