TAX COURT OPINION

Case: NextEra Energy, Inc., and Subsidiaries
Docket Number: 6653-00
Judge: Ruwe
Opinion Type: memo
Filed: 05/28/2008
Pages: 37

ADM. RECORDED SERVICE CAL. STAT. _S.A¼ JUDGE FILES T.C. Memo..2008-144 UNITED STATES TAX COURT FPL GROUP, INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 5271-96, 6653-00, Filed May 28, 2008. 10811-00.1 K. Lee Blalack and Chris Faiferlick, for petitioner. Jill A. Frisch and Halvor N. Adams, III, for respondent. MEMORANDUM OPINION RUWE, Judae: This opinion involves petitioner's motions to enforce settlement agreement. (motions) filed pursuant to Rule 502 1 By order dated Jan. 17, 2007, these cases were consolidated for trial, briefing, and opinion on the motions . 2 Unless otherwise indicated, all Rule references are to the ) (continued . . . SERVED MAY 2 8 2008 in "thYeé cases involving petitioner' s tax years 1988 through 1992 (docket No. 5271-96), 1994 and 1995 (docket·No. 6653-00), and 1996 (docket No. 10811-00). Petitioner's motions raise the following issues: (1) Whether the parties entered into an enforceable settlement agreement wherein they agreed to use a spécifiéd methodology to determine which of certain expenditures should be capitalized and which should be currently deductible as repairs (the repairs issue); (2) if respondent did not agree to an enforceable settlement methodology, whether statements made by one of respondent's attorneys are sufficient to compel respondent to settle the repairs issue using the aforementioned methodology; or, in the alternative, (3) whether _respondent should be estopped from denying that he agreed to an enforceable settlement of the repalrs 1ssue. Some of the facts have been stipulated and are so found. The stipulation of facts, the supplemental stipulation. of facts, and the attached exhibits are incorporated by this .reference. FPL Group Inc. (petitioner), is a corporation organized and existing under the laws of the State of Florida with its princiipal office .in Juno Beach, Florida. 2 (. . . continued) Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect years in 1ssue. for the - 3 - Background This Court has already issued two opinions in docket No. 5271-96 pertaining to the repairs issue for the years 198 through 1992. In that'docket petitioner claimed that it had improperly capitalized many expenditures that should havé been deducted as repairs. For the tax years 1988 through 1992 petitioner alleged in its second amended petition that respondent erred in failing to allow it to deduct $210,925,534 of repair expenses that it had capitalized in determining the tax liabilities s.et forth in its consolidated Federal income ax returns for those years. In the first .of our prior opinions in docket No. 5271-96 we granted respondent'.s motion for partial summary judgment, holding that petitioner' s method of accounting for tax purposes d ring the years 1988 through .1992 was the same method that it used for Federal Energy Regulatory Commission (FERC) and Florida P blic 3 For the tax years 1994 and 1995, petitioner allege in its respondent erred in failing petition in docket No. 6653-00 that to allow it to deduct $62, 024, 968 of repair expenditures that it had deducted and $54, 625., 486 of repair expenditures that it had capitalized in determining the tax liabilities. set forth in its consolidated Federal. income tax returns for those years. For tax year 1996 petitioner alleged in its petition in docke No. 10811-00 that respondent erred in failing to allow it to educt $11,131,371 of repair expenditures that it had deducted and $15,676.,793 of repair expenditures that it had capitalize -in determining the tax liabilities set forth in its consolid ted Federal was issued for 1993, and it is therefore not a year before the Court although a refund claim was filed for that year and remains pending. income tax return for that year. the . . No notice of deficiency Service Commission (FPSC) regulatory purposes and for financial accòunting purposes. See FPL Group, Inc. & Subs. v. Commissioner, 115 T.C. 554, 575-576 (2000) (FPL I) . We further held that petitioner's claim for additional deductions for repalrs was an attempt to make an impermissible change in its ,e method of accounting for which p.etitioner had.failed to secure the consent of the Secretary as required by section 446(e). Id. at 576.4 Our Opinion in FPL I was issued in.December 2000. Other issues in docket No. 5271-96 remained unresolved, and counsel for both parties continued dealing with each other. In late spring 4 In a subsequent opihion involving the same docket, we then respondent changed Income Tax Regs. See FPL Gráup, Inc. denied petitioner's motion for partial summary judgment where petitioner argued that if its method of accounting for tax purposes had been the same method it used for regulatory and financial accounting purposes, petitioner's method to the "method of accounting" required by sec. 1.162-4, & Subs. v. Commissioner, T.C. Memo. 2005-210 (FPL II). Petitióner also argued that respondent abused his discretion by^denying petitioner's retroactive "protective request" for a change in method of accounting,.which was filed on Apr. 10, 2001, years 1988 through 1996. FPL I and served .as a "sequel" to FPL I. declined to "accept petitioner's characterization of section 1.162-4, distinguishable from petitioner's method". petitioner's argument during the examination were tantamount method of accounting. failed to demonstrate disparate treatment coápared with competitors and found no abuse of discretion in respondent's refusal for a.change in method of accounting for the years 1988 through 1996. to grant petitioner's retroactive "protectivá request Income Tax Regs., as a 'method of accounting' Id. Finally, we held that xpetitioner to changing petitioner's Id. In FPL II we that adjustments respondent made or allowed Id. We rejected Id. FPL II incorporated our Opinion in for the .Id. 2 a of 2002 there was a change -in the management of respond n 's attorneys responsible for petitioner's pending cases. Thë new managers were interested in expl,oring a settlement of the repairs issue. William.Merkle (Mr. Merkle),.the IRS Associate Ar a Counsel (Strategic Litigation),. who was stationed in Chicago, assumed supervisory control over the three docketed cases that are the subject of petitioner's motions Mr. Merkle had authority to settle the repairs issue in those cases. In June 2002. Mr. Merkle met with petitioner's counsel, Robert Carney (Mr. Carney), and with petitioner's senior anager of tax compliance and audits, Donald Chasmar (Mr. Chasmar). They discussed the repairs issue and determined that they would explore. a possible settlement. Mr. Merkle's willingness o explore settlement was.in accord with the Enterests of his supervisor, Area Counsel.James Lanning, who advocated att mpting to settle the issue, including those years subject to our Opinion in FPL I. One of Mr. Merkle's new subordinates was Robert Shilliday (Mr. Shilliday), a Special Trial Attorney with more than 30 years of experience as. an IRS attorney who was stationed in Atlanta and had been work1ng on 1ssues involving petitioner since 2000. Mr. Shilliday was assigned to negotiate on respondent's behalf regarding the repairs.issue. All of petitioner's and respondent's representatives understood that only Mr. Merkle had the authority to settle the repairs issue on respondent's behalf. Mr. Shilliday was authorized to discuss with petitioner's representatives any pötential terms of a.settlement and to communicate any proposals to Mr. Merkle. Likewise, if Mr. Merkle expressed views that-he wanted petitioner. to know regarding settlement of the repairs issue, Mr. Merkle expected Mr. Shilliday to communicate them to petitioner. Mr. Shilliday met with Messrs. Chasmar and Carney in August 2002 at petitioner's corporate headquarters in Juno Beach, Florida, to discuss the repairs issue and attempt to find a basis for settlement. The parties discussed various alternative methodologies but concluded that the major component methodology had the most promise for settlement. Dick Engstrom (Mr. Engstrom), a supervisor of property plant accounting for petitioner, joined them toward the end of the meeting after the focus of settlement moved to the major component methodology. The major component methodology is described in Mr. Shilliday's Settlement Status Report (SSR) as follows: The definition of major component is to be the Federal Energy Regulatory controlled by part 116 of Commission Regulations governing FPL's utility accounting practices. enclosed. Under methodology, is being replaced on a piece of equipment, order involved will be classified as capital. if an entire blower or fan, the major component settlement A copy of this regulation is for example, the work If·on The reason FPL capitalized the blower or fan the other hand the seals on the.blower or fan 'are being replaced, repair. seals for utility accounting purposes 1s that Commission Regulations allow major component subaccounts to be established at utility. down into various minor sub-components. These sub-accounts break the major component that wórk order would be classified as a the discretion of the Whereas the method of accounting that petitioner used for regulatory, financial, and tax accounting purposes from'1988 e through 1992 that we described in our Opinion in FPL I allowed flexibility, see FPL Group, Inc. & Subs. v. Commissioner, supra at 556-557, the major component methodology proposed for settlement purposes would.require classifying expenditures listed in petitioner's work orders in strict accord with the list of retirement units contained in part 116 of the FERC regulations. Under this method, if an expenditure was for.an entire retirement unit listed in part 116 of the FERC regulations, i.e., a major component, it would be capitalized. If an expenditure was for a part of a listed retirement unit, it would be considered a repair and be deducted. To provide Mr. Shilliday with examples of the application of the major component methodology. during the August 2002 meeting, Mr. Engstrom took 19 work orders selected by Mr. Shilliday and demonstrated" how each work order would mbe classified. After Mr. Engstrom completed this analysis, Mr. Shilli,day informed Mr. Chasmar that he thought the methodology was promising and that he was willing to recommend it to Mr. Merkle. As of the August 2002 meeting the parties understood that it would be necessary for approximately 1, 500 work orders to be reviewed in order to have a settlement on the repairs.issue. . . Messrs. Carney and Chasmar informed Mr. Shilliday that petitioner was prepared to use the methodology. However, they explained to Mr. Shilliday that petitioner did not want to perform the work necessary to classify the 1,500 disputed work orders unless Mr. Merkle first agreed to use the major component methodology. At the conclusion of the August 2002 meeting Mr. $hilliday volunteered to put together a written recommendation of the proposal to submit to Mr. Merkle for approval and agreed to provide Mr. Chasmar with a copy of the proposal to review in order to ensure that it accurately reflected the understanding reached at the August 2002 meeting.5 After the August 2002 5 Mr. Chasmar testified: * * to submit A [Mr. Chasmar]. * Mr. Shilliday stated that he would be putting together a proposal Merkle's approval and that he would forward copy to me to review to make sure that it's an accurate representation of the agreement that we had reached at presented factually correct. to Mr. Merkle for Mr. the meeting so it was Q [Petitioner's counsel at trial]. did you in fact at some point after the meeting receive .a draft of his written recommendation? And (continued . . . ) meeting Mr. Shil.liday prepared a proposed ·SSR and sent a bopy to Mr. Chasmar. Mr. Chasmar reviewed the proposal for accuracy and discussed its contents with Mr. Shilliday. Mr. Chasmar also made changes to the draft that Mr. Shilliday incorporated into the proposal. Mr. Shilliday wanted to make.sure that he accucately understood petitioner's position before he finalized the SSR to send to Mr. Merkle.6 Mr. Chasmar did not suggest that the SSR 5(...continued) A. I did. Q. Did you review it? A. I did. Q. Did you'have any conversations with Mr. Shilliday about it? . A. Yes. Q. Okay. And after those conversations, what was.your understanding about what would happen next? A. That Mr. Shilliday was going to finalize the document _and. submit it to .Mr. Merkle for his review, and I asked Mr. Shilliday if he would please forward me a copy when he completed finalizing it. Q. Why did you ask Mr. Shilliday to provide you a copy of this written recommendation he was providing to Mr. Merkle? A. Because I wanted to have it for my records. 6 Mr. Carney had authorized Mr. Shilliday to communicate directly with Mr. Chasmar, and most of the communications (conti ued...) - 10 - should .specifically require the.. parties to enter into a binding agreement to use the major component methodology before petitioner's classification of the 1,500 disputed work orders, and the finalized SSR submitted to Mr. Merkle contains no such requirement. Mr. Chasmar understood that Mr. Shilliday would - subsequently. submit the SSR containing the recommendation of a settlement proposal to Mr. Merkle for his review. Mr. Shil·liday understood that the SSR reflected petitioner's proposal, though that was not stated in the SSR and the SSR was not signed by Mr. Chasmar or any other representative of petitioner. Mr. Shilliday sent the SSR to Mr. Merkle on or about August 27, 2002.7 Mr. Shilliday also sent a copy of the SSR to Mr. Chasmar. In the second paragraph on the first page of the SSR, Mr. Shilliday wrote: for Settlement: It is proposed that each Proposal Florida Power work order in controversy be inspected by FPL' s utility regulation accounting department, and a division of repair, be made