Court Opinion

ID: 4337415
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:21:07.614849+00
Date Added: 2024-06-11T14:20:50.851294
License: Public Domain

T.C. Memo. 2009-5

                       UNITED STATES TAX COURT

 ESTATE OF EUGENIA F. WILLIAMS, Deceased, FIRST TENNESSEE BANK,
                  N.A., Executor, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket No. 12210-02.              Filed January 6, 2009.

     Sheldon Kay, Joseph DePew, and William Merrit for

petitioner.

     Martha Weber, Nancy Hale, and James May, for respondent.

               MEMORANDUM FINDINGS OF FACT AND OPINION

     HOLMES, Judge:    Eugenia Williams was a wealthy woman who

lived a long life but had no natural heirs.      She decided to leave

almost her entire estate to four charities, with one important

exception.    She bequeathed the stock in a closely held company to
                                 -2-

the children and grandchildren of her father’s business partner.

After she died, there was hardfought litigation in Tennessee

state court between the charities (acting through her Estate) and

the family of her father’s partner.    They fought about whether

the stock had already been sold, about whether the terms of its

sale were unfair, and about whether some members of the family

had abused their positions of trust with Williams in numerous and

varied ways as she grew older.    The case was settled.   We must

decide whether the settlement supports an additional charitable

deduction to the Estate.

                           FINDINGS OF FACT

A.   Early History

     A little more than a century ago the Coca-Cola Corporation

had not yet even been organized, but James Patrick Roddy, Sr.

thought that bottling Coke would be a profitable enterprise.    He

needed a partner to sweeten his prospects with capital, so he

approached his friend and doctor, David Hitt Williams.    Dr. Will-

iams joined the venture, and in 1902 they started the Roddy Manu-

facturing Company.   Roddy Manufacturing was one of the first

Coca-Cola bottlers in the country and had an exclusive franchise

for eastern Tennessee and a bit of Kentucky.    Roddy proved him-

self an exceptional entrepreneur, and both Roddy Manufacturing

and its successor, Roddy Coca Cola Bottling Company (Roddy Coke),

became lucrative enterprises.
                                -3-

     J.P. Roddy, Sr. and Dr. Williams later expanded their

business by founding the Coca-Cola Bottling Company of Johnson

City, Tennessee.   At trial it was estimated that the David Hitt

Williams Trust (the Williams Trust), which held Dr. Williams’s

stock interests at the time of his death, owned just under 50

percent of Johnson City Coke’s Stock.

     Although it was Roddy and his family who actually ran Roddy

Coke and Johnson City Coke, Roddy and Dr. Williams remained

friends until Dr. Williams’s death in 1929.   Dr. Williams made

Roddy the executor of his will and the families remained close,

with the Roddy children becoming lifelong friends of Dr. Willi-

ams’s daughter, Eugenia.

     But while Roddy and his family were fruitful and multiplied,

the Williamses did not:
                                  -4-

     Eugenia was Dr. Williams’s only child to survive into adult-

hood.     J.P. Roddy, Sr. had two children, J.P. Jr. and Ellen Kate

Roddy.     Ellen Kate Roddy had no children, but J.P. Jr. had three:

J.P. Roddy III, Mary Ellen Roddy Mitchell, and Thomas Roddy (the

Third Generation Roddys).    (We include her husband, William

Mitchell, in the Third Generation Roddys).     The Third Generation

Roddys have ten children among them, whom we’ll call the Fourth

Generation Roddys.

B.   Dispersal of the Stock

     The shares of Roddy Coke and Johnson City Coke began to

disperse in 1929 with the deaths of both Dr. Williams and J.P.

Roddy, Sr.

     1.      J.P. Roddy, Jr.’s stock.   J.P. Roddy, Jr. gave a

portion of the stock that he inherited from his father to his own

children while he was still alive.      Hoping to avoid the problems

that can happen when a family’s block of shares becomes fragment-

ed over time, the Third Generation Roddys concluded a Stockholder

Agreement at the end of 1971 that established a Voting Trust.

The key term was their agreement to vote their Roddy Coke and

Johnson City Coke stock as a block; and they also agreed that if

any Roddy wanted to sell his stock, the other Roddys would be

granted rights of first refusal.

