T.C. Memo. 1996-559

UNITED STATES TAX COURT

HOSPITAL CORPORATION OF AMERICA AND SUBSIDIARIES, Petitioners v.

 COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 10663-91, 13074-91 Filed December 30, 1996.

 28588-91, 6351-92.

N. Jerold Cohen, Randolph W. Thrower, J.D. Fleming, Jr.,

Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark,

Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley,

and John W. Bonds, Jr., for petitioners in docket No. 10663-91.

N. Jerold Cohen, Randolph W. Thrower, J.D. Fleming, Jr.,

Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark,

Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley,

John W. Bonds, Jr., and Daniel R. McKeithen, for petitioners in

docket No. 13074-91.

N. Jerold Cohen, Walter H. Wingfield, Stephen F. Gertzman,

Amanda B. Scott, Reginald J. Clark, Randolph W. Thrower, Walter
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1 The instant case involves several issues, some of which have

been settled or decided. The issues remaining for decision

involve matters falling into three reasonably distinct

categories, which the parties have denominated the HealthTrust

issue, the MACRS depreciation issue, and the captive insurance or

Parthenon Insurance Co. issues. Issues involved in the first two

categories were presented at a special trial session together

with certain tax accounting issues previously decided, and the

captive insurance issues were severed for trial purposes and were

presented at a subsequent special trial session. Separate briefs

of the parties were filed for each of the distinct categories of

issues. We addressed the tax accounting issues in Hospital Corp.

of Am. v. Commissioner, T.C. Memo. 1996-105; Hospital Corp. of

Am. v. Commissioner, 107 T.C. 73 (1996); and Hospital Corp. of

Am. v. Commissioner, 107 T.C. 116 (1996). The instant opinion

addresses the HealthTrust issue. Other issues will be addressed

in one or more separate opinions subsequently to be released. 

T. Henderson, Jr., and John W. Bonds, Jr., for petitioners in

docket No. 28588-91.

N. Jerold Cohen, Reginald J. Clark, Randolph W. Thrower,

Walter T. Henderson, Jr., and John W. Bonds, Jr., for petitioners

in docket No. 6351-92.

Robert J. Shilliday, Jr., Vallie C. Brooks, and William B.

McCarthy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WELLS, Judge: These cases were consolidated for purposes of

trial, briefing, and opinion and will hereinafter be referred to

as the instant case.1 Respondent determined deficiencies in

petitioners' consolidated corporate Federal income tax as shown

below.
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 Tax Year Ended Deficiency

 1978 $2,187,079.00

 1980 388,006.58

 1981 94,605,958.92

 1982 29,691,505.11

 1983 43,738,703.50

 1984 53,831,713.90

 1985 85,613,533.00

 1986 69,331,412.00

 1987 294,571,908.00

 1988 25,317,840.00

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 issue to be decided in the instant opinion is the amount

petitioners realized during tax years ended 1987 and 1988 from

the sale of the stock of certain subsidiaries. To ascertain the

amount realized, we must decide the fair market value of

preferred stock and common stock warrants petitioners received as

part of the consideration for the sale of that stock.

FINDINGS OF FACT

Some of the facts have been stipulated for trial pursuant to

Rule 91 and are incorporated herein by reference. We find as

facts the parties' stipulations of fact.

During the years in issue, petitioners were members of an

affiliated group of corporations whose common parent was Hospital

Corporation of America (HCA), which was incorporated under the
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2 On Feb. 10, 1994, HCA was merged with and into Galen

Healthcare, Inc., a subsidiary of Columbia Healthcare Corp. of

Louisville, Kentucky, and the subsidiary changed its name to HCAHospital Corp. of America. On that same date, the parent changed

its name to Columbia/HCA Healthcare Corp.

laws of the State of Tennessee.2 HCA maintained its principal

offices in Nashville, Tennessee, on the date the petitions were

filed. For each of the years involved in the instant case, HCA

and its domestic subsidiaries filed a consolidated Federal

corporate income tax return (consolidated return) on Form 1120

with the Director of the Internal Revenue Service Center at

Memphis, Tennessee.

Petitioners' primary business is the ownership, operation,

and management of hospitals. In Hospital Corp. of Am. v.

Commissioner, T.C. Memo. 1996-105, we set forth a detailed

description of petitioners' hospital operations, which will not

be reiterated here. We incorporate herein our findings of fact

contained in that Memorandum Opinion. In Hospital Corp. of Am.

v. Commissioner, 107 T.C. 73 (1996), issued September 12, 1996,

we addressed an accounting issue relating to the sale of the

stock involved in the instant opinion. Except to the extent they

apply to the instant opinion, we do not restate below the

findings of fact contained in that Opinion, but we incorporate

herein those findings of fact.
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At the outset of its organization, HCA generally placed all

newly constructed or acquired hospitals in separate corporations. 

During later years, in some cases, HCA placed all newly acquired

or newly constructed hospitals located in a particular State in a

separate corporation rather than having a separate corporation

for each hospital in that State. In a few instances, HCA

acquired a group of hospitals that, for various business reasons,

were placed in a single corporation or were allowed to remain in

the acquired corporation.

The Reorganization

During early 1987, HCA's management (HCA Management) decided

that petitioners could function more efficiently if HCA operated

a smaller, more homogeneous group of hospitals than the

approximately 250 facilities petitioners then owned and operated. 

HCA Management concluded that petitioners would retain the large,

full-service hospitals, and that they would sell facilities that

did not meet those criteria. HCA Management ultimately selected

104 hospitals (Hospitals) and approximately 90 professional

office buildings and related medical facilities to divest from

the HCA organization. Hereinafter, we shall refer to the

Hospitals and related medical facilities collectively as the

Facilities. 

Located primarily in suburban and rural areas in 22 States

of the United States, the Facilities ranged in size from 1,500
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square feet to 379,300 square feet. Approximately 40 percent of

the Hospitals were the only hospitals for the communities they

served, and approximately 20 percent of the remaining Hospitals

were one of two hospitals for the communities they served. 

Petitioners acquired or constructed 15 of the Hospitals during

1984, 1985, or 1986. The Hospitals had an average age of

approximately 7.5 years. Prior to its decision to divest the

Hospitals, HCA had invested substantial amounts of capital in the

Hospitals for construction, additions of modern equipment, and

maintenance of physical plants. HCA eliminated 20 hospitals from

the pool of hospitals being considered for divestiture because

those hospitals needed extensive capital expenditures for

construction, modernization, or maintenance. 

As a group, the Hospitals had not performed as well

financially as the hospitals petitioners retained. For the year

ended 1986, the Hospitals had operating revenues of approximately

$1.5 billion, operating expenses of $1.3 billion, and net income

of $7.4 million. 

During 1987, Bankers Trust Co. (Bankers Trust) suggested

that petitioners sell some hospitals in a leveraged transaction

to a corporation controlled by an employee stock ownership plan

and trust (ESOP). HCA Management preferred a leveraged ESOP

buyout for the divestiture of the Facilities because that type of
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3 In a leveraged ESOP buyout the funds borrowed to finance the

acquisition to a large extent are repaid with tax-deductible

contributions to the ESOP, and the lenders generally charge less

interest because they receive tax benefits with respect to the

interest they receive. 

transaction would help petitioners obtain a greater amount of

cash consideration for the Facilities.3

In furtherance of the reorganization, petitioners activated

HCA Holding Corp., which prior to that time had been an inactive

HCA subsidiary incorporated under the laws of the State of

Delaware. HCA Investments, Inc. (HCAII), another wholly owned 

HCA subsidiary, owned all of the stock of HCA Holding Corp.,

which latter corporation was renamed HealthTrust, Inc.--The

Hospital Co. (HealthTrust). 

HCA Management selected R. Clayton McWhorter (Mr.

McWhorter), HCA's then president and chief operating officer, to

become chairman and chief executive officer of HealthTrust. At

that time, he had been employed by HCA for 17 years and had been

a member of HCA's executive management since 1976. Mr. McWhorter

chose Charles N. Martin, Jr. (Mr. Martin), HCA's then executive

vice president for marketing and development, to become president

and chief operating officer of HealthTrust. Mr. Martin had

joined HCA in 1980, after serving as president of General Care

Corp. Mr. McWhorter picked Donald S. MacNaughton (Mr.

MacNaughton), then chairman of HCA's executive committee, to
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become chairman of the executive committee of HealthTrust. Mr.

MacNaughton had joined HCA in 1978 following his retirement from

the Prudential Insurance Co. of America, for which he had served

as chairman and chief executive officer. Mr. McWhorter selected

other HCA employees to fill other key management positions with

HealthTrust. HealthTrust Management assumed operating

responsibility for the Facilities effective June 22, 1987. 

HCA Management decided to effectuate the reorganization

through a sale of stock of the subsidiaries that owned the

Facilities. In some instances, HealthTrust was to acquire every

hospital, office building, or related facility owned by a

subsidiary (Subsidiary). In those instances, prior to the sale

to HealthTrust, HCA transferred all of the Subsidiary's stock to

HCAII in exchange for stock of HCAII, and HCAII then sold all of

the Subsidiary's stock to HealthTrust. In other instances,

HealthTrust was not to acquire every hospital, office building,

or related facility owned by a subsidiary. In those instances,

the subsidiary (New Parent) contributed to a newly formed

subsidiary (New Subsidiary) the assets that HealthTrust would

acquire. The New Parent immediately thereafter transferred all

of the stock of the New Subsidiary to HCAII in exchange for stock

of HCAII, and HCAII then sold all of the stock of the New

Subsidiary to HealthTrust. Hereinafter, we shall refer to the

Subsidiaries and to the New Subsidiaries collectively as the
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Subsidiaries. After the reorganization, HealthTrust became the

second largest hospital management company (after HCA) in the

United States measured by the number of domestic hospitals owned,

and the fourth largest hospital management company (after HCA,

Humana, Inc., and American Medical International, Inc.) measured

by the number of domestic beds owned. 

The Purchase and Reorganization Agreement

HCA, HCAII, and HealthTrust executed a Purchase and

Reorganization Agreement on May 30, 1987 (the Original

Agreement), in which HCAII agreed to sell all of the stock of the

Subsidiaries to HealthTrust for a combination of cash, preferred

stock, and warrants to acquire shares of HealthTrust common stock

(the Acquisition). 

 The Original Agreement provided in pertinent part as

follows: 
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ARTICLE I

PURCHASE AND SALE OF STOCK;

RELATED MATTERS

1.01 Purchase and Sale of Stock. Subject to the terms

and conditions of this Plan, at the Closing provided for in

Section 1.03 hereof (the "Closing"), Seller shall sell,

convey, assign, transfer and deliver to Buyer (i) all of

the outstanding shares of capital stock owned of record and

beneficially by Seller (the "Subsidiary Shares") of the

subsidiaries of Seller set forth on Schedule 1.01(a) hereto

(the "Subsidiaries") which hold the assets of the hospitals

(the "Hospitals") and related medical facilities and

professional office buildings set forth on Schedule 1.01(b)

hereto (together with the Hospitals, the "Facilities"), and

(ii) all of the New Notes (as defined in Section 4.10

hereof), and Buyer shall purchase the Subsidiary Shares and

the New Notes from Seller.