on the basis of ühether the item of equipment being replaced is a major còmponent of equipment or not. these work orders, between capital and the 6 (. . . continued) regarding the repairs issue were between Messrs. Shilliday and Chasmar. Mr. Carney had no more substantive communications with Mr. Merkle or Mr. Shilliday regarding the resolution of repairs issue until 2003. the A copy of the final Settlement Status Report (SSR) is attached as an appendix. Although the SSR states that "A copy of * was not submitted to the Court or entered into evidence. the FERC regulations] ls enclosed", [part 116 of the copy * * - 11 - This was Mr. Shilliday's effòrlt to communicate to Mr. Merkle what he believed to be petitioner's proposal. However, the SSR nowhere states that it is petitioner's. proposal. The SSR contains the following recommendation: It is recommended that you [Mr. Merkle] approve the major component settlement system analysis and authorize FPL to conduct complete the classification of controversy. When completed, analysis to ensure its accuracy. the survey necessary to the work orders in I will check FPL's The SSR does not state that FPL would not perform. the work necessary to classify the 1,500 work orders unless Mr..Merkle first agreed to settle using the major component methodology. The SSR lacks final adjustment numbers and does not address how any disputes regarding the proper classification.of work orders would be resolved. The SSR does not include.a signature line for Mr. Merkle's approval. After sending the finalized SSR to Mr. Merkle, Mr. Shilliday telephoned Mr. Merkle in late August or early September 2002 in order to discuss the proposal. Mr. Shilliday testified that he explained to Mr. Merkle that petitioner wanted Mr. Merkle to agree to settle in accordance with the major component methodology before petitioner performed the analysis of the 1,500 work orders in order to classify them as capital expenditures or repair expenses. According to Mr. Shilliday, Mr. Merkle told him in a subsequent telephone conversation to "go ahead with the deal". Mr. Shilliday testified that he understood this to mean - 12 - that Mr. Merkle agreed to use the methodology described in the SSR for settlement purposes. In contrast, Mr. Merkle described his recollection of his conversation with Mr. Shilliday as follows: [Mr. Shilliday] described the settlement methodology that he wanted to follow with regards to settling the repairs issue. regulatory method. the discussion. He said he wanted to follow a FERC That was the predominant portion of He said he wanted my approval of that analysis so he can go forward and complete it, and then he also said that Mr. Chasmar was refusing to do any further analysis on the issue unless I agreed to settle the case using this methodology. At that point in time I sort of laughed either out told * loud or to myself and said I can't do that, and I believe I his conducting the analysis of methodology because otherwise there would be no settlement. [Mr. Shilliday] the settlement * * to go ahead with When asked at trial whether he interpreted the SSR as an offer from petitioner, Mr. Merkle testified.as follows: Well, as it was explained to me * * * with regards * * to follow. [Mr. Shilliday] said here's the to the discussion on that status report and the methodology * methodology we want rational and that we needed to look at it further to determine if it was reasonable with regards to the amounts at question, what are the amounts at issue. And he also said that Mr. Chasmar was not willing to go forward with doing the work to determine -- or actually doing the work with regards ,to the analysis. I said it looks At that point in time I didn't, I did not interpret Mr. Chasmar's remarks as a settlement offer because I did not consider Mr. Chasmar a representative of with or as a representative of should be dealing on this case with Respondent. the Peti·tioner that.I was supposed to·be dealing the Petitioner that - 13 - I had one other point to make. This was more in my experience what I've seen in the many cases I've worked on as a taxpayer's employees and staff complaining about doing work on a case. happened * representation between myself and taxpayers. considered this as nothing more than disgruntled talk by Mr.. Chasmar. proposed settlement offer from the counsel of record in this case. * on occasion with my experiences with just did not understand it as a And this has And I So I * Mr. Merkle acknowledged that he told Mr. Shilliday to p "proceed as.proposed". When asked at trial whether this was in reference to the proposal.outlined in the SSR, Mr. Merkle stated: What I was telling * proceed with his analysis, since- there was further analysis to be done. I was not telling him to proceed with a proposal, but with the analysis, which was what I the status report was all about. [Mr. Shilliday] to do was to thought * * Mr. Shilliday testified that he called Mr. Chasmar sometime between the end of August and early in the first week of September 2002 and told him that "the methodology had been authorized by Mr. Merkle". Mr. Chasmar testified that Mr. Shilliday's verbatim statement was that Mr..Merkle had given "the green light to go ahead with the deal." Mr. Chasmar informed Mr. Shilliday that he would contact Mr. Engstrom and ask him to perform the classification analysis on the 1,500 disputed. work orders. Mr. Chasmar told Mr. Shilliday that -he. would be in contact once. the work was completed to schedule a followup meeting to review the results of Mr. Engstrom's analysis. None of the participants in the aforementioned telephone conversations between Messrs. Shilliday and Merkle and between - 14 - Messrs. Shilliday and Chasmar made any contemporaneous notes or memoranda of those conversations. Mr. Chasmar did not request that Mr. Shilliday provide any written verification from Mr. Merkle as to the alleged agreement. Neither Mr. Carney nor Mr. Chasmar sent a confirming letter regarding Mr.. Merkle's alleged approval of petitioner's alleged offer to settle in accordance with the major component methodology. The process of classifying the work orders cost petitioner $10,000. When Mr. Engstrom finished his analysis ofv the work orders, Mr. Chasmar arranged a meeting with Mr. Shilliday at petitioner's Juno Beach office on September 23-24, 2002, to review the results. The parties met for 2 days while Mr. Shilliday reviewed petitioner's classifications of the 1,500 work orders: Mr. Shilliday requested changes to some classifications of the work orders. Mr. Chasmar agreed to change some of the classifications that Mr. Shilliday disputed, and Messrs. e Shilliday and Chasmar eventually came to an understanding on all of the classifications. Following the analysis of the work. orders., petitioner prepared a calculation of the results of the analysis with regard to the years 1988 through 1997, including the nondocketed years 1993 and 1997. On October 16, 