        On January 30, 1993, J.P. Roddy, Jr. withdrew the shares he

still owned from the Voting Trust.      In April 1993, the men of the
                                  -5-

Third Generation Roddys–-J.P. Roddy III, William Jess Mitchell,

and Thomas Roddy–-signed a Voting Trust Agreement with the Fourth

Generation Roddys.     This further consolidated the Third Genera-

tion Roddys’ control of the companies by expanding the 1971 Vo-

ting Trust to capture the Fourth Generation’s partial ownership

of the stock.    It also added one of them, Joseph Hodges McKenzie

Roddy, as a trustee.

      2.    The Ellen Kate Roddy Trust.   Ellen Kate Roddy, J.P.

Jr.’s sister, had no children.    When she died, the shares she

inherited from her father were placed in the Ellen Kate Roddy

Trust.     The Third Generation Roddys had control over this trust,

and it too was a member of the Voting Trust.

      3.    The Williams stock.   When Dr. Williams died in 1929,

his 386 shares of Roddy Coke stock and 10 shares of Johnson City

Coke stock became the corpus of the Williams Trust.     Eugenia was

the trustee, as well as the beneficiary of the Williams Trust’s

“income and profits.”    The remainder of the Trust was to be

divided between the National Geographic Society and J.P. Roddy,

Jr.

      Wealthy families and successful businesses are rarely left

unmarked by litigation; in 1930, Eugenia sued J.P. Roddy, Jr. to

determine whether she owned her father’s estate outright or sub-

ject to the Williams Trust.     Chandler v. Roddy, 43 S.W.2d 397
                                 -6-

(Tenn. 1931).   The answer was that her father’s property,

including his stock, would largely remain subject to a trust.

     More litigation erupted when Roddy Coke declared a stock

dividend.   National Geographic claimed the dividend was “corpus”

rather than “profits” of the trust.    Natl. Geographic Socy v.

Williams, 497 S.W.2d 908, 909 (Tenn. Ct. App. 1973).   If the

dividend was corpus, it would be distributed to National Geogra-

phic and the Roddys, but if it was income, Eugenia would get it.

Eugenia won that suit, and the Williams Trust distributed

additional shares of Roddy Coke stock to her.   Added to the stock

in the Williams Trust she owned as a trustee, she ended up in

control of 1,714 shares.

     These suits brought by National Geographic made J.P. Roddy

Jr. and Eugenia adversaries in court, but didn’t seem to embitter

relations between the families at all.   Despite the lawsuits, but

without a family of her own, Eugenia relied on the Roddy family

more deeply as she grew older.   Early in 1985, she appointed J.P.

Roddy, Jr. to be her attorney-in-fact, granting him broad powers

to manage all of her affairs.    That appointment was prompted by

the possibility that Eugenia might become unable to care for

herself as she grew older.   As it happened, within three years,

she moved to St. Mary’s Medical Center in Knoxville, where she

lived--by all accounts, well cared for--for the rest of her life.

J.P. Roddy Jr. was also becoming quite old and in 1989, Eugenia’s
                                 -7-

power of attorney was amended to allow William Jess Mitchell to

act on Eugenia’s behalf if J.P. Roddy, Jr. became incapacitated.

This meant that, from 1985 until her death, either J.P. Roddy,

Jr. or his son-in-law had the power to control all of Eugenia’s

affairs, including the disposition of her 1,714 shares of Roddy

Coke stock.

     Eugenia, it may be remembered, had been the trustee of the

Williams Trust since her father’s death in 1929.   She needed to

plan for that Trust and, in 1990, she named J.P. Roddy, Jr. and

the Third Generation Roddys as trustees.   This meant the Williams

Trust would have a trustee, but also meant that the Roddys, in

one capacity or another, would control nearly all of Roddy Coke’s

stock.

     In January 1991, the Roddys, acting as trustees of the

Williams Trust, agreed with the National Geographic Society to

have Roddy Coke redeem the Trust’s 386 shares for $1,640,500.

Even though Eugenia had an interest in the profits of the Trust

and the Roddys and National Geographic held an interest only in

the Trust’s corpus, Eugenia was not consulted before the redemp-

tion.    Instead, the Roddys redeemed her shares with William Jess

Mitchell acting as her attorney-in-fact.   After redemption, the

Voting Trust controlled more than 50 percent of the outstanding

Roddy Coke stock for the first time.
                                -8-

C.   The Merger

     During the early 1990s, Coca-Cola decided to integrate its

operations by consolidating control over its franchises.   What

happened after Coca-Cola reached into eastern Tennessee to gain

control over Roddy Coke and Johnson City Coke is what eventually

led to this case.