1.02 Purchase Price. Subject to the terms and

conditions of this Plan, in reliance on the representations,

warranties and agreements of Parent and Seller contained

herein, and in consideration of the aforesaid sale,

conveyance, assignment, transfer and delivery of the

Subsidiary Shares and the New Notes, Buyer shall pay to

Seller the aggregate amount of $2,099,970,000, payable (i) 

$1,113,970,000 in cash, subject to Section 4.10 hereof (the

"Cash Purchase Price"); (ii) $300,000,000 in (x) shares of

Class A Preferred Stock of Buyer and Class B Preferred Stock

of Buyer having substantially the terms set forth on

Schedule 1.02(a) hereto (the "Preferred Stock") and (y)

warrants to purchase shares of common stock of Buyer having

substantially the terms set forth on Schedule 1.02(b) hereto

(the "Warrants"); and (iii) through the assumption of all

of the obligations of Seller under the Bridge Loan (as

defined in Section 4.10 hereof) of $686,000,000 plus the

amount of any additional borrowings otherwise assumed by

Buyer pursuant to this Plan.

* * * * * * *

4.10 Refinancing of Facilities Debt; Adjustment.

(a) Prior to the Closing Date, Seller shall

borrow such amounts as are necessary (including, without

limitation, a borrowing in the amount of $686,000,000 from
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DBL [Drexel Burnham Lambert Incorporated], the "Bridge

Loan") for all of the Subsidiaries to refinance all or

substantially all of the long-term debt presently allocated

to the Facilities by Parent as listed on Schedule 4.10

hereto, such allocated long-term debt having been evidenced

by promissory notes of the Subsidiaries to Parent (the

"Existing Notes"). The Bridge Loan shall contain terms and

provisions reasonably acceptable to Buyer.

(b) If any portion of the long-term debt related

to any Facility (including, without limitation, long-term

debt presently allocated to the Facilities by Parent) can,

according to its terms, be assumed by a Subsidiary, and if

Buyer and Parent mutually agree to have a Subsidiary assume

that debt, the Subsidiary shall assume that debt, the

principal amount of the Existing Note related thereto shall

be cancelled and the Cash Purchase Price shall be reduced by

the principal amount of the debt so assumed. Seller shall

lend the proceeds of the Bridge Loan to each of the

Subsidiaries in the amount of the principal amount of the

Existing Notes not so cancelled in exchange for promissory

notes (the "New Notes") of each of the Subsidiaries having

terms substantially similar to the terms of the promissory

note underlying the Bridge Loan. Seller shall cause each of

the Subsidiaries to repay the principal amount of the

Existing Notes not so cancelled prior to the Closing. 

Parent shall use its best efforts to apply all funds paid by

the Subsidiaries in repayment of the Existing Notes to

discharge all or substantially all of that portion of the

indebtedness of Parent allocated to the Subsidiaries,

either, to the extent possible, by direct payment to the

obligees of such indebtedness or to a trustee through

advance refunding of such indebtedness. The repayment or

the advanced refunding of such indebtedness shall occur to

the extent possible as promptly as practicable following the

Closing.

(c) If Parent shall borrow, or cause Seller or

the Subsidiaries to borrow any funds in addition to the

Bridge Loan in order to refinance any long-term debt

presently allocated to the Facilities, Parent or Seller

shall apply the proceeds of such borrowing to such

refinancing in the same manner as the proceeds of the Bridge

Loan, Buyer shall assume all of the obligations of Parent

and Seller in connection with such borrowings at the Closing

and the Cash Purchase Price shall be reduced by the amount

of the debt so assumed; provided, however, that the terms of
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such borrowings to be assumed by Buyer pursuant to this

Section 4.10(c) shall be mutually agreeable to Parent and

Buyer.

4.11 Supplementary Agreements. On or prior to the

Closing, Parent, Seller and Buyer shall enter into separate

agreements (collectively, the "Supplementary Agreements")

relating to the subject matters and having substantially the

terms and conditions set forth in the following Schedules

and as otherwise mutually agreed to by the parties thereto:

(i) purchases of supplies through arrangements

with Parent (Schedule 4.11(a)):

(ii) provision of computer services (Schedule

4.11(b));

(iii) provision of transition services (Schedule

4.11(c));

(iv) purchase of the Warrants (Schedule 1.02(b));

(v) Preferred Stock subscription (Schedule

1.02(a));

(vi) participation in Equicor's provider network

(Schedule 4.11(d));

(vii) assumption of certain obligations and

contracts by Buyer (Schedule 4.11(e)); and 

(viii) sublease of certain office space (Schedule

4.11(f)).

* * * * * * *

ARTICLE V

CONDITIONS TO CLOSING

5.01 Conditions Precedent to Obligations of Buyer,

Parent and Seller. The respective obligations of Buyer, on

the one hand, and Parent and Seller, on the other hand, to

consummate the transactions contemplated by this Plan are

subject to the satisfaction, at or prior to the Closing

Date, of each of the following conditions, any or all of

which may be waived in whole or in part by Buyer, on the one
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hand, or Parent and Seller, on the other hand, to the extent

permitted by applicable law:

* * * * * * *

(e) Conclusion of the Committee. The Committee,

after considering the written opinions of its advisers and

such information as it may deem necessary or advisable,

shall have reached the conclusions, evidenced by a written

resolution of the Committee, that the purchase by the Buyer

ESOP of shares of the common stock of Buyer at the price

agreed upon by the Committee and the seller of such shares

is fair to and in the best interest of the Buyer ESOP and

its participants and beneficiaries, and that such price

constitutes "adequate consideration" for the purchase of

such shares (within the meaning of Section 3(18) of ERISA),

and shall have directed the trustee of the trust established

under the Buyer ESOP to make such purchase as contemplated

in the appropriate agreement or agreements.

* * * * * * *

ARTICLE IX

MISCELLANEOUS

* * * * * * *

9.09 Entire Agreement; Representations and Warranties. 

This Plan and the exhibits, schedules and other documents

referred to herein or delivered pursuant hereto which form a

part hereof contain the entire understanding of the parties

hereto with respect to its subject matter. This Plan

supersedes all prior agreements and understandings, oral and

written, with respect to its subject matter. Other than as

specifically set forth in Articles II and III hereof, the

parties make no representations or warranties of any kind,

whether express or implied, in connection with the

transactions contemplated hereby.

* * * * * * *

Schedule 1.02(a) of the Original Agreement described the

preferred stock to be issued by HealthTrust as part of the

reorganization. Pursuant to that schedule, HealthTrust would
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issue 2 million shares of class A preferred stock, with a

liquidation value of $50 per share, for a total amount of $100

million, and 4 million shares of class B preferred stock, without

par, for a total amount of $200 million. Dividends on both the

class A preferred stock and the class B preferred stock could be

payable in additional shares of the applicable Preferred Stock. 

Hereinafter, we shall refer to the class A preferred stock and

the class B preferred stock collectively as the Preferred Stock.

Schedule 1.02(b) of the Original Agreement described the

warrants to be issued by HealthTrust (Common Stock Warrants) as

part of the reorganization. Pursuant to that schedule,

HealthTrust would issue 18 million Common Stock Warrants, each

transferable and exercisable by the holder to purchase one share

of HealthTrust common stock (Common Stock). Hereinafter, we

shall refer to the Preferred Stock and Common Stock Warrants

collectively as the Securities.

HCA Management employed a financial model (model) developed

by Bankers Trust to devise the stated purchase price of

approximately $2.1 billion. The model used a number of factors,

including the value of the assets to be divested and the

Hospitals' projected cash-flow from operations, to estimate the

debt load the Hospitals could support and the amount of cash

consideration petitioners could obtain. Bankers Trust advised

petitioners that, in order to acquire the financing for the
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Acquisition as structured, petitioners must possess an equity

interest in HealthTrust equal to approximately 15 percent of the

total transaction. The amount stated for the Securities,

therefore, represented the residue after subtracting from the

purchase price the cash consideration HealthTrust would pay HCAII

and the HCA debts HealthTrust would assume. HCA Management

considered the $2.1 billion stated purchase price to be a full

but fair price for the Facilities.

The Supplement and Amendment to the Purchase and

Reorganization Agreement

During April and May 1987 the operating results of the

Hospitals reflected a decline in financial performance. 

Subsequently, sometime between May 30, 1987, and July 1987,

Drexel Burnham Lambert Incorporated (Drexel), an investment

banking firm retained by petitioner to arrange financing for the

reorganization, advised petitioners that, because of the decline,

it would be difficult to place the debt securities to be used as

part of the Acquisition, and, accordingly, the debt to be placed

on HealthTrust would have to be reduced from $1.8 billion to $1.6

billion. The lenders also required that certain other changes be

made to the Original Agreement. 

Consequently, on September 17, 1987, HCA, HCAII, and

HealthTrust executed a Supplement and Amendment to the Purchase

and Reorganization Agreement (Amended Agreement) to change the

composition of the consideration to be paid for the Subsidiaries. 

The principal changes in the Amended Agreement were that (a) the
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cash consideration was decreased by $258,805,719 to $855,164,201;

(b) the total liquidation value of the Preferred Stock to be

issued to HCAII was increased by $160 million to $460 million;

(c) the number of Common Stock Warrants to be issued to HCAII was

decreased from 18 million to 17,741,379; and (d) the amount of

the debt to be assumed by HealthTrust was increased by

$98,805,719 to $784,805,719. The stated purchase price remained

$2,099,970,000. 

The lenders also required HCA to guarantee the Guaranteed

Debentures pursuant to the terms of a guarantee agreement

(Guarantee Agreement) that HCA executed. The Guarantee Agreement

provided that the HCA guarantee would extend to debt of

HealthTrust which was incurred to refinance the Guaranteed

Debentures. HCA was never called upon to make any payments

pursuant to the Guarantee Agreement. 

Additionally, the lenders demanded that HCA and HealthTrust

enter into a make well agreement (Make Well Agreement) as of

September 17, 1987, that HCA and HealthTrust executed. The Make

Well Agreement required HCA to purchase up to 800,000 shares of

class A preferred stock from HealthTrust at $50 per share for an

aggregate investment of up to $40 million if HealthTrust's cashflow (as defined in the Make Well Agreement) for any 12-month

period ending on the last day of any calendar quarter was less

than certain specified amounts. The number of shares required to

be purchased would be determined by the amount of the deficit. 
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HCA's obligations under the Make Well Agreement terminated on the

earlier of August 31, 1990, or the date on which the cash-flow of

HealthTrust during the immediately preceding four full fiscal

quarters equaled or exceeded $300 million. HCA never purchased

any stock pursuant to the Make Well Agreement. 

