By: David J. Herzig
Great news, the awesome clerks at the Delaware Courts were nice enough to help me get my hands on the trial transcript. I guess I have some heavy reading to do now. My goal is to first look through the transcript to see if anything jumps off the pages. My longer goal is to try to create a tax opinion using the transcript and any depositions if necessary. I would like to see whether I agreed with Cravath or L&W. After all, the judge did not decide whether the transaction withstood a should opinion. Rather, he plotted the various opinions and decided that there was not a sufficient cluster to consider a should opinion was warranted.
[As a quick aside, I can’t believe that all the documents are not readily available for free on the court web site. The judge (chancellor) references the trial transcript in his opinion, yet, the supporting document is not available on-line for free. I have free lexis access as an academic and can find portions of documents but not the docket or the document. As a member of society, this certainly raises an access to justice problem. Thankfully, the clerks are super helpful and accommodated me.]
I also have received some thoughtful responses and theories about the case. I will be wrapping them up into my opinion post later (sorry you have to follow me on twitter (@professortax) to know when it hits or better yet keep checking surlysubgroup.com). But some of the best initial thoughts take into account some of my concerns.
First, I am still not sure why there was an out in the deal base on the should opinion. The way I read the condition precedent is that the lack of a should opinion means that ETE can back out of the deal because it may be subject to taxation as a disguised sale. Even with a should opinion, the transaction may still be reclassified later as a disguised sale. The only utility an opinion has is the potential to avoid penalties. Getting the opinion may save the penalties but the lack of one does not doom the deal. So, then why is a should opinion a condition precedent?
Let’s assume that L&W issues a should opinion. That does not mean that the transaction is above being challenged by the I.R.S.. If the I.R.S. challenges the transaction and wins, does that mean the L&W was incorrect in their analysis? No. It merely means that a court decided that the disguised sale rules applied. It may mean that L&W was wrong. But, in all likelihood, it merely means that a court came out the other way.
Second, this really is a structuring case. The goal is to get cash back to the Williams shareholders without tax liability. This happens all the time in the corporate and the partnership reorganization context. Here, the case centers around the 721 disguised sale rules. One can’t avoid the rules of 721 by distributing cash. But the underlying question of how to organize the business deal without the tax tail wagging the process is quite complicated. I will have more thoughts on this later as they more fully develop.
Third, even though I poo-pooed the tax opinion and the risks associate with the opinions, they are often inevitable and cannot be avoided. Issuing tax opinions is, after all, a core part the practice. There are most likely better opinion related lessons:
- Problems in the engagement process. I think of this as a chicken and egg problem. The client does not want to pay a bunch of money upfront for the opinion pre-deal and the lawyer does not want to have a bunch of time in a file that has to be written off if the deal is not agreed to. In a best case scenario, L&W on (hopefully) thin facts and research said it looked like the structure would work. The deal gets done and then L&W has to get to real work. For example, I assume that L&W was paid a little bit upfront to do some research and hear from Cravath why the structure worked. With little time in the file, it seemed that the transaction was fine, so they said they would write the opinion. The deal language gave L&W and out if at the end of the day after a real fee had been paid, they decided that the deal would not qualify under 721. The client was not going to pay L&W a lot of money to figure out for sure if the deal qualified until the merger was agreed upon.
- In a worst case scenario, how did L&W get this far into a deal and then realize their mistake? After all, they committed to giving an opinion on a transaction that they structured (hard to believe they did not) but are not prepared to give the opinion if market values change and apparently have not told anyone that? That seems rather troublesome. This may lead to my most important point.
- Tax and deal lawyers need to work better as a team. For example, if a tax opinion is required before a deal is agreed upon (as opposed to tax structure that makes the deal better), then the opinion should be substantially researched before the deal is agreed upon. Using the facts here, the deal should be agreed upon whether or not the transaction was subject to 721. If it did qualify, then the tax opinion would be an extra benefit.