     Coca-Cola was willing to offer nearly $130 million for Roddy

Coke, but it did not want to get bogged down in disputes over how

to divvy up the money.   And so the transaction became quite com-

plicated.   In February 1990, the Third Generation Roddys and Rod-

dy Coke signed a right-of-first-refusal agreement with Coca-Cola

Enterprises.   The Agreement gave Coca-Cola Enterprises a right of

first refusal over any Roddy Coke stock that members of the Third

Generation Roddys wanted to sell, with certain exceptions for

intrafamily transfers.   The Agreement also specified the price

Coca-Cola Enterprises would pay for any shares of the bottling

companies that fell into the control of the Third Generation.

     The Roddys’ foresight in creating the Voting Trust was

proved.   Rather than a straight cash-for-shares deal, Coca-Cola

Enterprises paid the parties to the Voting Trust a control premi-

um of $24,500,000 for their majority ownership of Roddy Coke.

And Coca-Cola Enterprises also paid the Roddys who managed the

bottlers $8,700,000 as a special premium in the form of a noncom-

petition agreement.
                                 -9-

     Left outside this flurry of dealmaking were the shares held

by J.P. Roddy Jr. and Eugenia.   The Roddy witnesses testified

credibly that the family did not want to have J.P. Roddy, Jr.’s

low-basis stock sold for a considerable capital gain, only to

have the proceeds taxed again as part of his estate when he died.

     They also testified that, from their perspective, Eugenia

was in a similar situation.   She too was old, and she too would

be taxed on an enormous capital gain if she just sold her shares

into the merger.   But we find her position to have been diffe-

rent.   As the Roddys knew, she had no obvious heirs; and her

will, as they also knew, left her estate to charity--except for

the Roddy Coke stock.    So, if the Roddys sold her stock, all of

the proceeds would end up being taxed away as capital gains or

given away to charity.   If the stock could somehow be kept in her

name, none of its accumulated value would be taxed away as capi-

tal gains, and the stock would go to the Roddys under the terms

of her will.   Under the Roddys’ agreement with Coca-Cola Enter-

prises, that stock would then be sold at a set price.   The Roddys

would have to pay any tax on the capital gains (reduced by the

step-up in basis), and the Estate would have to pay any tax on

the stock’s value at the time of Eugenia’s death.   But at least

the money would not all go to charity.

     The Roddys’ solution to these problems was put in place in

April 1993.    Coca-Cola Enterprises and a subsidiary that it had
                               -10-

created to acquire the Roddy Coke stock agreed with William Jess

Mitchell (acting under his power of attorney for Eugenia) to a

“Right of First Refusal Agreement” with Coca-Cola Enterprises.

This Agreement barred J.P. Roddy, Jr. and Eugenia from transfer-

ring their Roddy Coke stock--other than by will--without the

consent of Coca-Cola Enterprises.     It set no purchase price at

which Coca-Cola would buy the shares.    It allowed for transfers

of Roddy Coke stock to Roddys who had signed the Right of First

Refusal Agreement with Coca-Cola Enterprises or were parties to

related agreements with Coca-Cola Enterprises or its affiliates.

And it required Eugenia’s shares themselves to bear a legend

noting that the shares were from that time on subject to these

restrictions.   But the Agreement was not a gratuitous transfer:

Coca-Cola Enterprises agreed to pay both Eugenia and J.P. Roddy,

Jr. four percent of the value of their stock holdings each year.

Between 1993 and Eugenia’s death, these payments totaled nearly

$6 million, and implicitly valued her stock at about $30 million.

    On the same day that it signed this Right of First Refusal

Agreement with the elderly Roddy Coke stockholders, Coca-Cola

Enterprises and its acquisition subsidiary signed a Conditional

Agreement with the Third and Fourth Generation Roddys.    This

Conditional Agreement included a promise by those Roddys that, if

any of them acquired Roddy Coke stock, they would “immediately”

sell it to Coca-Cola Enterprises at a price per share that was
                                -11-

equal to what Coke had been willing to pay in its initial offer,

but with a yearly increase of 1.5 percent in purchase price and

5.5 percent for interest.   The effect was to give both J.P.

