Opinion ID: 614511
Heading Depth: 1
Heading Rank: 4

Heading: The lack of intent to share profits and losses

Text: In light of Culbertson's identification of the actual control of income and the purposes for which it is used as a metric of a partnership's legitimacy, the terms of the GNMA basis-build constitute compelling evidence that Southgate was not a true partnership. Beal reserved for himself total control over all of the income produced by the GNMAs. At the time of their contribution to Southgate, the GNMAs could have provided real economic benefits to the partnership in any of four distinct ways. But the structure of the basis-build transaction ensured that Southgate would never receive any of those benefits. First, the GNMAs had been used as collateral to obtain a $162 million secured loan from UBS. The loan proceeds were derived from the value of the GNMAs, but Beal did not distribute any of the proceeds to Southgate. Instead, he injected the $162 million back into the Bank as capital. There was no prospect of Southgate's ever receiving any of the loan proceeds. Second, the GNMAs would attract principal payments as the owners of the mortgages backing the securities made their mortgage payments. [67] These payments, too, were diverted away from Southgate pursuant to Beal's unconditional right to direct the use and application of all proceeds from the GNMAs. The principal payments were used to repay UBS for the secured loan, thereby ensuring that the loan remained a self-liquidating transaction. There was no prospect of Southgate's ever receiving any of the principal payments. Third, the GNMAs bore a fixed annual interest rate of 7 percent. This was a major source of the GNMAs' immediate present value during the time they were held by Southgate. But Southgate's amended operating agreement explicitly provided that all of the interest that accrued on the GNMAs after their contribution to Southgate was allocated to Beal. There was no prospect of Southgate's ever receiving any of the interest income. Finally, the value of the GNMAs could increase in response to interest-rate fluctuations. In other words, the market price of the GNMAs would necessarily reflect their relative attractiveness vis-a-vis other available investment options. If interest rates were to rise, the GNMAswith their fixed interest rate of 7 percentwould become relatively less attractive to investors, and their market value would go down. If interest rates were to drop, the GNMAs would become relatively more attractive, and their value would climb. When Beal contributed the GNMAs to Southgate, he agreed that if a drop in interest rates were to cause the GNMAs to gain in value, any post-contribution gain was to be shared among all three Southgate partners. Thus, there was a prospect that Southgate might receive some economic benefit if GNMAs appreciated in value. But that prospect existed only on paper. In the absence of a realization event, any gain in the value of the GNMAs would not actually redound to the benefit of the partners. As the district court found, Southgate's other partners could share in the gain only in the event of a sales transaction. But Southgate's amended operating agreement gave Beal the absolute right, in his sole discretion, to determine whether, and if so when, the GNMAs would be sold. If Beal wanted to avoid a sale, he had an absolute right to cause Martel to distribute the GNMAs back to Beal, and such a distribution would not create an obligation on Southgate's part to make corresponding distributions to Montgomery or Cinda. And the district court found that Beal never intended to share any potential gains or losses from the GNMAs with the other partners in Southgate. [68] In light of the vise grip that Beal maintained on all economic benefits flowing from the GNMAs, the district court was correct to conclude that the GNMA basis-build lacked objective economic reality under Klamath. Beal reserved for himself all loan proceeds, principal payments, interest income, and built-in gain. He contributed the right to share in any post-contribution gain in the event the GNMAs were sold, but he retained an unconditional right to decide whether to sell the GNMAs in the first place, and he had no intention of selling them. Stripped to its essentials, Beal's putative contribution of the GNMAs was no contribution at all. When an asset is contributed to a partnership that will only benefit the partnership in the event of a sale, on terms and under circumstances that make it beyond unlikely that a sale will occur, with the result that no sale ever occurs and the partnership receives no value from the contribution, the contribution cannot be said to have economic substance. [69] For present purposes, the economically insubstantial nature of the GNMA basis-build is important primarily because of what it reveals about the intentions of Beal, Montgomery, and Cinda. [70] The sine qua non of a partnership is an intent to join together for the purpose of sharing in the profits and losses of a genuine business. Because of the basis-build transaction's structure, the district court found, Beal personally received all of the potential benefits, and retained all of the risks, associated with the GNMAs. Beal's decision to structure the basis-build as he did, Montgomery's willingness to accede to such one-sided terms, and Cinda's total lack of participation in the transaction are inconsistent with their professed intent to share, as partners, in Southgate's profits and losses. [71]