2002, Mr. Shilliday received this calculation which purported to be a complete computation of the net effect of the capital versus repair adjustment. Mr. Chasmar understood that the calculation faxed to Mr. Shilliday on October 16, 2002, was to be incorporated by Mr. Shilliday into a document that would contain the proposed settlemeht numbers that Mr. Shilliday would submit to Mr. Merkle·for Mr. Merkle's approval. Only Mr. Merkle had authority to approve the classifications for· purposes of computing final settlement figures. On November 4, 2002, Mr. Merkle e-mailed a spreadsheet updating the status of all the. FPL issues to several people within the IRS, including Mr. Shilliday. The spreadsheet described the repairs issue as an "Open Issue" as opposed to a "Resolved", "Pending," or "Computational" issue. This spreadsheet was attached to an e-mail from Mr. Merkle, the body . of which contained the following sentence: "I have also verbally reviewed this list with Bob Carney and we are in general agreement"with the items at issue and status, i.e. Resolved, Dispute, Pending trial." Mr. Shilliday did not reply to Mr. Merkle's e-mail. Beginning on or about October 11,.2002., ánd through the spring of 2003, Mr. Merkle communicated with IRS employees from the examination team, technical advisers, the industry issue resolution task force for the accounting method issue, and the Chief Counsel's national office regarding the potential settlement of the .repairs issue. All expressed opposition to the settlement. - 16 - Mr. Shilliday drafted a Counsel" Settlement Memorandum (CSM) that included the results of petitioner's calculation for Mr. Merkle.8 Mr. Shilliday shared the factual portion of the proposed CSM on the repairs issue with petitioner.. The CSM set forth the results of the proposed.settlement and took into account 1993 and 1997 even though the parties understood that Mr. Merkle had no authority to settle those years, which were not then before the Tax Court.9 (cid:16)042 Mr. Shilliday prepared two versions of the CSM, one dated on or about November 15, 2002, and a second that he sent to Mr. Merkle on December 2, 2002. Both versions contained proposed settlement amounts for additional repair deductions and amounts for depreci.ation associated with the additional repair deductions. The first version did not analyze the settlement in the context of FPL I, particularly with regard to the accounting 8 A Counsel Settlement Memorandum (CSM) is a written the resolution, document stating the basis of settlement of an issue. follows a format consisting.of a statement of statement of a discussion of settled other than upon the merits, of litigation. countersigned, approving official. a discussion of A CSM is signed by the attorney and then the applicable law, and if the issue is to be following an "Approved" line, by the managing or a discussion of the relevant facts, A CSM the issue, a the hazards 9 PetitiOner ClaiMed a refund, which was pending,' for 1993. Mr. Shilliday had no discussions with petitioner's representatives regarding how the proposed 1993 deficiency would be assessed or whether assessment was barred. The discussion of the dollar tax impact that the claim was pending in the IRS's Appeals Office. for 1997 includes a reference to the fact method .issue.!° Mr. Merkle requested that Mr. Shilliday revise the first CSM to address the. Court's Opini.on. in FPL I. Mr. Shilliday. complied with Mr. Merkle's request by adding a ection labeled "Issue 2 and sent the revised version to Mr. Merkle on December 2, 2002. The final version of :the CSM includes the following statement: . for -Settlement: .It is proposed that each Proposal Florida Power work order in controversy be reviewed, and a division of- these work orders, between capital . and repair, be made on the basis of whether the item of equipment being replaced is a mayor component of equipment or not. the The CSM closes with Mr. Shilliday's recómmendation "That the propósal for settlement be accepted" and contains. a signature line for Mr. Merkle's approval. Mr. Merkle never approved the settlement figures in the CSM and never signed the CSM. Mr. Merkle informed Mr. _Shilliday by .telephone in De ember 2002 that Mr. Shilliday was being transferred out of Mr. Merkle's group effective January 12, 2003. At some point after Mr. Shilliday's transfer Mr. Merkle contacted Mr. Shillïday nd indicated that he should have no further involvement in petitioner's case. In early 2003 Mr. Carney contacted Mr. Merkle. Mr. Merkle informed Mr. Carney that he was still reviewing the settl ment proposal. Mr. Merkle requested that Mr. Carney draft a history Respondent was not able to locate a copy of the first version of the CSM. - 18 - of the repairs issue in the form of a . letter that described the 3 factual and procedural issues that existed before .Mr. Merkle assumed responsibility for the case. Mr. Carney sent a letter to Mr. Merkle on February 14, 2003. - Mr. Carney's letter referred to the "proposed settlement" of--the repairs issue and stated that "In the event that the pending settlement proposal is not finalized, additional litigation will be required in the Tax Court to review Respondent' s refusal to grant * * * [petitioner's protective request to change its: method of accounting]". The letter did not mention an existing settlement regarding methodology, nor did it refer to potential litigation to enforce such an agreement. On or about March 20', 2003, ..the parties scheduled a meeting in Mr. Carney's office in Washington, D.C., for April 16, 2003, to discuss the repairs issue and other outstanding items. On March 27, 2003, Mr. Merkle sent a letter to Mr. Carney in which he stated that the proposed settlement of the repairs issue did not adequately reflect the "hazards of litigation" from respondent's perspective. Following the receipt of Mr. Merkle's March 27, 2003, letter, Mr. Carney contacted Mr. Merkle by telephone on or about April 1, 2003. During the call. Mr. Merkle told Mr. Carney that potential settlement would be kept under consideration for the April 16, 2003, meeting between the parties. . - 19 - On April 7, 2003, Mr. Carney e-mailed James Higgins (Mr. Higgins), petitioner's vice president of tax, Mr. Chasmar and Suanne Fechtmeyer (Ms. Fechtmeyer) a first and then a revised draft of a proposed letter in response to Mr. Merkle's March 27, 2003, letter. Both dra'fts of the letter referred to a "proposed settlement" of the repairs issue and to a "prior agreement" to a settlement methodology. Mr. Higgins subsequently e-mailed Mr. Chasmar and Ms. Fechtmeyer and attached a revised draft of the letter in which Mr. Higgins added the following.sentence: "Petitioner requests that Respondent explain why it is reneging on.its prior agreement." The mention of a "prior agreement" in these drafts represents the first written statement, internally or otherwise, alleging that the parties had an agreement regarding settlement of the repairs