Roddy, Jr. and Eugenia an income stream for the rest of their

lives, Coca-Cola Enterprises the right to buy that stock when

either of them died, and the Roddys who stood to inherit that

stock a higher sale price when they finally received and sold the

stock.

     On April 21, 1993, the transaction between Roddy Coke and

Coca-Cola Enterprises closed.   Under the merger agreement, Roddy

Coke remained in existence as a corporate subsidiary of Coca-Cola

Enterprises.   In that capacity it began to pay management fees to

its new parent for risk management, tax management, information

technology, and other similar services.1

D.    Eugenia’s Will and the Estate Distribution

      Eugenia Williams never changed her will after the merger.

She died on February 26, 1998 and bequeathed all of her property

except the bottling-company stock to several charities.    These

included bequests of $10,000 to the Old Gray Cemetery of

      1
        What happened to the Johnson City stock is somewhat un-
clear from the record. It seems, however, that nearly half of
the Johnson City shares were in the Williams Trust with the rest
subject to the Roddy family’s Voting Trust, and that the stock
found its way to Coca-Cola Enterprises in a parallel deal, albeit
with much lower numbers. In any event, the Johnson City stock,
because it was entirely subject to a trust in which Eugenia had
no residuary interest, never found its way to her estate. It
doesn’t affect the outcome of this case.
                                 -12-

Knoxville, more than $6 million to the University of Tennessee,

and the residue in equal shares to four Tennessee institutions:

St. Mary’s Memorial Hospital, the Printing House For the Blind,

Vanderbilt University, and the East Tennessee Children’s Hospital

(collectively, the Charities).

     Eugenia had named First Tennessee Bank as her executor, but

as early as October 1998 the Charities began to suspect that the

Roddys’ handling of Eugenia’s financial affairs had prevented

them from receiving a larger share of her estate.   Fearful of

litigation, the Bank was hesitant to distribute the stock to the

Roddys.   This meant that the Roddys could not take possession of

the stock, and could not sell it under the Conditional Agreement

to Coca-Cola Enterprises.

     The Roddys and First Tennessee Bank began moving toward a

solution by executing an Estate Distribution Agreement.   Under

this Agreement, the stock was put in a Restricted Fund.   The

Roddys were allowed to withdraw the stock to sell it to Coca-Cola

Enterprises, but with the proceeds going into the Restricted

Fund.   The Roddys could then withdraw some cash from the Fund, as

long as the Fund’s value did not drop below a minimum amount.

This Fund was to be the sole property of the Fourth Generation

Roddys, because the Third Generation Roddys had all disclaimed

any interest in Eugenia’s stock they might inherit.
                                -13-

     After receiving the Fund, the Fourth Generation Roddys

entered into a Tenants in Common Agreement.   Under this Agree-

ment, they paid to the Bank as executor the amount of the estate

taxes attributable to the Roddy Coke stock.   Each of the Roddy

beneficiaries also kept an interest in the Restricted Fund equal

to his allocable share of the Roddy Coke stock.   Other require-

ments under the Tenants in Common Agreement were that the Roddys

were each responsible for paying the income taxes attributable to

their portions of the Fund and that each Roddy’s allocable por-

tion was alienable.

     With these Agreements in place, the Bank distributed Eugen-

ia’s stock, and the Roddys sold the stock to Coca-Cola Enterpri-

ses for about $33 million.   None of these proceeds were returned

to the Estate; the Roddys did put $20 million of the proceeds

into the Restricted Fund.    The Bank then filed the Estate’s Form

706, valuing the 1,714 shares of Roddy Coke at $14,052,638.

     This meant that, whether through inheritance or via the

agreements they had signed years earlier with Coca-Cola Enterpri-

ses, the Roddys had received the entire value of the Roddy Coke

stock.   The stock was thus not considered part of the residuary

proceeds of Eugenia’s estate.   This resulted in each of the four

charities’ receiving a mere $6,695,774, much less than each would

have received if Eugenia had just sold her stock back in 1993 and

held on to what would have been left after taxes.
                               -14-

E.   The Charities Sue

     One could predict litigation.    From the Charities’ perspec-

tive, what the Roddys did to Eugenia--from the redemption of the

Williams Trust stock (giving their Voting Trust majority control

of Roddy Coke) to the payment to the Roddys of a control premium

to the Right of First Refusal Agreement that stripped Eugenia of

the power to sell her stock to anyone but Coca-Cola Enterprises--

all looked like a massive violation of the various duties that

various Roddys owed Eugenia, all aimed at getting as much of the

Roddy Coke stock’s value for themselves.    From the Roddys’ per-

spective, that’s more or less correct--but with the very large

reservation that they didn’t think they were violating any duties

they owed her.   Instead, they were fulfilling what they saw as

her desire that the Roddy family--not the IRS and not the Chari-

ties--realize the ultimate value of nearly a century’s worth of

work that their families had put into Roddy Coke when she died.