Excepting negotiations relating to the selection of the

Facilities to be divested, HCA Management and HealthTrust

Management did not negotiate between themselves the terms of the

Acquisition. HCA Management representatives conducted all

negotiations relating to the terms of the Acquisition with

Bankers Trust, Drexel, and the lenders. HCA Management

representatives responsible for negotiating the financial terms

of the Acquisition with Drexel considered the Preferred Stock to

have a fair market value less than its liquidation value of $50

per share, but they formed no opinion as to what was the fair

market value of the Securities. HCA Management did not negotiate

the fair market value of the Securities with HealthTrust

Management, Drexel, or any of the lenders. 

Section 1.02 of the Amended Agreement reads as follows:

"1.02 Purchase Price. Subject to the terms and

conditions of this Plan, in reliance on the representations,

warranties and agreements of Parent and Seller contained

herein, and in consideration of the aforesaid sale,

conveyance, assignment, transfer and delivery of the

Subsidiary Shares and the New Notes, Buyer shall pay to

Seller the aggregate amount of $2,099,970,000 payable (i)

$855,164,281 in cash (the "Cash Purchase Price"); (ii)

$460,000,000 in (x) shares of Class A Preferred Stock of

Buyer and Class B Preferred Stock of Buyer having

substantially the terms set forth on Schedule 1.02(a) hereto

(the "Preferred Stock") and (y) warrants to purchase shares
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of common stock of Buyer having substantially the terms set

forth on Schedule 1.02(b) hereto (the "Warrants"); (iii)

through the assumption of all of the obligations of Seller

under the Bridge Loan (as defined in Section 4.10 hereof) of

$777,041,795; and (iv) through the assumption by the

Subsidiaries of all of the obligations of Parent as set

forth on Schedule 4.10(b) hereto of $7,763,924." 

Additionally, amended section 4.10 reads as follows:

"4.10 Refinancing of Facilities Debt; Adjustment.

(a) Prior to the Closing Date, Seller shall

borrow such amounts as the parties agree are necessary

(including, without limitation, a borrowing in aggregate

amount of $777,041,795, such amount being borrowed in the

amount of $521,940,000 net proceeds from DBL [Drexel] and

$255,101,795 from certain Banks, collectively the "Bridge

Loan") for all of the Subsidiaries to refinance

substantially all of the aggregate long-term debt presently

allocated to the Facilities by Parent of $784,805,719 as

listed on Schedule 4.10(a) hereto, such allocated long-term

debt having been evidenced by promissory notes of the

Subsidiaries to Parent (the "Existing Notes"). The Bridge

Loan shall contain terms and provisions reasonably

acceptable to Buyer.

(b) Parent and Buyer agree that certain

Subsidiaries shall at the Closing assume that portion of the

long-term debt related to certain Facilities (including,

without limitation, long-term debt presently allocated to

the Facilities by Parent) in the amount of $7,763,924 as set

forth on Schedule 4.10(b) hereto.

(c) Seller shall lend the proceeds of the Bridge

Loan to each of the Subsidiaries in the amount of the

principal amount of the Existing Notes not so cancelled in

exchange for promissory notes (the "New Notes") of each of

the Subsidiaries having terms substantially similar to the

terms of the promissory note underlying the Bridge Loan. 

Seller shall cause each of the Subsidiaries to repay the

principal amount of the Existing Notes not so cancelled

prior to Closing. Parent shall use its best efforts to

apply all funds paid by the Subsidiaries in repayment of the

Existing Notes to discharge all or substantially all of that

portion of the indebtedness of Parent allocated to the

Subsidiaries, either, to the extent possible, by direct

payment to the obligees of such indebtedness or to a trustee

through advance refunding of such indebtedness. The

repayment or the advanced refunding of such indebtedness
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shall occur to the extent possible as promptly as

practicable following the Closing.

(d) Buyer hereby acknowledges that Parent shall

remain a guarantor pursuant to certain of the debt set forth

on Schedule 4.10(b). Buyer hereby indemnifies and holds

Parent harmless from and against any and all liabilities,

obligations, losses, damages, penalties, actions, judgments,

suits, proceedings, costs, expenses and disbursements of any

kind or nature which may be imposed on or incurred by, or 

asserted against, Parent and in any way relating to or

arising out of Parent's guaranty of such obligations."

Pursuant to Schedule 1.02(a) of the Amended Agreement,

5,200,000 shares of class A preferred stock, with a liquidation

value of $50 per share, for a total amount of $260 million, and 4

million shares of class B preferred stock, with a liquidation

value of $50 per share, for a total amount of $200 million, were

to be issued to HCAII as part of the reorganization. Pursuant to

Schedule 1.02(b) of the Amended Agreement, HealthTrust would

issue to HCAII 17,741,379 Common Stock Warrants, each

transferable and exercisable by the holder to purchase one share

of HealthTrust Common Stock. HealthTrust was required to file at

its expense a registration statement with the Securities and

Exchange Commission (SEC) as soon as practicable after the

closing of the Acquisition and to use its best efforts to take

all actions necessary to permit public resale of the Securities. 

Hereinafter, we shall refer to the Original Agreement as

supplemented and amended by the Amended Agreement as the

Reorganization Agreement. 

The Preferred Stock
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The 5,200,000 shares of class A preferred stock that

HealthTrust issued to HCAII provided for a liquidation preference

of $50 per share, or $260 million in the aggregate, plus accrued

but unpaid dividends computed through the date of liquidation. 

Dividends were payable at an adjustable rate indexed to the

performance of certain market rate financial instruments. The

Reorganization Agreement required HealthTrust to pay dividends in

additional shares of class A preferred stock until September 30,

1992. Dividends paid in stock of the issuing company sometimes

are referred to as pay-in-kind dividends or as PIK dividends. 

The Reorganization Agreement further required HealthTrust to pay

PIK dividends in class A preferred stock after September 30,

1992, if, pursuant to the terms of HealthTrust's loan agreements,

HealthTrust could not pay cash dividends. (The Original

Agreement had provided that the payment of PIK dividends on the

class A preferred stock would be optional.) For the initial

dividend period of September 17, 1987, to September 30, 1987,

HealthTrust computed a dividend rate under the contract on the

class A preferred stock of 14 percent. 

The 4 million shares of class B preferred stock HealthTrust

issued to HCAII provided for a liquidation preference of $50 per

share, or $200 million in the aggregate, plus accrued but unpaid

dividends computed through the date of liquidation. The

Reorganization Agreement required HealthTrust to pay dividends in

additional shares of class B preferred stock until September 30,
- 21 -

1992, at an annual rate of $6.25 per share or 12.5 percent. The

Reorganization Agreement further required HealthTrust to pay PIK

dividends in class B preferred stock after September 30, 1992,

if, pursuant to the terms of HealthTrust's loan agreements,

HealthTrust could not pay cash dividends. (The Original

Agreement had provided that the payment of PIK dividends on the

class B preferred stock would be optional.) 

The Reorganization Agreement required HealthTrust to redeem

10 percent of the then outstanding Preferred Stock in each of

years 21 through year 30 following the Acquisition at the stated

liquidation value plus accrued but unpaid dividends. HealthTrust

could elect to redeem the Preferred Stock prior to that time,

subject to paying a declining redemption premium in excess of the

stated liquidation value which did not apply after year 10. 

The Common Stock Warrants

In furtherance of the reorganization, Drexel suggested that

HealthTrust sell Common Stock Warrants to investors as an

inducement to them to acquire HealthTrust subordinated

securities. Subsequently, HCA Management agreed that HCAII would

receive Common Stock Warrants as part of its equity interest in

HealthTrust. Ultimately, HealthTrust issued 19,551,724 Common

Stock Warrants as part of the reorganization. HCAII acquired

17,741,379 Common Stock Warrants and institutional investors

procured the remaining 1,810,345. 
- 22 -

The 17,741,379 Common Stock Warrants that HealthTrust issued

to HCAII were each exercisable for one share of HealthTrust

Common Stock, beginning on March 1, 1988, for a period of 20

years. In the aggregate those Common Stock Warrants were

exercisable for 34.3 percent of HealthTrust's Common Stock, on a

fully diluted basis. The exercise price through 1989 was $30 per

share. Thereafter, the exercise price was to be reduced annually

for the next 6 years until it reached a price of $10 per share. 

The exercise price was to remain $10 per share through 2008

unless HealthTrust's Common Stock reached specified levels and

the ESOP loans were current, in which case the exercise price

would be further reduced to $6 per share, starting in 1993.

The Employee Stock Ownership Plan

The Acquisition Agreement required that HealthTrust

establish an ESOP for the benefit of its employees. Accordingly,

an ESOP was established by HealthTrust and funded with a trust

(the ESOP), and Mr. Thomas Neill, Mr. William Gregory, and Mr.

Mark Warren, who were employees of HealthTrust, were appointed by

HealthTrust to serve on the ESOP administrative committee (ESOP

Committee), which operated independent of HealthTrust Management. 

HealthTrust appointed the First American Trust Co. of Nashville,

Tennessee, to serve as trustee (Trustee) for the ESOP. The ESOP

Committee retained independent legal counsel and its own

investment advisor, Interstate Securities Corp (Interstate). 
- 23 -

Financing The Acquisition

On September 17, 1987, HealthTrust adopted the ESOP and made

an initial contribution to it of $30,000. On that same date, the

ESOP used the initial contribution together with $809,970,000 it

borrowed from HealthTrust to purchase 27 million shares of Common

Stock at a purchase price of $30 per share. Of the total shares

of Common Stock the ESOP acquired from HealthTrust, 26,999,000

shares were placed in an escrow account to serve as collateral

for the loans to the ESOP. The Common Stock would be released

from the escrow account to the ESOP as the loans were repaid. On

September 17, 1987, HCAII also sold to the ESOP for $30 per share

the 1,000 shares of Common Stock that it then owned. 

HealthTrust obtained the amount it loaned to the ESOP by

borrowing $540 million (ESOP Term Loans) and from the proceeds

from HealthTrust's issuance of promissory notes (ESOP Senior

Notes) in the aggregate principal amount of $270 million. 

Interest was payable on the ESOP Term Loans at a fluctuating rate

which initially was 8.713 percent. The ESOP Senior Notes bore an

interest rate of 11-3/4 percent. 

In furtherance of the reorganization, HealthTrust also

incurred approximately $392 million of debt under a credit

agreement (Credit Agreement) with several banks. It further

assumed the obligations of HCAII under Increasing Rate Senior

Subordinated Notes (Senior Subordinated Notes) having an
- 24 -

aggregate principal amount of $286 million and Increasing Rate

Guaranteed Subordinated Debentures (Guaranteed Debentures) having

an aggregate principal amount of $240 million. Additionally, the

Subsidiaries assumed the obligations of HCA and certain of its

subsidiaries under certain loans having an aggregate principal

amount of approximately $7,700,000.

Interest was payable on the loans under the Credit Agreement

at a fluctuating rate, which initially was 10.25 percent. 