issue. In the final version of. Mr. Carney's letter, dated April 9, 2003, Mr. Carney made statements regarding the alleged methodology agreement and requested that respondent "exercise good faith and abide by the prior agreement." The "prior agreement" to which Mr. Carney referred was the alleged agreement to use the major component methodology. The parties met on April·l6, 2003, at Mr. Carney's office in Washington, D.C. Mr. Carney began the meeting by explaining petitioner's position that Mr. Merkle had entered into an agreement on methodology. Mr. Merkle advised petitioner's - 20 - representatives that respondent would not settle the repairs issue in the first docket, docket No. 5271-96, which was the subject of our Opinion in FPL I. Mr. Merkle stated that he would keep the possibility of settlement open for 10 days with regard to the years after the.first docket in order to confer with the national office and others within the IRS.who had knowledge of the repairs issue. Following the April 2003 meeting, Mr. Merkle consulted with various constituencies familiar with the repairs issue within the IRS, all of whom indicated they were not in favor of a settlement with petitioner. Discussion The first issue we must decide. is whether the parties (cid:16)042 entered into an enforceable settlement agreement wherein they agreed to use a specified methodology to determine which of certain expenditures should be capitalized and which should be deductible as repairs. General principles regarding the enforcement of settlements in the Tax Court were set out in Dorchester Indus., Inc. v. Commissioner, 108 T.C. 320, 330 (1997) (quoting Manko v. Commissioner, T.C. Memo. 1995-10), affd. without published opinion 208 F.3d 205 (3d Cir. 2000), as follows: "For almost a century, it has been settled that voluntary settlement of civil controversies 1s ln high judicial favor. Williams. v. First Natl. Bank, 216 U.S. 582, 595 (1910); St. Louis Minina & Millina Co. v. -.21 - A valid .once reached, cannot be repudiated by Montana Minino Co., 171 U.S. s650, 656 .(1898). settlement, either party, and a'fter the parties have entered into a binding sett.lement agreement, :the actual merits of settled controversy are without consequence.. This Court has declined to set aside a settlement duly executed by the parties and filed with the Court absence of v. Commissioner, Commissioner, 42 T.C. 110 (1964). However, will not settlement was intended. Autera v. Robinson, 419 F.2d 1197 (D. C. Cir . 1969) . fraud or mutual mistake.. Stamm Intl. Corp. force a settlement on parties where no 90 T.C. 315 (1988); Spector v. a court in the the A settlement is a contract and, consequently, to its essential A prerequisite to the formationi of general principles of contract law determine,whether a settlement has been reached. Robbins Tire & Rubber Co. v. Commissioner, 52 T.C. 420, 435-436, supplemented by 53 T.C. 275 (1969). a contract.is an objective manifestation of mutual assent T.C. Memo. 1994-417; 17A Am. Jur. 2d, Contracts, secs. 27 and 28 (1991); 1 Williston on Contracts,. sec. 3:5 (4th ed. 1990). Mutual assent. generally requires an offer and an acceptance. 17A Am. Jur. 2d, Contracts 'An.offer is.the manifestation of sec. 41 willingness to enter into a bargain, so made as to justify another person in understanding that his assent to that bargain is invited and will conclude it.' Restatement, Contracts 2d,.sec. 24 terms. Heil v. Commissioner, (1991). (1981). 1 "In a tax case, it 'is not necessary that the rather, a settlement agreement may. be reached parties execute a closing agreement under section 7121 .in order to settle a case pending before this Court, but, through offer and acceptance made by.letter, or even in the absence of. a writing.' T.C. Memo.. 1994-515. Settlement offers made and accepted by letters are enforced as binding agreements. Haiduk v. Commissioner, T.C. Memo. 1990-506; see also Himmelwricht v. Commissioner, T.C. Memo. 1988'114." Lamborn v. Commissioner, Petitioner argues that Mr. Merkle orally accepted petitioner's settlement proposal to use the major component methodology to determine how to classify approximately 1,500 - 22 - disputed expenditures as either capital expenditures or deductible repair expenses. According to petitioner, its proposal was conveyed to Mr. Merkle through Mr. Shilliday's written SSR and Mr. Shilliday's oral telephone explanation to Mr. Merkle that petitioner's proposal to perform the classification of 1,500 work ·orders was contingent on Mr. Merkle's up-front agreement to use the methodology without first knowing the results that it might produce. The evidence upon which petitioner primarily relies is the SSR and the testimony of Messrs. Shilliday and C.hasmar. In their testimony both Messrs. Shilliday and Chasmar indicated a common understanding that petitioner did not wan.t to perform the analysis of the 1,500 work orders without some agreement between the parties that the major component methodology was going to be used to classify the work orders upon which the settlement figures would be determïned. Both also understood that the proper classification of each of the work order expenditures could still be disputed by flr. Merkle. Both Messrs. Shïlliday and Chasmar testified that they worked together to incorporate the terms.of the settlement proposal into the written SSR, and that Mr. Chasmar was given the opportunity to review the draft of the SSR before its submission to Mr. Merkle to make sure that the proposal was accurate. Mr. Shilliday testified that after submitting the finalized SSR to Mr. Merkle, 23 - Mr. Shilliday explained in a telephone conversation with Mr. Merkle that petitioner wanted Mr. Merkle to agree to use the methodology for settlement purposes before petitioner performed the analysis of the 1,500 work orders. Mr. Shilliday testified that Mr. Merkle told him that he would look over the material. Mr. Shilliday testified that in a subsequent telephone conversation Mr. Merkle told him to go ahead with the deal,.and Mr. Shilliday conveyed this response to Mr. Chasmar. Mr. Merkle testified that when Mr. Shilliday told him of. petitioner's wish to have an up-front agreement, he told Mr. Shilliday that he would not agree to be bound to use the methodology without first knowing the ·results of its application. Bo.th Messrs. Shilliday and Merkle agree that Mr. Merkle told Mr. Shilliday: "Go ahead with the deal" or "Proceed as proposed" or words to that effect. Mr. Shilliday then told Mr. Chasmak "that Mr. Merkle had given the green light to go.ahead with the deal." The primary conflict is between Mr. Merkle's testimony that he told Mr. Shilliday that he would not agree to use the methodology for settlement.pur.poses without first.knowing: the results of its application and Mr. Shilliday's testimony that he believed that Mr. Merkle agreed with the proposal to use the methodology for settlement before knowing the ·results of its application. We recognize. that