     The Charities prepared for war.    They wanted the much

greater profit from the actual sale of the stock, rather than

what was left of the payments which Eugenia had received under

the Right of First Refusal Agreement.    They demanded that the

Bank, as executor of the Estate, sue on their behalf.    An

administratrix ad litem, Anna Hinds, was appointed.     She then

sued William Jess Mitchell and the Roddys, demanding that all
                              -15-

proceeds from the sale of Eugenia’s stock be given to the

Charities.

     The original suit listed several causes of action; an

amended complaint added another for constructive sale.

       Defendant          Cause of Action            Result
William Jess Mitchell   Breach of duty as      Resolved by the
                        attorney-in-fact for   settlement
                        Eugenia F. Williams
J.P. Roddy, III         Breach of duty as      Chancery Court
Mary Ellen Roddy        co-trustees of the     ruled for the
Mitchell                David Hitt Williams    Roddys
Thomas Roddy            Trust
William Jess Mitchell   Constructive fraud     Resolved by the
J.P. Roddy, III         as Eugenia F.          settlement
Mary Ellen Roddy        Williams’ attorney-
 Mitchell               in-fact and as
Thomas Roddy            trustees
                        Breach of duties as
                        majority
                        shareholders
                        Civil conspiracy
                        Fraudulent
                        concealment and non-
                        disclosure
                        Conspiracy to
                        conceal and non-
                        disclosure
                        Intentional
                        interference with
                        inheritance
                        Conversion
                               -16-

                        Intentional            Dismissed by
                        interference with      Chancery Court
                        inheritance (this is
                        the only action in
                        which the Charities
                        themselves were
                        plaintiffs)
William Jess Mitchell   Constructive sale      Added by an
J.P. Roddy, III                                amended complaint,
Mary Ellen Roddy                               then resolved by
 Mitchell                                      the settlement.
Thomas Roddy
First Tennessee Bank
The Fourth Generation
 Roddys (added to
impose a
constructive trust)

     The Estate argued that the stock had been constructively

sold before Eugenia’s death because, if the stock had been sold

before her death, the proceeds would have become a part of Eu-

genia’s residuary Estate, much to the Charities’ advantage.     The

administratrix ad litem even moved for partial summary judgment

using this theory.   The parties argued fervently over the mo-

tion’s merits, but then settled before the Chancery Court ruled.

The settlement left the Charities with $20 million, all payable

from the Restricted Fund set up under the Estate Distribution

Agreement that the Roddy beneficiaries had negotiated with the

Executor.   Although all the defendants named in the various cau-

ses of action received the benefit of the settlement, the settle-

ment money came only from the Restricted Fund.
                                 -17-

F.   The Notice of Deficiency

     While the state-court suit was being fought, the Commission-

er began looking at the Estate’s tax return, and in April 2002 he

sent a notice of deficiency, determining that the Estate owed

$596,086.     The primary source of the alleged deficiency was an

understatement of $927,999 in the value of the Roddy Coke stock.

After litigation got underway, the Commissioner actually conceded

this issue--the parties now agree on a value of $12 million for

that stock--but the Estate began a counteroffensive by claiming a

refund under section 6512(b)(1)2 of the lesser amount of the va-

lue of the shares or the settlement proceeds distributed to the

Charities.    The Estate’s claim arises from the undisputed fact

that the Charities got more than the roughly $6 million each that

the Estate reported on the Form 706.     The Estate argues that this

additional money is nothing more than a share of the sale price

of Eugenia’s stock to Coca-Cola Enterprises.     The Commissioner

argues that any extra money that the Charities got is attribut-

able not to the shares, but to the settlement of the state-court

litigation.    He argues that any increase in the charitable deduc-

tion merely matches the value--which the Estate left off its re-

turn--of that litigation.