Interest was payable on the Senior Subordinated Notes at a

fluctuating rate which increased each quarter and initially was

12.063 percent. The Guaranteed Debentures were guaranteed by HCA

and interest thereon was payable at a fluctuating rate which

increased each quarter and initially was 8.563 percent. In

total, HealthTrust borrowed over $1.7 billion in connection with

its acquisition of the Subsidiaries' stock.

Pursuant to the reorganization, the ESOP purchased 99.5

percent of the initially outstanding Common Stock for $30 per

share, and HealthTrust Management purchased the remaining 0.5

percent also for $30 per share. HealthTrust Management borrowed

the funds from HealthTrust to purchase their Common Stock. The

loans to HealthTrust Management were for a 10-year period and

bore interest at the prime rate of Chase Manhattan Bank, which

was payable annually either in cash or by the delivery to

HealthTrust of promissory notes, which matured on September 17,
- 25 -

1997. During December 1988 and January 1989, HealthTrust

repurchased for $28.875 per share substantially all of the Common

Stock initially purchased by HealthTrust Management. The

purchase price was paid by reducing the amount of the promissory

notes. On January 31, 1989, HealthTrust canceled the remaining

indebtedness of HealthTrust Management and paid them additional

compensation to cover the taxes on the income resulting from the

debt cancellation and the payment of that additional

compensation. 

The Goldman Sachs Valuation

During 1987, petitioners retained the investment banking

firm of Goldman, Sachs & Co. (Goldman Sachs) to provide a

fairness opinion as to whether the consideration to be received

for the Facilities was fair. Accordingly, Goldman Sachs

evaluated the fair market value of the Securities. In a report

dated February 2, 1988 (Goldman Sachs Valuation), Goldman Sachs

concluded that the fair market value of the class A preferred

stock was within a range of $152 million to $168 million

(midpoint, $160 million), that the fair market value of the class

B preferred stock was within a range of $97 million to $108

million (midpoint, $102 million), and that the fair market value

of the Common Stock Warrants was within a range of $22 million to

$52 million (midpoint, $37 million). Goldman Sachs stated

further that it would not be unreasonable to use the midpoint of
- 26 -

each range of values as a single estimate of the fair market

value of the Securities, which in the aggregate totaled

$299,500,000. 

On the Form 10-Q filed with the SEC for the quarter ended

September 30, 1987, petitioners showed an aggregate value for the

Securities of $300 million. During January 1988, the SEC

questioned whether HCA should have recognized any gain from the

sale of the Subsidiaries on that Form 10-Q inasmuch as it

appeared to the SEC that petitioners continued to be

substantially at risk for the operations of the Subsidiaries

because of the Guarantee Agreement and the Make Well Agreement

and because of the Securities held by petitioners. Accordingly,

petitioners agreed during February 1988 to defer for financial

reporting purposes the gain on the sale of the Subsidiaries, and

they restated the results of the third quarter 1987 to reflect

that deferral. 

J.C. Bradford Valuation

During October 1987, HealthTrust retained the investment

banking firm of J.C. Bradford & Co. (J.C. Bradford) to value the

Securities for accounting and reporting purposes (J.C. Bradford

Valuation). J.C. Bradford concluded that as of September 17,

1987, the fair market value of the class A preferred stock was

$212 million, the fair market value of the class B preferred

stock was $114 million, and the fair market value of the Common
- 27 -

Stock Warrants issued to HCA and certain institutional investors

was $117 million, a total of $443 million. Based on the J.C.

Bradford Valuation, the 17,741,379 Common Stock Warrants HCA

owned (out of the 19,551,724 Common Stock Warrants issued) had a

fair market value of approximately $106,166,650. In valuing the

class A preferred stock for HealthTrust, J.C. Bradford used an

assumed dividend rate of 14.66 percent, which was equal to the

30-year Treasury bond rate of 9.66 percent in effect on September

17, 1987, plus 500 basis points. 

For financial reporting purposes, HealthTrust initially used

the fair market values for the Securities determined by J.C.

Bradford. HealthTrust also employed those fair market values on

a registration statement it filed with the SEC on January 19,

1988, in order to register the ESOP Senior Notes, class A

preferred stock, class B preferred stock, Common Stock, and

Common Stock Warrants. The SEC subsequently asked HealthTrust to

explain why HealthTrust reported different values for the

Securities from the values stated by petitioners on their Form

10-Q for the quarter ended September 1987. The SEC indicated its

belief that the discount rate which had been used by J.C.

Bradford should have been higher to reflect the significant risk

of HealthTrust's highly leveraged financial position. 

Accordingly, HealthTrust agreed to reduce the value placed on the

Common Stock Warrants from $117 million to $52 million. Based on
- 28 -

that reduction, the Common Stock Warrants issued to HCA would be

valued at approximately $47 million. HealthTrust made no change

to the fair market value placed on the Preferred Stock. 

HealthTrust informed the SEC that the values placed on the

Preferred Stock by Goldman Sachs and by J.C. Bradford could be

reconciled because the Preferred Stock constituted an asset to

HCA but was a liability to HealthTrust, and because HealthTrust

had to increase ratably the recorded value of that stock over the

term of the Preferred Stock until the applicable accounts

reflected the $50 per share mandatory redemption value. 

For Federal income tax purposes, HealthTrust reflected the

values for the Preferred Stock as calculated by J.C. Bradford and

the value of the Common Stock Warrants as calculated by J.C.

Bradford but adjusted as agreed to with the SEC. 

Interstate Valuation

The ESOP Committee retained Interstate to render an opinion

on the fairness of the Acquisition to the ESOP (Interstate

Valuation). In a report dated September 17, 1987, Interstate

stated that it believed that the Acquisition was fair to the

ESOP. 

Subsequent Public Offering

During December 1991, HealthTrust made a public offering of

its Common Stock. Immediately thereafter, pursuant to an

agreement between HCAII and HealthTrust entered into during June
- 29 -

4 Because of a lawsuit pending during 1987 relating to one of

the Hospitals acquired by HealthTrust, the parties to the

Acquisition placed in escrow $26,861,582 of the purchase price,

consisting of cash in the amount of $22,888,683 and 129,116

shares of class A preferred stock valued by HCA in the amount of

$3,972,899. During 1988, following settlement of that lawsuit,

the sale of the Hospital was finalized, and the escrowed funds

were released to HCAII.

1991, HealthTrust issued to HCAII approximately 11 percent of

Common Stock upon the exercise by HCAII of a portion of its

Common Stock Warrants. HCAII used a portion of its Preferred

Stock to pay the Warrant exercise price. Additionally, pursuant

to that agreement, HealthTrust redeemed the remaining Securities

held by HCAII for $600 million in cash. 

Treatment of Sale on HCA Consolidated Returns

On the consolidated returns for tax years ended 1987 and

1988,4 petitioners reported long-term capital gains from the sale

by HCAII of the stock of the Subsidiaries and the sale of the

HealthTrust Common Stock in the amount of $292,086,908 and

$20,436,509, respectively. In calculating the sales price of the

stock of the Subsidiaries, petitioners reported cash received

from HealthTrust in the amount of $855,164,281 and bridge loan

assumed by HealthTrust in the amount of $729,236,296 (i.e.,

$777,041,795 bridge loan reported assumed by HealthTrust and the

Subsidiaries less $47,805,499 reported assumed by the
- 30 -

5 HealthTrust and the Subsidiaries actually assumed

$770,799,282 of the bridge loan. Accordingly, petitioners

overstated the amount of the bridge loan assumed by HealthTrust

and the Subsidiaries by $6,242,513.

6 The parties stipulated this amount. The Notice of

Deficiency reflects sales prices as corrected for taxable years

ended 1987 and 1988 relating to the sale of stock to HealthTrust

of $2,096,179,540 and $51,359,666, respectively. Schedules

attached to the Revenue Agent's Report (RAR) for those years show

the computation of those amounts. The RAR indicates, among other

things, that the total cash and debt assumption consideration

received by HCA for both years was $1,583,928,661, a difference

of $471,916 from the amount stipulated by the parties. A

schedule in the RAR entitled Reconciliation of Cash Received to

Sales Agreement (reconciliation schedule), which shows the

computation of the cash and debt consideration for taxable year

ended 1987, indicates that $25,000 cash was returned to

HealthTrust. The reconciliation schedule also shows HCA

obligations assumed by HealthTrust in the amount of $7,763,924,

rather than the $7,755,539 that is reflected in a schedule

supplementing the reconciliation schedule. The parties do not

address the discrepancies among the amounts stipulated and those

reflected in the RAR, and we are unable to resolve the

discrepancies. We, therefore, shall accept the amounts

stipulated by the parties.

Subsidiaries),5 for an aggregate of $1,584,400,577.6 HCA also

reduced its basis in the stock of the Subsidiaries to reflect the

assumption by the Subsidiaries of $47,805,499 of the bridge loan

as well as $7,755,539 of HCA debt. Additionally, HCA reported

the value of the Securities in the aggregate amount of

$299,500,000, based on the midpoint of the range of fair market

values for the Securities suggested by Goldman Sachs. 

Notice of Deficiency

On audit, respondent determined that, for purposes of

determining gain from the sale of the stock of the Subsidiaries,
- 31 -

7 One of the adjustments to basis pertained to the proper

treatment of the 10-year spread of a sec. 481(a) adjustment

resulting from certain petitioners' changing their methods of

accounting from the cash or hybrid methods to an overall accrual

method for the tax year ended 1987 to conform to the requirements

of sec. 448. We addressed petitioners' challenge to respondent's

interpretation of sec. 448(d)(7), which specifies the applicable

spread period, in an Opinion issued Sept. 12, 1996. See Hospital

Corp. of Am. v. Commissioner, 107 T.C. 73 (1996).

petitioners had understated the values of the Securities. For

the value of the Preferred Stock, respondent used the liquidation

value of the class A preferred stock and the class B preferred

stock. For the value of the Common Stock Warrants, respondent

used the value of the Common Stock Warrants determined by J.C.

Bradford and without consideration of the adjustment agreed to

between HealthTrust and the SEC. Respondent determined that the

values of the Securities were as follows:

 Security Value

 Class A preferred stock 

 (5,200,000 @ $50 per share) $260,000,000

 

 Class B preferred stock

 (4,000,000 @ $50 per share) 200,000,000

 Common stock warrants (17,741,379

 @ $5.98 per warrant) 106,093,446

 Total 566,093,446

Respondent made additional adjustments to the sales price of the

stock of the Subsidiaries to reflect misclassified selling

expenses as well as adjustments to the basis of that stock.7 

Those adjustments are not at issue in the instant opinion and for

simplicity will not be detailed herein. In the aggregate
- 32 -

respondent determined net adjustments to the gain (or loss) from

the sale of stock of the Subsidiaries for 1987 and 1988 in the

amounts of $564,053,714 and ($11,514,100), respectively. 

OPINION

Section 1001 governs the determination of gains and losses

on the disposition of property. Commissioner v. Tufts, 461 U.S.