recollections of witnesses regarding specific conversations can produce inconsistencies and - 24 - that specific words and phrases can sometimes convey different meanings depending on the context in which they are uttered. In these .situations, it is useful to look to contemporaneously written documents and the contemporaneous actions of the parties at key points. The key document in this controversy is the SSR, which (cid:16)042 states, in pertinent part, as follows: for Settlement: It is proposed that each Proposal Florida Power.work order in controversy be inspected by FPL' s utility regulation accounting 'department, and a division of repair, be made on the basis of whether equipment being replaced is a major component of equipment or not. these work orders, between capital and the item of the The SSR contains a sample classification of 19 of the approximately 1, 500 disputed work orders using the proposed methodology. The analysis in the SSR indicates that 11 work orders totaling $2,676,768 should be. capitalized and 8 work orders totaling $1,403,903 should be classified as repairs. In the SSR Mr. Shilliday warns that These results may not be representative of the entire body of contested work orders, since only one plant was.involved for a short period of time and that - 25 - plant was a nuclear plant."" The SSR contains the following recommendation: It is recommended that you approve the major component settlement system analysis and authorize FPL to conduct classification of completed, accuracy. I will check FPL's analysis to ensure its the survey necessary to complete the the work orders in controversy. When Mr. Chasmar reviewed the "proposal" in the SSR before its submission to Mr. Merkle in order to be sure that both parties understood what was,being proposed. The SSR indicates that it is Mr. Shilliday's proposal, and it was signed by Mr. Shilliday. The SSR does not state that it contains petitioner's settlement proposal or that the proposal was intended to bind both parties to the methodology regardless of the results of its application. The SSR fails to state that petitioner would not perform the work necessary to classify the 1,500 work orders·unless Mr. Merkle first agreed to settle on the basis of _the proposed.methodology. Mr. Shilliday believes that Mr. Merkle gave oral approval to petitioner's proposal to use the methodology to settle the repairs issue. However, nöthing in the SSR or any other documents prepared by the representatives and employees of " The analysis of the 19 sample work orders resulted in approximately 66 percent of the amount capitalized and approximately 34 percent being expensed as repairs. Subsequently, approximately 1,500 wo.rk orders resulted in approximately 52 percent of approximately 48 percent being expensed as repairs. ·the analysis in the CSM of all of in dispute being capitalized and the amount in dispute being the petitioner or respondent during the approximately 7 months between Mr. Shilliday's telephone conversation with Mr. Merkle in September 2002 and the various drafts of Mr. Carney s letter to Mr. Merkle in April 2003 states that either party thought there was a binding agreement to use the methodology for settlement of the repairs issue. Considering that over $350 million of deductions was at stake in the repairs issue for the docketed years addressed in this opinion, one might reasonably expect some written confirmation, or at least contemporaneous internal memoranda or writings, memorializing a settlement. After significant pretrial discovery, no such documents materialized. Petitioner's representatives and employees apparently never made a contemporaneous written note or memorandum of petitioner'·s understanding of a binding agreement or its terms. Petitioner's counsel never sent a contemporaneous written confirmation of petitioner's understanding of a settlement and its terms to respondent. Only after nearly 7 months did petitioner's counsel write to Mr. Merkle alleging that the parties had a prior agreement. Until that .point petitioner's counsel consistently referred to a "proposed settlement" on both its internal documents and in correspondence with respondent. Similarly, respondent never sent . anything in writing to petitioner to confirm a methodology agreement with petitioner. No internal writings prepared by respondent' s representatives, - 27 - including Mr. Shilliday, stated that there had been a settlement as to methodology. .To the contrary, in a spreadsheet docùmenting the status of all of the FPL issues, the repairs issue was considered an "Open Issue" until at least November 4, 2002, well after Mr. Merkle's alleged consent to a settlement agreement occurred. As we have already mentioned, this spreadsheet was attached to an e-mail Mr. Merkle sent to, among.others, Mr. Shilliday, and.contained the following pertinent phrase: "I ha've also verbally reviewed. this list with Bob Carney and we are in general agreement with the items at issue and status, i.e: Resolved, Dispute, Pending trial." Mr. Shilliday did not contact Mr. Merkle to dispute the "open" status of the repairs issue on the spreadsheet. Finally, the last page of the proposed CSM that Mr. Shilliday prepared on the repairs issue indicates that a settlement had yet to be finalized: "Conclusion: That the proposal for settlement be accepted." This was followed by a signature line for Mr. Merkle. It is undisputed that Mr.± Merkle never signed the proposed CSM on the repairs issue. As the moving party, petitioner bears the burden of proof. Petito v. Commissioner, T.C. Memo. 2000-363; see also Pietanza v. . Commissioner, 92 T.C. 729, 736 (1989), affd without published opinion 935' F.2d 1282 (3d Cir. 1991); S. Cal. Loan Associátion v. Commissioner, 4 B.T.A. 223 (1926). After considering the[ entire record in this matter, we find that the evidence is insufficient - 28 - for us to conclude that the parties entered into a binding agreement to use the major component methodology to settle the repalrs 1ssue. Petitioner argues in the alternative that Mr. Shilliday's statement to Mr. Chasmar that Mr. Merkle had given "the green light" is binding on respondent, regardless of whether Mr. Merkle actually.agreed to use the methodology. Petitioner was aware that Mr. Shilliday did not have authority to bind respondent and that Mr. Merkle was the only person who had that authority. Unauthorized acts taken by Government agents do not bind the. Government. United States v. Killouch, 848 F.2d 1523, 1526 (11th Cir. 1988); Gardner v. Commissioner, 75 T.C. 475, 477-478 (1980); Webb v. Commissioner, T.C. Memo. 1994-549 (and cases cited therein), affd. without published opinion 68 F.3d 482. (9th Cir. 1995). in alleged disregard of instructions from the party, Petitioner relies heavily on Sun Oil Co. v. Behrino Props., Inc., 480 F.2d 310 (5th.Cir. 1973). to a land sale made another party his agent assenting to changes in- the contract transferring title. agent, agreed