     2
       All section references are to the Internal Revenue Code,
and the Rule reference is to the Tax Court Rules of Practice and
Procedure.
                                -18-

     The Commissioner also moved to amend his answer before

trial.   In his proposed amendment, the Commissioner specifically

denied that the Estate was entitled to any deduction based on the

distribution of the Hinds v. Mitchell settlement proceeds, and

alleged that the value of that litigation may have exceeded the

amount of settlement.    He asserted a revised deficiency of

$11,659,891.

     The Commissioner later retreated, and agreed that he was not

seeking to impose an additional tax liability on the Estate based

on the value of the litigation asset, but only arguing that the

Estate was not entitled to an overpayment refund because any

increased charitable deduction would be neutralized by an in-

crease in the value of the gross estate.    The Commissioner is

arguing, in other words, that the cause of action the Estate had

against the Roddys is not the same thing as the shares of stock

that--however encumbered by side agreements--Eugenia still owned

on the day she died.    We granted the Commissioner’s motion to

amend his answer, but only as a clarification of his position

that the settlement proceeds did not give rise to an increase in

the Estate’s charitable deduction.

     Trial was held in Knoxville, where Eugenia died and the

Executor has its principal place of business.
                                -19-

                               OPINION

     We begin by noting how curious the Estate’s argument must

look to a nonlawyer:   Its own return listed the stock as a tax-

able asset that was to be distributed to the Roddys.   Eugenia’s

name was (at least metaphorically--there’s no indication the

stock was held in street name and it wouldn’t matter if it was)

on the shares.   And when the Executor distributed the shares to

the Roddys, they sold them to Coca-Cola Enterprises--what could

they possibly be selling other than shares of stock?

     So how can the Estate possibly argue that the settlement

proceeds are somehow legally the same thing as those shares of

stock?

     The Estate’s argument might appear to be either nearly fri-

volous or remarkably subtle.   Its essential point is nonintui-

tive--an assertion that the Roddys had effectively sold the stock

before they actually received it--and that, appearances to the

contrary, Eugenia did not, as a matter of law, own the stock when

she died.

     To decide whether this argument is nothing more than fizz

requires us to begin with a brief explanation of how courts ana-

lyze the taxability of proceeds from settlements of litigation.

This is a venerable problem--dating back at least to Lyeth v.

Hoey, 305 U.S. 188, 196 (1938)--and the general rule may be sim-

ply stated:   If the proceeds of a settlement represent something
                                  -20-

that would have been taxable, such as lost wages, then they are

taxable. Id.   However, if the proceeds of a settlement represent

something that is not taxable, such as a personal-injury award,

the proceeds are not taxable. Id.

     The Estate’s position becomes more plausible if one ap-

proaches it through some simple hypotheticals.     Imagine someone

who owns only a pearl of great price, which she intends to leave

to charity when she dies.     Imagine that she dies, and the charity

gets the pearl.     It can sell the pearl or keep it--and if it

sells the pearl, it keeps the proceeds.

     Now imagine that our hypothetical decedent wills the pearl

to two charities.     It’s most likely that the executor would sell

the pearl and divide the proceeds between the two charities.

With the step-up in basis at death (and, since it’s a hypotheti-

cal, no post mortem increase in value), these cash proceeds would

be treated by the IRS the same way as the distribution of the

pearl itself--no income tax, and the charities get the value of

the pearl.

     Let’s add a complication.     A third party learns of the pearl

and, rather than sell all that he has to buy it, steals it in-

stead.   The decedent dies.    Her estate sues the thief for conver-

sion damages or return of the pearl.     How should the estate re-

port this?    Theft doesn’t grant good title, but the thief has the

pearl.   The answer, we think, is that it doesn’t really matter.
                                 -21-

The estate could list the pearl as the asset.     Then, if the law-

suit against the thief leads to the pearl’s return, the estate

can distribute the pearl or, if the estate wins damages, can

distribute those damages to its hypothetical charitable legatees.

Lyeth v. Hoey teaches us to treat any settlement proceeds as if

they were what they are substitutes for--in our hypothetical--the

pearl.   The right to damages would in some sense be the same as

the pearl of great price or, at the very least, not an additional

asset of the estate.