300, 304 (1983). Section 1001(a) provides in part that the gain

from the sale or other disposition of property shall be the

excess of the amount realized over the adjusted basis provided in

section 1011 for determining gain. Section 1001(b) provides in

part that the "amount realized from the sale or other disposition

of property shall be the sum of any money received plus the fair

market value of the property (other than money) received." 

The Reorganization Agreement states that the purchase price

for the stock of the Subsidiaries was $2,099,970,000, payable

$855,164,281 in cash, $777,041,795 in assumption of the Bridge

Loan, $7,763,924 in assumption by the Subsidiaries of debt

obligations of HCAII (for a total of $1,639,970,000 in cash and

debt assumption), and $460 million in (x) shares of class A

preferred stock and class B preferred stock, and (y) Common Stock

Warrants. For purposes of determining gain from the sale of the

stock of the Subsidiaries, the amount HCAII realized is the sum

of the cash HCAII received, the HCA debt HealthTrust assumed,

plus the fair market value of the Securities HCAII received from

HealthTrust. See Nestle Holdings, Inc. v. Commissioner, 94 T.C.
- 33 -

803, 815 (1990) ("redeemable preferred stock received on a sale

or other disposition of property is 'property (other than money)'

for purposes of section 1001(b), regardless of the method of

accounting used by the taxpayer, and is to be included in the

'amount realized' at its fair market value"). 

In the notice of deficiency, the respondent calculated the

amount HCAII realized from the sale of the stock to HealthTrust

as follows:

 1987 1988 Total

Cash and debt $1,536,541,894 $47,386,767 $1,583,928,661

Securities 559,637,646 6,455,800 566,093,446

 Total 2,096,179,540 53,842,567 2,150,022,107

For the value of the Preferred Stock, the Commissioner used the

liquidation value of the class A preferred stock and the class B

preferred stock. For the value of the Common Stock Warrants, the

Commissioner used the value of the Common Stock Warrants reached

by J.C. Bradford. 

Does The Danielson Rule Apply?

Respondent now contends that, pursuant to the rule first

articulated in Commissioner v. Danielson, 378 F.2d 771 (3d Cir.

1967), vacating and remanding 44 T.C. 549 (1965) (the so-called

Danielson rule), for purposes of determining the amount realized

from the sale of stock to HealthTrust petitioners are bound to

their agreement that the value of the Acquisition was
- 34 -

$2,099,970,000. The rule in Danielson v. Commissioner, supra at

775, vacating and remanding 44 T.C. 549 (1965), is that, although

the Commissioner is not bound by allocations or characterizations

stated in a contract, a taxpayer can disavow the terms of an

agreement, in order to challenge the tax consequences flowing

therefrom, only by adducing proof showing mistake, undue

influence, fraud, duress, or other ground that in an action

between the parties to the agreement would be admissible to set

aside that agreement or alter its construction. We have not

adopted the Danielson rule. Coleman v. Commissioner, 87 T.C.

178, 202 and n.17 (1986), affd. without published opinion 833

F.2d 303 (3d Cir. 1987). We generally apply the less stringent

"strong proof" rule. Id. at 202. That rule requires the

taxpayer, in disavowing the terms of a written instrument in

order to challenge the tax consequences flowing therefrom, to

present "strong proof", i.e., more than a preponderance of the

evidence, that the terms of the written instrument do not reflect

the actual intentions of the contracting parties. Estate of

Durkin v. Commissioner, 99 T.C. 561, 572-573 (1992) (Court

reviewed); Elrod v. Commissioner, 87 T.C. 1046, 1066 (1986); G C

Servs. Corp. v. Commissioner, 73 T.C. 406, 412 (1979); Stephens

v. Commissioner, 60 T.C. 1004, 1012 (1973), affd. without

published opinion 506 F.2d 1400 (6th Cir. 1974). Nonetheless,
- 35 -

the Court of Appeals for the Sixth Circuit, to which an appeal in

the instant case would lie absent stipulation of the parties to

the contrary, has indicated its acceptance of the Danielson rule. 

See North American Rayon Corp. v. Commissioner, 12 F.3d 583, 587

(6th Cir. 1993), affg. T.C. Memo. 1992-610; Schatten v. United

States, 746 F.2d 319, 321-322 (6th Cir. 1984) (per curiam). 

Accordingly, if the Danielson rule is applicable in the instant

case, we must follow it. Golsen v. Commissioner, 54 T.C. 742,

756-757 (1970), affd. 445 F.2d 985 (10th Cir. 1971).

Respondent contends that the Danielson rule requires that

the amount realized from the sale of stock of the Subsidiaries

must be determined by using the purchase price stated in the

Reorganization Agreement, rather than the value of the component

parts of the consideration received from HealthTrust as asserted

by petitioners. 

Petitioners contend that the Danielson rule does not apply

in the instant case because the parties made no mutual agreement

as to the fair market value of the Securities. Petitioners argue

that the Reorganization Agreement merely referred to the

liquidation value of the Preferred Stock in reciting the form of

the consideration that HCAII would receive. Petitioners contend

that the fair market value of the Securities was $299,500,000.
- 36 -

In Danielson, the court bound the taxpayer to the terms of

an agreement for the sale of his business that allocated a

specific portion of the sales price to a covenant not to compete. 

Commissioner v. Danielson, supra at 778. Courts, however, have

applied the Danielson rule beyond the confines of allocations of

payments to a covenant not to compete. E.g., Schatten v. United

States, supra at 321-322 (6th Cir. 1984) (per curiam) (whether

payments from taxpayer's ex-husband were for property settlement

or alimony); Bradley v. United States, 730 F.2d 718, 720 (11th

Cir. 1984) (whether funds received from real property purchaser

were interest income or payments on a continuing option); Spector

v. Commissioner, 641 F.2d 376, 382 (5th Cir. 1981), revg. 71 T.C.

1017 (1979) (whether transaction in which taxpayer surrendered

his partnership interest in an accounting firm was a sale or a

liquidation); Coleman v. Commissioner, supra at 202 (whether the

taxpayers had a depreciable interest in certain computer

equipment involved in computer leasing arrangements). 

In refusing to permit the taxpayer to disavow the

allocations specified in the contract, the court in Danielson

stated that the policy considerations for the rule were the

desire to avoid a unilateral reformation of a contract which

could lead to possible unjust enrichment of one of the parties to

the contract; a concern for predictability in allocating the tax
- 37 -

consequences in the sale of a business; and a concern for the

administrative burdens and possible whipsaw problems that the

Commissioner could face absent the rule. Commissioner v.

Danielson, supra at 775. Where those underlying policy

considerations were absent, the Court of Appeals for the Third

Circuit has found the Danielson rule inapplicable. See Strick

Corp. v. United States, 714 F.2d 1194, 1206 (3d Cir. 1983);

Amerada Hess Corp. v. Commissioner, 517 F.2d 75, 86 (3d Cir.

1975), revg. White Farm Equip. Co. v. Commissioner, 61 T.C. 189

(1973). Other courts have similarly found the Danielson rule

inapplicable where those underlying policy considerations were

absent. Comdisco, Inc. v. United States, 756 F.2d 569, 578 (7th

Cir. 1985); Harvey Radio Lab., Inc. v. Commissioner, 470 F.2d

118, 120 (1st Cir. 1972), affg. T.C. Memo. 1972-85; Freeport

Transp., Inc. v. Commissioner, 63 T.C. 107, 116 (1974).

Petitioners contend that the Reorganization Agreement's mere

reference to the stated liquidation value of the Preferred Stock

was a recital of the consideration that did not constitute an

agreement as to fair market value of the Securities. In support

of their contention, petitioners rely on Campbell v. United

States, 228 Ct. Cl. 661, 661 F.2d 209 (1981), wherein the Court

of Claims held that a contract providing that the shareholders of

a corporation would sell their stock for "(a) $21 million in
- 38 -

cash; (b) $6.6 million represented by three unregistered Unitec

[the seller's] 6 percent notes payable over 3 years; (c) $4

million represented by unregistered Unitec 6 percent notes * * *;

and (d) 100,000 shares of unregistered Unitec common stock"

constituted a "bares bones recital as to the amount and form of

consideration to be paid" and not "an agreement intending to

establish the fair market value for that consideration." Id. at

665, 675, 661 F.2d at 212, 217. Petitioners argue that, as in

Campbell, the Reorganization Agreement contained no agreement as

to the fair market value of the Securities but merely recited the

form of the consideration HCAII would receive.

Respondent contends, however, that once HCA and HealthTrust

reached agreement on the Facilities that HealthTrust would

acquire, the Bankers Trust model used asset and cash-flow

valuations as well as other factors to establish the purchase

price of those Facilities. Respondent alleges that HCA and

HealthTrust agreed that the purchase price determined by the

Bankers Trust model would govern the value of the transaction. 

Additionally, respondent asserts that the Bankers Trust model

determined that the fair market value of the Facilities was

$2,099,970,000, and that amount was a fair and reasonable price

for the Acquisition. Respondent contends further that the

Amended Agreement merely restructured the financial terms of the

Acquisition--it did not change the agreed upon purchase price or

the fair market value of the Facilities. Consequently,
- 39 -

respondent asserts, the value of the transaction, and the value

of the component parts of the transaction, remained at

$2,099,970,000. 

Respondent contends that the parties valued the Securities

at $460 million--the difference between (a) the sum of the cash

and bank loans and (b) the agreed fair market value of the

transaction--because the Reorganization Agreement specified a

purchase price of $2,099,970,000. Accordingly, respondent

argues, because petitioners have not shown that the

Reorganization Agreement would be unenforceable among the parties

because of mistake, fraud, duress, undue influence, or similar

reasons, petitioners may not now contend that the sale price

actually was approximately $1,884,000,000. 

Petitioners, however, deny that the Bankers Trust model

established the fair market value of the Facilities. They

contend that it merely determined the maximum amount of debt load

that HealthTrust could carry. Petitioners assert that the $460

million stated in the Reorganization Agreement for the Securities

did not represent their fair market value. Rather, petitioners

argue, it embodied the amount of equity that HealthTrust needed

to reflect in order to obtain financing for the Acquisition. 

Additionally, petitioners argue that an attempt to construe the

terms of the Reorganization Agreement as assigning a $460 million

value to the Securities creates ambiguities, including what

portion of that $460 million to assign to the class A preferred
- 40 -

stock, to the class B preferred stock, and to the Common Stock

Warrants. 

As we understand the Danielson rule, it is not applicable

where the parties have not established the fair market value of

the property at the time agreement is adopted because, under

those circumstances, there is no agreement to which a party may

be held. See Campbell v. United States, 228 Ct. Cl. at 675-677,

661 F.2d at 217-218; see also Commissioner v. Danielson, 378 F.2d

at 778 ("it would be unfair to assess taxes on the basis of an

agreement the taxpayer did not make"). Furthermore, the

Danielson rule is not applicable if the contract is ambiguous. 

