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Maguire Partners -- Master Investments LLC v. United States

February 4, 2009

MAGUIRE PARTNERS -- MASTER INVESTMENTS, LLC, MAGUIRE PARTNERS, INC., TAX MATTERS PARTNERS, ET AL., PLAINTIFFS,
v.
UNITED STATES OF AMERICA, DEFENDANT.



The opinion of the court was delivered by: John F. Walter United States District Judge

FINDINGS OF FACT AND CONCLUSIONS OF LAW

This action came on for a court trial on August 12, 13, and 14, 2008. Steven R. Mather and Lydia Turanchik of Kajan Mather and Barish appeared for Plaintiffs Maguire Partners -- Master Investments LLC, Maguire Partners Inc., Thomas Master Investments LP, Thomas Partners Inc., Tax Matters Partner, Huntington/Fox Investments LP, Edward D. Fox, Jr., Thomas Division Partnership LP, Thomas Investment Partners Ltd., (collectively "Plaintiffs"). Andrew Pribe, Rick Watson, and Jonathan Sloat of the Office of the United States Attorney appeared for Defendant United States of America ("Defendant"). On September 22, 2008, the parties filed their proposed Post-Trial Findings of Fact and Conclusions of Law. On October 6, 2008, the parties each filed their Post-Trial Briefs and their marked copies of the opposing parties' proposed Post-Trial Findings of Fact and Conclusions of Law. After considering the evidence, briefs and argument of counsel, the Court makes the following findings of fact and conclusions of law:*fn1

Findings of Fact*fn2

I. Factual and Procedural Background

A. The Principals and Their Entities

1. James Thomas

James Thomas, a real-estate investor and developer, is the trustee of the Lumbee Clan Trust, which is a partner in Thomas Investment Partners Ltd. ("TIP"), which, in turn, is a partner in Thomas Division Partnership LP ("TDP"). In 2001 through 2002, these various partnerships owned an interest in: the Library Tower in Los Angeles; the Gas Company Tower in Los Angeles; the Wells Fargo Center in Los Angeles; the MGM Plaza in Santa Monica; the Solana project in Dallas; and Commerce Square in Philadelphia. These investments were highly leveraged with debt in the range of eighty to ninety percent of the value of the property. Thomas's net worth in 2001 was approximately $200 million, with approximately twenty to thirty percent in cash or marketable securities/cash equivalents and the remainder in real estate holdings, including those identified above.

2. Edward Fox

Edward Fox, a real-estate investor and developer, is the trustee of The Edward D. Fox, Jr. Family Trust dated February 14, 1990 (the "Fox Trust"), which is a partner in Huntington/Fox Investments LP ("HFI"), which, in turn, is a partner in both Maguire Partners -- Master Investments LLC ("MP-MI") and Thomas Master Investments LP ("TMI"). In 2001 through 2002, these various partnerships owned an interest in: the Library Tower in Los Angeles; the Gas Company Tower in Los Angeles; the Wells Fargo Center in Los Angeles; the MGM Plaza in Santa Monica; the Solana project in Dallas; and Commerce Square in Philadelphia. These investments were highly leveraged with the debt in the range of eighty to ninety percent of the value of the property.

In 2001, Fox also was a major investor in the publicly-held Center Trust REIT where he served as chairman of the board and chief executive officer. The Media Center Shopping Mall in Burbank, California was one of the key assets owned by the Center Trust REIT. In 2001, Fox also was a founder and owner of Commonwealth Partners, which was assembling a portfolio of commercial real estate projects in partnership with various California state pension funds. Fox's net worth in 2001 was approximately $50 million.

B. The Transactions At Issue

1. The Lumbee Clan Trust Transaction

On December 20, 2001, the Lumbee Clan Trust and AIG entered into a transaction in which the Lumbee Clan Trust paid $1.5 million to AIG. The source of the funds used to pay AIG was a distribution from TIP. Thomas contends that the purpose of the transaction was to serve as a hedge against potential loss in the value of his real-estate interests arising from the risk of terrorism after September 11, 2001. Thomas also contends that the Lumbee Clan Trust paid $1.5 million for an opportunity to receive a net maximum of $38.4 million. The potential payout from the transaction was tied to the value of a portfolio of twenty REIT stocks (the "REIT basket").