     Add another twist:    The thief turns out to be clever.   In-

stead of coming in the night to steal the pearl, he comes in the

bright light of day with a cleverly designed paste pearl which he

substitutes for the real one.     The decedent dies.   We can see no

reason why the results of the last hypothetical don’t again

apply:   The estate could list the real pearl as an asset, but

would really have only a right of action against the thief for

damages or return of the pearl.     In the end, again, the right to

damages would be treated the same as the pearl of great price

--not as an additional asset of the estate.

     And one last hypothetical:     The hypothetical decedent’s

hypothetical estate doesn’t realize at first that all it had was

paste, so it lists the pearl on its return as if it were the

pearl of great price.     If our hypothetical decedent left the

pearl not to charities but to friends, the estate might pay tax
                               -22-

on the value of the pearl.   But then the estate realizes that the

pearl of great price is missing.   The thief has long since sold

it.   The estate would still have only a right of action against

the thief for conversion or restitution.   Any damages would again

be taxed the same as if the pearl itself were returned.    But if

the estate won only money, rather than the return of the pearl,

the specific bequest of the pearl would be defeated.3

      We return to the real world, only to face a complication

absent from our hypotheticals--the Roddys, far from being

thieves, were the objects of Eugenia’s affection.    She wanted

them to receive the stock-of-great-price and said so in her will.

But the problem here is that the Roddys may have so encumbered

that stock with restrictions and diminished it in value that Eu-

genia’s estate might have been left with something that was--if

not a paste pearl--not really the same as the stock Eugenia had

before the Roddys’ deal with Coca-Cola Enterprises back in 1993.

      And that is the Estate’s argument here.   It is claiming a

refund because it originally paid taxes on the Estate’s Roddy

Coke stock as if it all went to the Roddys instead of treating it

as having been constructively sold years before.

      3
        The estate-law term for this is “ademption by extinc-
tion,” defined as the “‘doing of some act with regard to the
subject-matter which interferes with the operation of the will.’”
University of the South v. Klank, 984 S.W.2d 602, 604 (Tenn.
1999) (quoting Am. Trust & Banking Co. v. Balfour, 198 S.W. 70,
71 (Tenn. 1917)).
                                -23-

     The Commissioner argues that the stock was never sold till

after Eugenia died, and so the settlement proceeds must instead

have been proceeds of an asset--the Estate’s tort action against

the Roddys--that wasn’t listed on the original return.      If the

Commissioner is correct, the settlement proceeds would still be

part of the residual estate and still go to the Charities, but

because the litigation asset was not listed on the return, it

would not have been accounted for in the original estate tax paid

and the Estate would not be entitled to a refund now.

     The parties battle on two fronts.   The first is the effect

of the Roddys’ Estate Distribution Agreement with the Executor on

the characterization of the settlement proceeds.   The Commission-

er says the terms of that Agreement show that the Roddys had such

unfettered control over the stock as to prove that they really

owned it.   The Estate argues that the Restricted Fund was, well,

restricted--and so proves nothing.

     The second front is how to interpret the Settlement Agree-

ment itself, together with the negotiations leading to it.     And

to characterize settlement proceeds for tax purposes:

            we must look to various factors, including
            the allegations in the State court pleadings,
            the evidence adduced at trial, a written
            settlement agreement, and the intent of the
            payer.

Threlkeld v. Commissioner, 87 T.C. 1294, 1306 (1986), affd. 848
F.2d 81 (6th Cir. 1988).
                               -24-

A.   The Estate Distribution Agreement and Restricted Fund

     The Estate Distribution Agreement was a compromise between

the Executor and the Roddys.   Both the Commissioner and the Es-

tate agree that the Restricted Fund that the Agreement created

was subject to constraints, but it was also a creative solution

to another problem:   It was clear that the Estate’s tax liability

would be due before the resolution of any potential claims the

Charities or the Estate had against the Roddys.   A simple distri-

bution of the shares to the Roddys would have left the Bank open

to potential liability to the Charities.   But if the Bank com-

pletely refused to distribute the shares to the Roddys, it could

have been violating its duty to the Roddys as beneficiaries under

the will.   And, most importantly in our view, it would have

possibly been stripping off much of the value of the shares--

salable as they were at a high price under the Conditional Agree-

ment between the Roddys and Coca-Cola Enterprises.