See North American Rayon Corp. v. Commissioner, 12 F.3d at 589

("the Danielson rule does not apply if there is no contract

between the parties or if the contract is ambiguous"); see also

Patterson v. Commissioner, 810 F.2d 562, 572 (6th Cir. 1987),

affg. T.C. Memo. 1985-53. 

In the instant case, the Reorganization Agreement does not

explicitly state that the value of the Securities was $460

million, or that the value of the stock of the Subsidiaries was

$2,099,090,000, or even that the value of the Facilities was

$2,099,970,000. Rather, it states that the $2,099,970,000

purchase price for the Acquisition was

payable (i) $855,164,281 in cash * * *; (ii)

$460,000,000 in (x) shares of Class A Preferred Stock

of Buyer and Class B Preferred Stock of Buyer * * * and

(y) warrants * * *; (iii) through the assumption of all

of the obligations of Seller under the Bridge Loan * *
- 41 -

* of $777,041,795; and (iv) through the assumption by

the Subsidiaries of all of the obligations of Parent

[HCA] * * * of $7,763,924.

 

Respondent's position that the parties agreed to a fair

market value of $460 million for the Securities rests on a number

of assumptions. The first assumption is that the Bankers Trust

model determined that the fair market value of the Facilities was

$2,099,970,000. The second assumption is that the aggregate

value of the stock of the Subsidiaries equaled the fair market

value of the Facilities--HealthTrust purchased the stock of the

Subsidiaries, not the assets they owned. The third assumption is

that the parties agreed that the value of the Securities equaled

the difference between the sum of the cash HCAII received plus

the debt HealthTrust assumed and $2,099,970,000. 

The record, however, reveals that there was no agreement

among the parties as to the fair market value of the Securities,

of the stock of the Subsidiaries, or of the Facilities. To the

contrary, the record supports petitioners' contention that the

$2,099,970,000 purchase price as originally formulated was

"backed into" so that HealthTrust's balance sheet would reflect

equity equal to 15 percent of the cash that petitioners expected

to derive from the transaction. No HealthTrust Management

representative participated in negotiations with the lenders or

with HCA Management representatives in determining the terms of

the Acquisition. At trial, petitioners presented evidence,

uncontroverted by respondent, that no HCA Management
- 42 -

representative responsible for negotiating the terms of the

Reorganization Agreement believed that the fair market value of

the Securities was $460 million. 

Respondent's contention that the fair market value of the

Facilities was $2,099,970,000, although facially plausible, is

not established. Even if correct, however, it does not

necessarily follow that the fair market value of the Facilities

was equal to the fair market value of the stock of the

Subsidiaries owning those Facilities. Nor does it necessarily

follow that the fair market value of the Securities was equal to

the liquidation value of the Preferred Stock. 

We find no evidence that the parties to the Acquisition

agreed that the fair market value of the Securities was $460

million. Indeed, on audit, the respondent took a different

position, valuing the Preferred Stock at liquidation value of $50

per share and the Common Stock Warrant at $5.98 per warrant for a

total value for the Securities of $566,093,446. Furthermore, for

financial and tax reporting purposes, neither petitioners nor

HealthTrust adhered to the purported agreed value.

In sum, we think that the cases on which respondent relies

are distinguishable from the facts of the instant case. In each

of those cases one of the parties to an agreement was challenging

a value or characterization agreed upon in the contract. E.g.,

North American Rayon Corp. v. Commissioner, 12 F.3d 583 (6th Cir.

1993); Sullivan v. United States, 618 F.2d 1001 (3d Cir. 1980);
- 43 -

8 For these same reasons, we find that the strong proof rule

also does not apply.

9 Sec. 1060 provides in pertinent part as follows:

SEC. 1060. SPECIAL ALLOCATION RULES FOR CERTAIN ASSET

ACQUISITIONS.

(a) General Rule.--In the case of any applicable asset

acquisition, for purposes of determining both--

(1) the transferee's basis in such assets, and

(2) the gain or loss of the transferor with

respect to such acquisition,

the consideration received for such assets shall be

allocated among such assets acquired in such

acquisition in the same manner as amounts are allocated

to assets under section 338(b)(5).

(b) Information Required To Be Furnished to Secretary.--

Under regulations, the transferor and transferee in an

applicable asset acquisition shall, at such times and in

such manner as may be provided in such regulations, furnish

to the Secretary the following information:

(continued...)

Amerada Hess Corp. v. Commissioner, 517 F.2d 75 (3d Cir. 1975);

Estate of Rogers v. Commissioner, 445 F.2d 1020 (2d Cir. 1971),

affg. T.C. Memo. 1970-192; Seas Shipping Co. v. Commissioner, 371

F.2d 528 (2d Cir. 1967), affg. T.C. Memo. 1965-240. In contrast,

in the instant case, no value for the Securities is stated in the

Reorganization Agreement, nor is there any evidence that the

parties assigned a fair market value to those Securities. 

Accordingly, we conclude that the Danielson rule is not

applicable in the instant case.8

Does Section 1060 Apply to the Reorganization Agreement?

 Respondent contends further that, pursuant to section

1060,9 petitioners and HealthTrust must use $2.1 billion as the
- 44 -

9 (...continued)

(1) The amount of the consideration received for

the assets which is allocated to goodwill or going

concern value.

(2) Any modification of the amount described in

paragraph (1).

(3) Any other information with respect to other

assets transferred in such acquisition as the Secretary

deems necessary to carry out the provisions of this

section.

(c) Applicable Asset Acquisition.--For purposes of this

section, the term "applicable asset acquisition" means any

transfer (whether directly or indirectly)--

(1) of assets which constitute a trade or

business, and

(2) with respect to which the transferee's basis

in such assets is determined wholly by reference to the

consideration paid for such assets.

A transfer shall not be treated as failing to be an

applicable asset acquisition merely because section 1031

applies to a portion of the assets transferred.

The amendment to sec. 1060(a) made by the Omnibus Budget

Reconciliation Act of 1990 (OBRA 90), Pub. L. 101-508, sec.

11323(a), 104 Stat. 1388-464, is not reflected above inasmuch as

it applies generally to acquisitions after Oct. 9, 1990. But see

infra note 10.

agreed purchase price. Respondent argues that section 1060 is

applicable to the Reorganization Agreement and that the

legislative history underlying section 1060 states that taxpayers

must report consistent positions as required by the Danielson

case. Petitioners contend that the provision in section 1060

that binds parties to allocations of consideration among assets

or to the value of assets set forth in a written agreement does

not apply to the instant case because the parties did not agree

in a written agreement as to the allocation of consideration and

because the Acquisition occurred prior to the October 9, 1990,
- 45 -

10 Sec. 1060(a) as amended by OBRA 90, see supra note 9,

effective generally for acquisitions after Oct. 9, 1990, reads as

follows:

SEC. 1060. SPECIAL ALLOCATION RULES FOR CERTAIN ASSET

ACQUISITIONS.

(a) General Rule.--In the case of any applicable asset

acquisition, for purposes of determining both--

(1) the transferee's basis in such assets, and

(2) the gain or loss of the transferor with

respect to such acquisition,

the consideration received for such assets shall be

allocated among such assets acquired in such acquisition in

the same manner as amounts are allocated to assets under

section 338(b)(5). If in connection with an applicable

asset acquisition, the transferee and transferor agree in

writing as to the allocation of any consideration, or as to

the fair market value of any of the assets, such agreement

shall be binding on both the transferee and transferor

unless the Secretary determines that such allocation (or

fair market value) is not appropriate. [Emphasis added.]

effective date of the amendment to section 1060(a) upon which

respondent apparently relies.10 

Because we have found supra at 38-40 that the Reorganization

Agreement does not constitute an agreement among the parties as

to the fair market value of the Securities, we agree with

petitioners that the provision of section 1060 on which

respondent relies does not apply in the instant case.

Is the Interstate Valuation Admissible as an Admission by

Petitioners?

Before we address the substantive issue of the fair market

value of the Securities, it is necessary to address an

evidentiary issue. At trial, respondent proffered a document,

the "Interstate Valuation", as proof of the fair market value of
- 46 -

the Common Stock. Petitioners objected to admission of the

Interstate Valuation on the basis that it is hearsay. 

Petitioners also objected on the ground that Rule 143(f)

precludes admission of the document because the Interstate

Valuation constitutes an opinion of an expert who did not prepare

an expert report and who was not present at trial to present

testimony and be subjected to cross-examination.

Proceedings in this Court are conducted in accordance with

the Federal Rules of Evidence. Sec. 7453; Rule 143. Generally,

"Hearsay is not admissible" in Federal courts, unless otherwise

explicitly provided by the Federal Rules of Evidence. Fed. R.

Evid. 802. Hearsay is "a statement, other than one made by the

declarant while testifying at the trial or hearing, offered in

evidence to prove the truth of the matter asserted." Fed. R.

Evid. 801(c). 

Respondent contends that the Interstate Valuation is not

hearsay because it constitutes an admission by petitioners.

Petitioners counter that the Interstate Valuation does not

constitute an admission.

Rule 801(d) of the Federal Rules of Evidence expressly

excludes from hearsay, among other things, a statement if

(2) Admission by party-opponent. The statement is

offered against a party and is (A) the party's own statement

in either an individual or a representative capacity or (B)

a statement of which the party has manifested an adoption or

belief in its truth, or (C) a statement by a person

authorized by the party to make a statement concerning the

subject, or (D) a statement by the party's agent or servant

concerning a matter within the scope of the agency or

employment, made during the existence of the relationship,
- 47 -

or (E) a statement by a coconspirator of a party during the

course and in furtherance of the conspiracy. 

The Interstate Valuation was not prepared by petitioners,

but by Interstate, an investment banking firm unrelated both to

petitioners and to HealthTrust. The statements contained in the

Interstate Valuation, therefore, do not constitute an admission

under rule 801(d)(2)(A) of the Federal Rules of Evidence. A

conspiracy is not involved in the instant case; therefore, rule

801(d)(2)(E) of the Federal Rules of Evidence is not implicated. 

Statements admitted under rule 801(d)(2)(B), (C), and (D) of

the Federal Rules of Evidence are admissible only against parties

who have adopted them or who bear the specified relationship to

the declarant. Zenith Radio Corp. v. Matsushita Elec. Indus.

Co., 505 F. Supp. 1190, 1238 (E.D. Pa. 1980), affd. in part and

revd. in part on other issues sub nom. In re Japanese Elec.

Prods. Antitrust Litig., 723 F.2d 238 (3d Cir. 1983), revd. on

another issue 475 U.S. 574 (1986). As to such issues, the record

is devoid of any evidence that HCA adopted as its own the

Interstate Valuation or demonstrated a belief that Interstate's

value of the Common Stock was accurate. Consequently, the

requirements of rule 801(d)(2)(B) of the Federal Rules of

Evidence are not satisfied. Additionally, the ESOP Committee,

not HCA, authorized Interstate to value the HealthTrust Common

Stock in the course of preparing a fairness report on the

purchase of the Common Stock by the ESOP. Consequently, the
- 48 -

requirements of rule 801(d)(2)(C) of the Federal Rules of

Evidence are not met.