to an extension of Court of Appeals for the Fifth Circuit held that because the third party dealing with the agent had no notice regarding the limitations on the agent's authority, and nothing in the course of dealing or the relative positions of third party any indication that the agent exceeded its authority, the party was bound by the agent's unauthorized representations. time for executing the contract. the parties gave the In Sun Oil a party for purposes of The The Petitioner argues that Mr. Shilliday. had authority to communicate Mr. Merkle's acceptance of petitioner's offer to petitioner and that petitioner had no notice that Mr. Shilliday's (continued...) - 29 . As previ.ously mentioned, thë facts do not establish hat Mr. Merkle approved a settlement agreement. It is also.not c ear that Mr. Shilliday conveyed to Mr. Mer.kle an offer" from petitioner to enter into 'a binding agreement to use the mäjor component methodology regardless of the results it míght roduce. The-SSR does not state that FPL would not do·the work necessary to classify the work orders unless Mr. Merkle first agreed to a settlément- using the major component methodology. Mr. Chasmar reviewed the SSR in order to make (cid:0)541urethat the proposal therein was accurate. Mr. Chasmar did not suggest that language be inserted intó the SSR that would require a binding agreemènt by the .parties to use the major .component methodology before petitioner's classification of the 1,500 disputed work orders, nor did the SS1Faddress how ahy.disputes regarding thë p per classificatiòn of work orderslwould be rèsölved. Neither party produced contemporaneous1ÿ prepared documentation indicatlng that a binding settlement had been made. Undef the circumstanbes, the fact that Mr. Shilliday told Mr.' Chasmar that Mr. Merkle ad given '.'the green light to go ahead with the deail". is too "(. . .continued) communicatìons regarding Mr. Merkle's a leged acceptance inaccurate or unauthoriked. from Sun Oil regarding the limitations of the agent's authority to ass nt changes to assent conveying Mr. Merkle's assent. Petitioner knew that Mr. Shïl to anything. At best his authorstýNas limi'tëd to ere The instant case is distinguishable in'that .the third party÷in that case had no hotice to iday never had authority - 30 - ambiguous to create a binding contract to settle, even if Mr. Shilliday was authorized to convey Mr. Merkle's response to a proposal by petitioner. Petitioner also argues that, in the absence of a contract or apparent authority, respondent is estopped from refusing to. adopt the major component methodology. "'[T]he doctrine of equitable estoppel is applied against the Government "with the utmost caution and restraint."'" Kronish ir. Commissioner, 90 T.C. 684, 695 (1988) (quoting Boulez v. Commissioner, 76 T.C. 209, 214-215 (1981), affd. 810 F.2d 209 (D.C. Cir. 1987)). The elements necessary to succeed on an estoppel claim against the Government are as follows: the (2) an the Thus, law; (3) ignorance of is claimed; and (5) adverse the acts or statement of the one against in an opinion or (4) the true facts; (1) A false represen,tation or wrongful, The following conditions must be satisfied before equitable estoppel will be applied against Government: misleading silence by the party against whom the opposing party seeks to invoke the doctrine; error in a statement of fact and not statement of reasonable reliance on.the acts or statements of one against whom estoppel effects of whom estoppel is claimed. See Kronish v. Commissioner, supra at 695, and cases cited therein; Foam Recyclino Associates v. Commissioner, T.C. Memo. 1992-645. estoppel requires a finding.that.a claimant relied on the Government's representations and suffered a detriment because of that reliance. Schuster v. Commissioner, 312 F.2d 311 (9th Cir. 1962), affg. 32 T.C. 998 (1959), affg. in part First Western Bank & Trust Co. v. Commissioner, 32 T.C. 1017 (1959); Boulez v. Commissioner, supra; Estate of Emerson v. Commissioner, Underwood v. Commissioner, 535 F.2d 309 (5th Cir. 1976). 67 T.C. 612, 617-618 (1977); 63 T.C. 468 (1975), affd. in part and revg. - 31 Norfolk S. Corp. v. Commissioner, 104 T.C. 13, 60 (1995), affd. 140 F.3d 240 (4th Cir. 1998) . The elements of estoppel are. not met in this case. While there have been some misunderstandings, petitioner's argument that it reasonably relied on a false representation while in ignorance of the true facts is inconsistent with the previously discussed evidence. The testimony indicates that the statements made at the time of the alleged agreement were ambiguous. This, combined with the contemporaneous actions of the parties änd the lack of any contemporaneous ·documentation memorializing an 'alleged agreement on methodology, indicates that.there was no false representation on.which petitioner reasonably relied. In addition to the general requirements, in order to establish estoppel against the Government, there must be detrimental. reliance by the party claiming the. benefit of the doctrine. Boulez v. Commissioner, supra at 215. Estoppel applies against the Government only if, among the other required elements, the Government's wrongful act causes a serious injustice. Watkïns v. U.S. Army, 875 F.2d 699, 707 (9th Cir. 1989). Relative to more than $350 million of claimed deductions at stake in this case, the $10,000 petitioner spent to peþform the analysis of the 1,500 work orders is a minor cost to petitioner, insufficient to be considered a "serious injustice". Accordingly, "we conclude that the acts of reliance by petitioner 32 - do not involve the level of detriment necessary to bring the instant case within the category of those 'rare instances' where respondent should be estopped." Boulez v. Commissioner, supra at 216; see also Estate of Emerson v. Commissioner, 67 T.C. 612, 618 (1977 ) . Finally, the terms of the methodology agreement alleged by petitioner are too indefinite to form an ·enforceable settlement agreement. Indefiniteness and uncertainty as to any of the essential terms of an agreement have often been held to prevent the creation of an enforceable contract. 1 Corbin, Corbin on Contracts, sec. 4.1, at 525 (1993). A contract whose terms are so indefinite, uncertain, and incomplete that the reasonable intentions of the contracting parties cannot be fairly and reasonably distilled from them is not enforceable. Nelson Bros., Inc. v. Commissioner, T.C. Memo. 1991-52 (citing Cook v. Brown, 393 .So. 2d 1016, 1018 (Ala. Civ. App. 1981) ) . When the evidence c·learly shows, either by reason of definite language or otherwise, that the only (and the complete) subject matter that is under consideration is left for further negotiation and agreerñent, there is no contract. 