a. The Structure of the Transaction

In general, the transaction between the Lumbee Clan Trust and AIG consisted of a short option, a long option, and a promissory note. On December 20, 2001, the Lumbee Clan Trust and AIG in order to implement the transaction did the following: (1) the Lumbee Clan Trust sold a short option to AIG for $100 million; (2) the Lumbee Clan Trust purchased a long option from AIG for $61,683,169; (3) the Lumbee Clan Trust purchased a promissory note from AIG for $39,816,831; and (4) the Lumbee Clan Trust pledged the proceeds from the long option and the promissory note to secure the short option. The Lumbee Clan Trust's transaction costs amounted to $1.5 million. The long and short options were Asian-style European options.*fn3 The promissory note eliminated AIG's obligation to transfer funds to the Lumbee Clan Trust in the amount representing the difference between the price of the short option and the price of the long option. The strike price of the short option was fifty percent of the value of the REIT basket, or $100,021,176. The strike price of the long option was seventy percent of the value of the REIT basket, or $140,029,647.

b. The Terms of the Transaction

The terms of the transaction provided that any payoff depended on the average value of the REIT basket between December 20, 2001, and March 19, 2002, as compared to the value as of December 19, 2001. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, did not fall by greater than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Lumbee Clan Trust would receive no payout. If the average value of the REIT basket between December 20, 2001, and March 19,2002, fell more than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Lumbee Clan Trust would receive a cash payment that would increase dollar-for-dollar with the reduction in the average value of the REIT basket below seventy percent of the value of the REIT basket on December 19, 2001, until a maximum payout of $40,008,471 was reached. This maximum payout would be reached if the average value of the REIT portfolio fell by fifty percent or more from its value of December 19, 2001. However, the Lumbee Clan Trust would never be obligated to pay out-of-pocket anything other than the $1.5 million transaction costs paid to AIG on December 20, 2001, for the transaction.

c. The Contributions to the Partnerships

On December 27, 2001, the Lumbee Clan Trust contributed the transaction to TIP. Specifically, the Lumbee Clan Trust contributed the long option and the promissory note, and TIP assumed the short option. On December 27, 2001, TIP contributed the transaction to TDP. Specifically, TIP contributed the long option and the promissory note, and TDP assumed the short option. These contributions of the assets and assumptions of the short option were with the approval of AIG. After the contributions to the partnerships, AIG's position in the short option remained secured by the pledge of the long option and the promissory note.

d. The Performance of the REIT Basket and the Transaction

The value of the REIT basket did not decline by an average of thirty percent for the period between December 20, 2001, and March 19, 2002, as compared to its value on December 19, 2001. Therefore, the transaction did not yield a net payment to TDP.

e. The Tax Reporting by the Partnerships and the IRS Adjustments Related to the Transaction

i. Thomas Investment Partners

TIP reported on its 2001 Form 1065 that $101,500,000 had been contributed in capital during the year and that this amount constituted an asset of TIP. TIP also reported on its 2001 Form 1065 that the Lumbee Clan Trust had increased its capital in TIP by $101,500,000. TIP also issued a K-1 (partner's share of income, credits, deductions, etc.) to the Lumbee Clan Trust for 2001 that reflected an increase in the Lumbee Clan Trust's capital account of $101,500,000 due to the contribution of the transaction. TIP reported on its 2002 Form 1065 that it had interest income of $191,640 and it claimed deductions of $1,691,640. TIP did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued a notice of Final Partnership Adjustment ("FPAA") which adjusted downward the capital contributed to and assets of TIP by $101,500,000 and sought to adjust the outside basis of LCT by $101,500,000. For 2002, the FPAA adjusted downward income by $191,640 and disallowed the deduction of $1,691,640.

ii. Thomas Division Partnership

TDP reported on its 2001 Form 1065 that $101,500,000 had been contributed in capital during the year and that this amount constituted an asset of TDP. TDP also reported on its 2001 Form 1065 that TIP had increased its capital in TDP by $101,500,000. TDP also issued a K-1 to TIP for 2001 that reflected an increase in TIP's capital account of $101,500,000 due to the contribution of the transaction. TDP reported on its 2002 Form 1065 that it had interest income of $191,640, and it claimed deductions of $1,691,640. TDP did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of TDP by $101,500,000, and sought to adjust the outside basis of TIP by $101,500,000. For 2002, the FPAA adjusted downward income by $191,640, and disallowed the deduction of $1,691,640.