Interstate prepared the appraisal of the Common Stock for

the benefit of the ESOP and its Trustee, both of whom were

independent of HCA and of HealthTrust. Respondent, however,

argues that Interstate served as an agent of HealthTrust or of

the ESOP in preparing the Interstate Valuation and, therefore,

because HealthTrust was a wholly owned subsidiary at the time the

Interstate Valuation was prepared, Interstate served as an agent

of HCA. We do not agree. 

Even if Interstate were found to be an agent of HealthTrust

the parent/subsidiary relationship between HCA and HealthTrust by

itself would not provide sufficient basis to make the statements

of Interstate an admission by HCA. See Zenith Radio Corp. v.

Matsushita Elec. Indus. Co., supra at 1247. We believe that the

facts and circumstances present in the instant case do not

support a conclusion that the Interstate Valuation constitutes an

admission by HCA of the fair market value of the HealthTrust

Common Stock.

An agency is "the fiduciary relation which results from the

manifestation of consent by one person to another that the other

shall act on his behalf and subject to his control, and consent

by the other so to act." 1 Restatement, Agency 2d, sec. 1(1)

(1958). In the instant case, there is no evidence that

Interstate had a fiduciary duty to HCA or that HCA, HealthTrust,
- 49 -

or the ESOP had the right to control Interstate as to the

valuation process or result.

There are cases in which the statements of an expert have

been found to be admissions. E.g., Collins v. Wayne Corp., 621

F.2d 777, 781-782 (5th Cir. 1980) (deposition testimony of expert

hired to investigate and report on an accident was an admission);

Mauldin v. Commissioner, 60 T.C. 749 (1973) (appraisal report

prepared by Library of Congress Evaluation Committee at direction

of the Librarian of Congress admitted as an admission against

Government's interest); Transamerica Corp. v. United States, 15

Cl. Ct. 420, 471-472 (1988), affd. 902 F.2d 1540 (Fed. Cir.

1990). We believe, however, that the facts of those cases are

distinguishable from the facts of the instant case because, in

the instant case, a valuation report was performed by an

independent appraiser who was retained by someone (the ESOP

committee) other than the party (HCA) against whom it is being

offered. We have found no case, and respondent has cited none,

in which the statements contained in a valuation report prepared

by an independent appraiser retained by a wholly owned subsidiary

have been found to be an admission by the parent. 

Moreover, we are not convinced that an independent appraiser

can serve as an agent of the client and also faithfully carry out

the responsibilities and duties of an appraiser. It seems to us

that, if an appraiser was an agent of the client, the appraiser

would not be independent because the appraiser would owe an

undivided loyalty to the client. The expert appraiser, however,
- 50 -

owes a fiduciary duty to the court and to the public. Estate of

Halas v. Commissioner, 94 T.C. 570, 578 (1990). An appraiser is

barred from presenting facts in a biased manner calculated to be

favorable to the client's position. Id. Experts who author

appraisal and valuation reports, moreover, serve as advisers to

the courts. See Fed. R. Evid. 702; Estate of Williams v.

Commissioner, 256 F.2d 217, 219 (9th Cir. 1958), affg. T.C. Memo.

1956-239. The appraiser's duty to the court exceeds any duty

owed the client. Estate of Halas v. Commissioner, supra. An

independent appraiser, therefore, could not subject himself or

herself to the control of the client, as an agent must do, and

still fulfill his or her duty to the court and to the public. 

Accord Kirk v. Raymark Indus., Inc., 61 F.3d 147, 163-164 (3d

Cir. 1995) (expert witness generally would not be agent of client

because an expert normally would not agree to be subject to the

client's control with respect to consultation and testimony);

Taylor v. Kohli, 642 N.E. 2d 467, 468-469 (Ill. 1994) (generally,

the client can influence but not control an expert's thought

processes). Compare 1 Restatement, supra sec. 14N, comment a

(Independent contractor as an agent) with id. comment b (Nonagent independent contractor). Moreover, we believe that an

agent appraiser must have to act as an advocate of the

principal's position to fulfill the fiduciary duty an agent owes

his or her principal. Such advocacy, however, is contrary to the

duty owed the court and the public in general and precludes the

assistance of the expert at trial. The Tax Court, in fact, has
- 51 -

rejected expert testimony when the methods opined by the expert

constituted advocacy. E.g., Estate of Halas v. Commissioner,

supra. 

Even if an appraiser can be an agent to the client, the

record in the instant case does not establish that Interstate was

an agent of HCA. The ESOP Committee retained Interstate to

prepare a fairness assessment of the purchase of the Common Stock

by the ESOP from HealthTrust. There is no evidence that

Interstate contracted to act for the benefit of HCA or of

HealthTrust or that HCA or HealthTrust had the right to control

Interstate in the course of that employment. The record,

moreover, does not show that HCA or HealthTrust exercised any

control over the ESOP or the ESOP Committee. The ESOP was a

separate entity formed by HealthTrust for the benefit of

HealthTrust's employees. HealthTrust, furthermore, was a

separate and distinct corporation from HCA and the other wholly

owned subsidiaries of HCA, and it served a valid business purpose

(i.e., to effectuate the divestiture by HCA of the Facilities). 

The record does not establish that HealthTrust was a mere sham or

dummy corporation or a mere alter ego or instrumentality of HCA

or any other subsidiary. See Standard Adver. Agency, Inc. v.

Jackson, 735 S.W. 2d 441 (Tenn. 1987); Electric Power Bd. v. St.

Joseph Valley Structural Steel Corp., 691 S.W.2d 522 (Tenn.

1985); see also Baker v. Hospital Corp. of Am., 432 So. 2d 1281

(Ala. 1983). Accordingly, we are not persuaded that Interstate

was an agent of HCA, of HealthTrust, or of the ESOP. 
- 52 -

Based on the foregoing, we agree with petitioner that the

Interstate Valuation does not constitute an admission by

petitioners. 

Even had we agreed with respondent that the Interstate

Valuation constituted an admission, we would not be precluded

from reaching a different value from that reached by Interstate. 

See Mauldin v. Commissioner, 60 T.C. at 760-761 (although

appraisal report was admitted as an admission against

Government's interest, the Court reached its own opinion as to

value of donated property based on the record as a whole); see

also Transamerica Corp. v. United States, 15 Cl. Ct. at 471-472

(same). Respondent provided neither the qualifications of the

preparer of the Interstate Valuation nor the bases of the

opinions expressed therein. No one involved in preparing the

Interstate Valuation was made available for cross-examination. 

Accordingly, we would accord the Interstate Valuation little, if

any, weight if we were to admit it. See Pack v. Commissioner,

T.C. Memo. 1980-65 n.23; see also Harris v. Commissioner, 46 T.C.

672, 674 (1966); Rowland v. Commissioner, 5 B.T.A. 770, 771-772

(1926); Montgomery Bros. & Co. v. Commissioner, 5 B.T.A. 258, 260

(1926); Kilburn Lincoln Mach. Co. v. Commissioner, 2 B.T.A. 363,

364 (1925).

Respondent further contends that the Interstate Valuation is

admissible under the business records exception to the hearsay
- 53 -

11 Fed. R. Evid. 803(6) provides as follows:

(6) Records of regularly conducted activity. A

memorandum, report, record, or data compilation, in any

form, of acts, events, conditions, opinions, or

diagnoses, made at or near the time by, or from

information transmitted by, a person with knowledge, if

kept in the course of a regularly conducted business

activity, and if it was the regular practice of that

business activity to make the memorandum, report,

record, or data compilation, all as shown by the

testimony of the custodian or other qualified witness,

unless the source of information or the method or

circumstances of preparation indicate lack of

trustworthiness. The term "business" as used in this

paragraph includes business, institution, association,

profession, occupation, and calling of every kind,

whether or not conducted for profit. 

rule. See Fed. R. Evid. 803(6).11 At trial, respondent made no

attempt to lay the foundation required under rule 803(6) of the

Federal Rules of Evidence for the admission of the Interstate

Valuation as a business record. See Waddell v. Commissioner, 841

F.2d 264, 267 (9th Cir. 1988), affg. per curiam 86 T.C. 848

(1986); Forward Communications Corp. v. United States, 221 Ct.

Cl. 582, 626-629, 608 F.2d 485, 510-511 (1979). Accordingly, we

find that the Interstate Valuation is not admissible under the

business records exception to the hearsay rule.

What Is the Fair Market Value of the Securities?

For Federal income purposes, the fair market value of

property is the price that a willing buyer would pay a willing

seller for that property, neither one being under any compulsion

to buy or sell and both persons having reasonable knowledge of

all the relevant facts. United States v. Cartwright, 411 U.S.
- 54 -

12 At trial, respondent sought to subpoena as an expert witness

Robert S. Doolittle (Mr. Doolittle), a partner in J.C. Bradford &

(continued...)

546, 551 (1973); Amerada Hess Corp. v. Commissioner, 517 F.2d at

83; Estate of Hall v. Commissioner, 92 T.C. 312, 335 (1989); sec.

20.2031-1(b), Estate Tax Regs. The buyer and the seller are

hypothetical, and their characteristics are not necessarily the

same as the personal characteristics of the actual seller or of a

particular buyer. Propstra v. United States, 680 F.2d 1248,

1251-1252 (9th Cir. 1982); Estate of Bright v. United States, 658

F.2d 999, 1005-1006 (5th Cir. 1981); Estate of Jung v.

Commissioner, 101 T.C. 412, 437-438 (1993).

Petitioners contend that for purposes of ascertaining the

amount realized from the sale of the stock of the Subsidiaries to

HealthTrust the fair market value of the Securities as of

September 17, 1987, was $299,500,000. As an alternative argument

to the Danielson rule, respondent contends that the fair market

value of the Securities acquired by HCAII as partial

consideration for that stock is $432,166,650 as of September 17,

1987 (i.e., the values J.C. Bradford assigned to them).

Expert Testimony

In support of their position, petitioners presented the

expert testimony of Charles T. Harris III (Mr. Harris), a partner

in Goldman Sachs and the team leader for the Goldman Sachs

Valuation. At trial, respondent presented no expert testimony as

to the fair market value of the Securities.12 As a substitute,
- 55 -

12 (...continued)

Co., to support the Commissioner's position that the fair market

value of the Securities was at least $443 million in total, of

which petitioners would own approximately $432 million. 

Respondent had not retained Mr. Doolittle as an expert witness,

and he did not wish to serve in that capacity. As Mr. Doolittle

was not being called as a fact witness, we declined to enforce

the subpoena that would have required Mr. Doolittle to serve as

an involuntary, uncompensated expert witness. 

respondent proffered the testimony of Howard Lewis (Mr. Lewis), a

valuation engineer with the Internal Revenue Service in Atlanta,

Georgia, as a rebuttal witness to Mr. Harris. 