1 Corbin, supra at 531. It is undisputed that Mr. Merkle retained authority to approve or dispute any of the classifications of the work orders that had been tentatively agreed to by petitioner and Mr. Shilliday. It is also undisputed that Mr. Merkle never approved - 33 - the classifications and never agreed to the final settlement figures proposed in the CSM, and there was no agreed mechánism . for resolving disputes as to the application of the methodology. Without an agreement on the proper classification of the 1,500 work orders, an essential element of an enforceable settlement agreement was missing. To reflect the foregoing, . An appropriate order will be issued denyina petitioner's motions to enforce settlement aoreement. Petitioner's counsel suggest that disputes over the this would place the Court the parties were to the alleged settlement and could likely involve. the 1,500 work orders could be in proper classification of.any of resolved by the Court. However, the position of deciding key issues that decide as part of a trial over potentially complicated issues. the alleged settlement was intended to avoid. When Mr. Shilliday was asked why he ·had not prepared a CSM in September the SSR he testified: least settlements in theory. otherwise the theory is useless to the Court. to, especially in a settlement, we have to do the numbers." We have to reduce the theory to a number "I just don't think, at A trial was what instead of I don't do The parties have - 34 - APPENDIX CC:LM:RFP:SLATL:TL-5271-96; 25084-96; 6653100; 10811-00 RJShilliday August 27, 2002 SETTLEMENT STATUS REPORT The Repair v. Capital Issue In re: FPL Group Inc. v. Commissioner Docket Numbers 5271-96; 25084-96; 6653-00; 10811-00 they be.capitalized under Sections 263 and ISSUE: Are costs incurred by FPL to perform work on its utility equipment deductible as ordinary, unnecessary [sic] business expenses under Sectïon 162 or must 263A? This is not an issue involving "heavy maintenance visits" nor does it involve the "plan of rehabilitation doctrine." This case involves the substitution or replacement of parts on FPL'S utility equipment equipment and portions of are not significant portions of materially increase the value and substantially prolong the useful involving both.major components of that the major components, which the equipment. the equipment life of that Proposal Florida Power work order in controversy be inspected by It is proposed that each for Settlement: . FPL's utility regulation accounting department, and a division of these work orders, between capital and repair, be made on the basis of whether the item of equipment being replaced is a major component of equipment or not. the The definition, of.major component is to be ? the Federal Energy Regulatory controlled by part 116 of Commission Regulations governing FPL's utility accounting practices. enclosed. Under methodology,. if an entire blower or fan, is being replaced on a piece of equipment, order involved will be classified as capital. the other hand the seals on the blower or fan are being replaced, that work order would be classified as a the major component settlement A copy of this regulation is for example, the work If on - 35 - The reason FPL capitalized the blower or fan repair. seals for utility accounting purposes is that Commission Regulations allow major component sub-accounts to be established at utility. down into various minor sub-components . These sub-accounts break the major componeñt the discretion of the For illustration of the workings of this settlement methodology, a group of work orders .Revenue Service by previously supplied to the Internal FPL was s'elected by the undersigned to be tested under the classification system. orders are numbered 1011 to 1642. of is as follows: The classification these work orders under the majbr component system The nonconsecutïve work Work Order Number Equipment. Amount Classification . . Capital or Repair 1011 1093 110 4 1111 1155 1227 1241 1281 1373-1374 1412 1429 1465 1522 1523 152 9 1546 Instrument . Flowmeter Seal s $163, 0 62 Turbo Changer $53, 718 . Pump Rotating Assy. $38,137 Motor Strainers $300,000 Tank Valve Snubbers . $350,000 Breaker Switch . Monitor Control Be aring $113, 168 Panel . $298,700 C C R R C R C R C C R C C C R P; 1564 1570 164 2 Mot or Gove rnor Impelle r $8 7, 118 C C R Eleven of the twenty work .order items, are major components of equipment resulting in the capitalization of work in an amount totaling $2,676,768. remaining nine work .orders were classified as repairs for a total of. $1,403,903. representative of orders, since only one plant was involved for a short period of time and that plant was · a nuclear plant . the entire body of contested work These results may not be The It is recommended that you approve the major component settlement system analysis and authorize FPL to conduct classification of completed, accuracy. I will check FPL' s analysis to ensure its the survey necessary to complete the the work orders in controversy. When a r The prototype for the major in situation three described in the the taxpayer is required to capitalize the cost Basis for Decision: component system is Rev. Rul. 2001-4, 2001-1 C.B. 295. This ruling involves the aircraft industry and concludes that ruling, of all work performed on the aircraft because the work involved replacements of major components. underpinning of three,. structural parts were also replaced, but is not presented in FPL since only replacements. of components are involved. is that significant portions of substarítial The other to situation the ruling, with respect that situation The adoption of a hard and fast rule that anythin other than the replacement of a major component, giv,en the detailed list of major components as developed by the Federal Energy Regulatory Commission,: is a system that can be used by the taxpayer for .classification purposes and monitored by Internal Revenue Service without the problem solving arena. minor component sub-accounts for tax accounting purposes preserves FERC' s utility accounting in its purest sub-accounts for tax purposes. form by disregarding FPL' s discretionary interjecting extensive subjective analysis into The elimination of FPL's Previously,. all attempts at settlement by is needed to .resolve this issue in FPL is. a reference to the general capitalization requirements of the code and regulations have resulted in failure. What relatively simple and objective system which eliminates engineers and utility expert witnesses from the accounting process. enclosed for your convenience, 1523 as an example of a typical FPL record, which is driving the classification process. A copy of Revenue Ruling 2001-4 is together with work order I will be happy to dïscuss tihe background of this issue with you at your convenience together with the change of the accounting method issue which has been the subject of so much rancor between the parties. Under this settlement approach, accounting method issue will not be addressed and a permanent system of accounting will await completion of the IRR process. the change of the J. nwTT3.mmv, Ro Special Trial Attorney CC: LN:RFP:SLCHI:ATL .