2. The Fox Trust Transaction

On December 20, 2001, the Fox Trust and AIG entered into a transaction in which the Fox Trust paid $675,000 to AIG. Fox contends that the purpose of the transaction was to serve as a hedge against potential loss in the value of his real-estate interests arising from the risk of terrorism after September 11, 2001. Fox also contends that the Fox Trust paid $675,000 for an opportunity to receive up to a net maximum of $17,242,574. The potential payout from the transaction was tied to the value of a portfolio of twenty REIT stocks (the "REIT basket"). This was the identical basket that the Lumbee Clan Trust transaction used.

a. The Structure of the Transaction

In general, the transaction between the Fox Trust and AIG consisted of a short option, a long option, and a promissory note. On December 20, 2001, the Fox Trust and AIG in order to implement the transaction did the following: (1) the Fox Trust sold a short option to AIG for $45 million; (2) the Fox Trust purchased a long option from AIG for $27,757,426; (3) the Fox Trust purchased a promissory note from AIG for $17,917,574; and (4) the Fox Trust pledged the proceeds from the long option and the promissory note to secure the short option. The Fox Trust's transaction costs amounted to $675,000. The options were Asian-style European options.

The promissory note eliminated AIG's obligation to transfer funds to the Fox trust in an amount representing the difference between the price of the short option and the price of the long option. The strike price of the short option was fifty percent of the value of the REIT basket, or $45,009,529. The strike price of the long option was seventy percent of the value of the REIT basket, or $63,013,341.

b. The Terms of the Transaction

The terms of the transaction provided that any payoff depended on the average value of the REIT basket between December 20, 2001, and March 19, 2002, as compared to the value as of December 19, 2001. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, did not fall by greater than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Fox Trust would receive no payout. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, fell by more than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Fox Trust would receive a cash payment that would increase dollar-for-dollar with the reduction in the average value of the REIT basket below seventy percent of the value of the REIT basket on December 19, 2001, until a maximum payout of $18,003,812 was reached. This maximum payout would be reached if the average value of the REIT portfolio fell by fifty percent or more from its value on December 19, 2001. However, the Fox Trust would never be obligated to pay out-of-pocket anything other than the $675,000 transaction costs paid to AIG on December 20, 2001.

c. The Contributions to the Partnerships

On December 27, 2001, the Fox Trust contributed the transaction to HFI. Specifically, the Fox Trust contributed the long option and the promissory note, and HFI assumed the short option. On December 27, 2001, HFI contributed $34,749,083 of the transaction to MP-MI. Specifically, HFI contributed seventy-six percent of the long option and the promissory note, and MP-MI assumed seventy-six percent of the short option. HFI had no prior investment in MP-MI. On December 27, 2001, HFI contributed $7,682,535 of the transaction to TMI. Specifically, HFI contributed seventeen percent of the long option and the promissory note, and TMI assumed seventeen percent of the short option. HFI had no prior investment in TMI. On December 27, 2001, HFI contributed the remaining seven percent of the transaction to Manhattan Properties, LP*fn4, which assumed the remaining seven percent of the short option. These contributions of the assets and assumptions of the short option were with the approval of AIG. After the contributions to the partnerships, AIG's position in the short option remained secured by the pledge of the long option and the note.

d. The Performance of the REIT Basket and the Transaction

The value of the REIT basket did not decline by an average of thirty percent for the period between December 20, 2001, and March 19, 2002, as compared to its value on December 19, 2001. Therefore, the transaction did not yield a net payment to Fox.

e. The Tax Reporting by the Partnerships and the IRS Adjustments Related to the Transaction

i. Huntington/Fox Investments

HFI reported its investment in MP-MI on its 2001 Form 1065 in the amount of $513,515. HFI reported its investment in TMI on its 2001 Form 1065 in the amount of $113,519. HFI reported on its 2002 Form 1065 deductions of $707,183 and income of $80,114 pertaining to the transaction. HFI did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of HFI by $42,431,618, and sought to adjust outside ...


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