Procedures Used by Goldman Sachs To Value the Preferred Stock 

At trial, Mr. Harris stated that Goldman Sachs had used

appropriate procedures in valuing the Securities during 1987 and

that the Goldman Sachs Valuation had reached accurate

conclusions. Mr. Harris explained that, in preparing the Goldman

Sachs Valuation, Goldman Sachs had concluded that it would be

unreasonable to value the HealthTrust PIK Preferred Stock solely

by reference to the trading prices of existing publicly traded

PIK preferred stock because (1) only a limited number of publicly

traded PIK preferred stocks existed at the time HealthTrust

issued the Preferred Stock; (2) shares of the publicly traded PIK

preferred stock were thinly traded; and (3) the issuers of the

publicly traded PIK preferred stock were not comparable companies

to HealthTrust as none were in the health care industry. Based

on recommendations of its traders, Goldman Sachs concluded that a

more reliable valuation approach would be to analyze the

increment between the market yield on the publicly traded PIK
- 56 -

13 During June 1988, HealthTrust issued subordinated debt that

received credit ratings of B3/CCC+ and that bore a market yield

of 15-1/4 percent.

preferred stocks and the market yield on the most junior

subordinated debt of the issuers of that preferred stock because

the corporate bond market was more active. 

Goldman Sachs decided that the market required a yield on

PIK preferred stock that was 3 to 4 percentage points higher than

the yield required on the most junior subordinated debt of the

issuer of the preferred stock. To approximate the yield that an

investor would have required to acquire subordinated debt of

HealthTrust, Goldman Sachs first estimated that HealthTrust

subordinated debt would receive a low single B rating and would

have a market yield of 15 percent.13 Consequently, Goldman Sachs

concluded that an investor in HealthTrust PIK preferred stock

would have required a yield of 18 to 19 percent. 

Goldman Sachs then discounted the scheduled cash flows on

the class A preferred stock and class B preferred stock, using

the estimated required yield for the PIK Preferred Stock, to

determine fair market value of the Preferred Stock as of

September 17, 1987. For that purpose, Goldman Sachs assumed that

the class A preferred stock would pay dividends at a 14-percent

rate (the actual rate for the initial dividend period) and that

the class B preferred stock would pay dividends at a 12.5-percent
- 57 -

14 Mr. Harris stated that the Black-Scholes model was the most

widely accepted option pricing model and that for purposes of

valuing the Common Stock Warrants the model took into account

factors such as the value of the Common Stock, the Common Stock

Warrant exercise price, the terms of the Common Stock Warrants,

an assumed volatility in the price of the Common Stock, and the

level of market interest rates. 

rate. Goldman Sachs concluded that as of September 17, 1987, the

class A preferred stock had a fair market value in the range of

$152 million to $168 million, and that the class B preferred

stock had a fair market value in the range of $97 million to $108

million. 

Procedures Used by Goldman Sachs To Value the Common Stock

Warrants 

To value the Common Stock Warrants, Goldman Sachs first

projected the value that the HealthTrust Common Stock would have

after 10 years. For that purpose, Goldman Sachs applied

multiples in the range of 6 to 9 to the projected income of

HealthTrust in its 10th year of operation. Next, Goldman Sachs

reduced those computed values by the projected amount of debt and

preferred stock, net of estimated available cash, that

HealthTrust would have in its tenth year of operation. Goldman

Sachs then discounted by 30 to 40 percent the estimated value of

Common Stock in that tenth year to estimate the value of the

Common Stock on a fully diluted per-share basis as of September

17, 1987, to be in the range of $1.25 to $3. Lastly, Goldman

Sachs used the Black-Scholes option pricing model14 to estimate

the value of the Common Stock Warrants. Goldman Sachs concluded
- 58 -

that the Common Stock Warrants had a value in the range of $22

million to $52 million. 

Respondent's Support of Fair Market Value Estimation

In support of the Commissioner's position, respondent relies

on the Interstate Valuation and on a compilation of materials

relating to the valuation of the Securities performed by J.C.

Bradford (Bradford Materials) assembled by respondent. As

explained above, we have sustained petitioners' objection to the

admission of the Interstate Valuation. 

Petitioners waived their objections to the admission of the

Bradford Materials. Consequently, the evidence relating to the

valuation prepared by J.C. Bradford has been admitted even though

that evidence could have been excluded as hearsay. See Waddell

v. Commissioner, 841 F.2d at 267. Petitioners, however, do not

concede the accuracy or validity of the statements contained in

the Bradford Materials. 

Even though admitted into evidence, we are free to accept or

reject the valuation amounts developed by J.C. Bradford, as we

deem appropriate based on the record. See Seagate Tech., Inc., &

Consol. Subs. v. Commissioner, 102 T.C. 149, 186 (1994); cf.

Transamerica Corp. v. United States, 15 Cl. Ct. at 471-472. No

one involved in preparing the Bradford Materials was available at

trial for cross-examination. See supra note 12. Accordingly, we

accord the Bradford Materials little weight.

Determination of Fair Market Value of the Securities
- 59 -

Petitioners argue that there is no basis upon which the

values they determined for the Securities may be disregarded

because the conclusions reached by Goldman Sachs have substantial

support, and respondent presented no probative evidence to the

contrary. Nonetheless, we are not required to adopt the values

advanced by Goldman Sachs. Cupler v. Commissioner, 64 T.C. 946,

955-956 (1975). Valuation issues are questions of fact and the

trier of fact must consider all relevant evidence to draw the

appropriate inferences. Commissioner v. Scottish Am. Inv. Co.,

323 U.S. 119, 123-125 (1944); Skripak v. Commissioner, 84 T.C.

285, 320 (1985); Cupler v. Commissioner, supra at 955. We weigh

expert testimony in light of the expert's qualifications as well

as all the other credible evidence in the record. Seagate Tech.,

Inc. & Consol. Subs. v. Commissioner, supra. We are not bound by

the opinion of any expert witness, and we shall accept or reject

that expert testimony when, in our best judgment, based on the

record, it is appropriate to do so. Id., and the cases cited

therein. While we may choose to accept in its entirety the

opinion of one expert, we may also be selective in the use of any

portion of that opinion. Id. 

We, however, do not reject expert evidence without objective

reasons for doing so. Neely v. Commissioner, 85 T.C. 934, 946

(1985). Respondent contends that the Goldman Sachs Valuation

contains errors, omissions, and is based on estimates and

assumptions not supported by independent evidence or
- 60 -

verification. Mr. Lewis did not independently value the

Securities. Rather, he essentially expressed his preference for

the J.C. Bradford approach over the Goldman Sachs approach in

valuing the Securities. Although Mr. Lewis raised some concerns

regarding the Goldman Sachs Valuation, we believe that Mr. Harris

successfully countered those concerns. Consequently, Mr. Lewis's

testimony has not persuaded us to disregard the Goldman Sachs

valuation in its entirety.

The Securities involved in the instant case are

unregistered, newly issued Preferred Stock and Common Stock

Warrants of HealthTrust. As of September 17, 1987, the valuation

date, the Securities were not publicly traded, and, therefore,

they had no listed market price. Cf. Amerada Hess Corp. v.

Commissioner, 517 F.2d at 83 (fair market value of securities

traded on a stock exchange generally is the average exchange

price quoted on the valuation date). There were no sales of the

Preferred Stock or of the Common Stock Warrants prior to, or

within a reasonable time after, the Valuation Date. Accordingly,

actual sales of the Securities cannot be used to determine fair

market value. Cf. Duncan Indus., Inc. v. Commissioner, 73 T.C.

266, 276 (1979). We agree in principle with respondent that

under similar circumstances using comparable sales of publicly

traded securities generally is preferable to the indirect method

employed by Goldman Sachs. See Estate of Hall v. Commissioner,

92 T.C. at 335. A comparable sales approach, however, is
- 61 -

premised on the existence of comparable transactions. 

Nonetheless, in the instant case the record does not establish

that the pay-in-kind preferred stock issued by a relatively few

publicly held corporations, all involved in fields unrelated to

the health care industry, that J.C. Bradford and by Goldman Sachs

identified were comparable to the pay-in-kind Preferred Stock

that HealthTrust issued to HCAII. Under the circumstances, we

are not convinced that the comparable sales approach used by J.C.

Bradford for valuing the Preferred Stock was more appropriate or

that the valuation method utilized by Goldman Sachs was

unreasonable. Moreover, we are not convinced that the

assumptions used by J.C. Bradford for valuing the Securities were

more reasonable than those employed by Goldman Sachs.

Accordingly, we think the conclusions reached by Goldman

Sachs are reasonable; i.e., that the fair market value of the

class A preferred stock in the aggregate is between $152 million

and $168 million, that the fair market value of the class B

preferred stock in the aggregate is between $97 million and $108

million, and that the fair market of the Common Stock Warrants in

the aggregate is between $22 million and $52 million. 

Based on the record as a whole, however, we do not agree

that the midpoint of those valuation ranges accurately represents

the fair market value of the Securities. Rather, we are

convinced that a willing buyer would have paid the high point of

the ranges advanced by Goldman Sachs. Although the Acquisition
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was a highly leveraged buyout, we believe that other factors

mitigated the high risks ordinarily associated with that

indebtedness. Most of the Hospitals had been owned and operated

by petitioners for several years prior to the Acquisition and,

therefore, they had an existing, experienced administrative

staff. Moreover, HealthTrust was headed by senior HCA Management

personnel who had extensive experience in the health care

industry and with HCA. HealthTrust Management, furthermore,

essentially began operating the HealthTrust organization during

May 1987. Except for the decline in operating results for April

and May 1987 (while rumors spread about the pending transaction),

the Hospitals' operating performance as a group exceeded the

projections used to determine the consideration for the

Acquisition.

Additionally, immediately after the Acquisition HealthTrust

held a commanding position in the health care industry. After

the Acquisition, HealthTrust became the second largest, after

HCA, hospital management company in the United States measured by

the number of domestic hospitals owned, and the fourth largest,

after HCA, Humana, Inc., and American Medical International,

Inc., measured by the number of domestic beds owned. The

Hospitals were comparatively modern facilities and initially

would not require extensive capital expenditures for

construction, modernization, or maintenance. A significant
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percentage of the Hospitals were the only hospitals in their

communities. 

Furthermore, although the Securities were not registered on

September 17, 1987, HealthTrust was required to file at its

expense a registration statement with the SEC as soon as

practicable after that date and to use its best efforts to take

all actions necessary to permit public resale of the Securities. 

Both classes of Preferred Stock carried a mandatory redemption

feature at a price of $50 per share plus accrued and unpaid

dividends.

Based on the foregoing, we conclude that willing buyers

could be found for the Securities at the high point of each range

advanced by Goldman Sachs. Accordingly, we hold that the fair

market value of the class A preferred stock in the aggregate is

$168 million, the fair market value of the class B preferred

stock in the aggregate is $108 million, and the fair market value

of the Common Stock Warrants issued to HCA in the aggregate is

$52 million, for an aggregate fair market value of the Securities

of $328 million.

To reflect the foregoing, 

 Appropriate orders

 will be issued.