Opinion ID: 778862
Heading Depth: 2
Heading Rank: 2

Heading: Camelot's decision to purchase the COLI VIII plan

Text: 25 The evolution of Camelot's COLI plan began in 1985, when Henry F. McCamish, a life insurance entrepreneur, developed a series of COLI policies to produce maximum cash flow (through interest deductions) for the companies that bought them. CM Holdings, 254 B.R. at 586. The original plan evolved over time to reflect changes in the tax law. In response to a 1986 amendment limiting deductibility of policy loan interest to $50,000 per insured, the payment schedule was altered so that payments ceased once the $50,000 loan limit was reached. Id. at 587. The plan was further modified to reduce the amount of premium paid per thousand dollars of death benefits to comply with 26 I.R.C. § 7702A, also enacted in 1986. Id. at 588. As noted, Camelot purchased the eighth version of the plan developed, known as the COLI VIII plan. 26 The Newport Group, Inc. (Newport) marketed the COLI VIII plan to Camelot. Jack Rogers, the CFO of Camelot, spoke with James Campisi of Newport in detail about it. Campisi described the COLI VIII plan's key factor to be its ability to absorb the interest deductions. Id. at 588. In December 1989, Campisi sent Rogers a set of 40-year sales illustrations showing projected cash flows and earnings performance. Id. at 589. In a memorandum, Rogers enumerated the risks attendant for Camelot: 1) A retroactive tax law change[,] 2) Camelot's failure to generate taxable income over several years in a row[, and] 3) IRS attack. Id. at 590. 27 Despite these risks, the policies went into effect on February 16, 1990. Although the policies were designed to be mortality neutral ( i.e., neither Camelot nor MBL expected to profit from the timing of employees' deaths), Camelot did receive an unexpected aggregate mortality gain of $1.3 million for the first eight years. CM Holdings, 254 B.R. at 633. However, even with this gain, absent interest deductions the plan would not have been profitable to Camelot. Id. at 634. Hartford (which, as noted, purchased MBL's COLI business) later added surcharges to recoup its mortality losses and ensure that such losses would not recur. Id. 28 After Congress passed the Health Insurance Portability and Accountability Act of 1996, Pub.L. No. 104-191, 110 Stat.1936, 2090, which phased out interest deductions on COLI loans, Camelot quickly instructed Hartford to stop billing it for annual premiums and to allow the policies to function as paid-up policies for a reduced amount of death benefit coverage. CM Holdings, 254 B.R. at 640. At the same time, Camelot made a partial withdrawal of policy value, called a force-out, and used it to pay off $26 million of the loan. Camelot recognized the $26 million as income, but was able to offset it with net operating loss carry forwards. Id. at 641 & n. 82. 29 In August 1996, Camelot filed for Chapter 11 bankruptcy protection in the District of Delaware. The District Court automatically referred the proceeding to the Bankruptcy Court. In November 1997, the Internal Revenue Service (IRS) filed a proof of claim for $4.4 million in taxes, $1.8 million in pre-petition interest, and a $1.35 million accuracy-related penalty. Camelot objected, creating an adversary proceeding, and the Government requested the District Court to withdraw the automatic reference from the Bankruptcy Court pursuant to 28 U.S.C. § 157(d). The District Court granted the motion. Internal Revenue Serv. v. CM Holdings, Inc., 221 B.R. 715, 724 (D.Del.1998). 30 On the merits, the District Court held that the loading dividends for years four through seven were shams in fact, and that the plan as a whole was a sham in substance. It also imposed accuracy-related penalties under 26 U.S.C. § 6662 for Camelot's substantial understatement of taxable income. CM Holdings, 254 B.R. at 654. 3