     The testimony of Keith Keisling (an officer of First Tennes-

see Bank) and Jim Roddy (which we specifically find credible on

this point), as well as the Estate Distribution Agreement itself,

made clear the parties’ intent.   Keisling testified that the

Estate Distribution Agreement was a mechanism for the Executor

both to ensure that the taxes would be paid and to avoid any

liability to the Charities, which were already expressing con-

cerns over the disposition of the stock.   Jim Roddy similarly
                               -25-

testified that the Estate Distribution Agreement was necessary

because:

           We needed to pay Estate taxes on this asset
           that was going to come to us, and we did an
           agreement with the trustees whereby we would
           sell the stock into a tenants in common
           restricted account. In the event that the
           shares didn’t belong to us, we would return
           it back to the Estate, but at this time, you
           know, the determination was that the shares
           would go to us and we would treat it that
           way.

     The Estate Distribution Agreement also contains a provision

that the restrictions on the Restricted Fund--and thus the Estate

Distribution Agreement itself--would terminate upon the earliest

of: the release by the Executor of any claims on the shares’ va-

lue; the issuance of a final (nonappealable) court order regard-

ing the disposition of the shares; or April 2, 2003.   This indi-

cates that the Estate Distribution Agreement was not an outright

distribution to the Roddys, but something resembling the res in

an interpleader.   It is as if the parties to a dispute about the

ownership of a load of bananas reasonably agree between them-

selves to sell the fruit before it spoils, and continue their

fight over the proceeds.   See also, e.g., U.C.C. sec. 2-704(2)

(1998).

     The Commissioner argues that the Roddys held sufficient

control over the Restricted Fund to make it the Roddys’ property.

Many factors support this argument:   The Roddys had discretion--

with the Estate’s permission as cosigner--to invest the proceeds
                              -26-

in cash or any readily marketable securities, “the sole property

of the Roddy Beneficiaries;” the Roddys were allowed to make

withdrawals from the Fund to pay taxes related to income from the

Fund if the Fund’s income exceeded 4 percent; and the Roddys ack-

nowledged in the Agreement that the sale of the stock would re-

sult in tax consequences to them.    The Commissioner also argues

that if the Roddys did own the Restricted Fund, the settlement

payment was made from the Roddys’ own property, indicating it was

actually the settlement of a tort claim.   We don’t think any of

this makes much difference--the Estate’s theory is that the

Roddys’ payment back to the Estate was the equivalent of return-

ing proceeds from the sale of the stock, not additional compensa-

tion for other torts committed against Eugenia, and the source of

the funds used for the payment makes no difference to that char-

acterization.

     The Estate points to the significant restrictions on distri-

butions from the Restricted Fund as evidence that the sale pro-

ceeds never actually accrued to the Roddys.   The Estate contends

that, though meandering, the path the money took led to the same

destination it would have reached if Eugenia had sold the stock

and the Charities received the money as residuary beneficiaries.

     The Estate does highlight one fact about the settlement’s

having been paid out of the Restricted Fund--because the Third

Generation Roddys had disclaimed any interest in the shares, that
                                 -27-

payment from the Restricted Fund was a direct loss only to the

Fourth Generation Roddys.   And the Fourth Generation Roddys did

not have the same duties to Eugenia as the Third Generation

Roddys.

     We therefore find that the Restricted Fund was created as a

receptacle for the proceeds of the stock until any legal issues

between the Roddys and the Estate could be resolved and the stock

or its proceeds could be properly distributed.    We hold that its

terms do not affect our characterization of the settlement pro-

ceeds as either compensation for torts or other wrongs committed

by the Roddys, or as restitution for a constructive sale of Eu-

genia’s stock before she died.

B.   Characterization of the Settlement in Hinds v. Mitchell

     We next turn to a direct analysis of the settlement proceeds

from the state-court litigation.    The Estate urges us to begin

and end with the language of the Settlement Agreement.    That

Agreement is quite clear:

          Whereas, Hinds and the Residuary Beneficia-
          ries contend in the Litigation that the spe-
          cific bequest of the [shares] was, as a mat-
          ter of law, adeemed and/or the said shares
          were constructively sold, and thus the
          [shares or their value] actually passed or
          should have passed to the Residuary Benefici-
          aries.

This was the only cause of action specifically named in the

Settlement Agreement.
                               -28-

     The Commissioner argues that we shouldn’t rely on the Agree-

ment’s text.   He asserts that the Agreement was written in collu-

sion between the Roddys and the Charities once they realized that

pinning the settlement proceeds to the constructive-sale theory

could lead to a significant refund claim redounding to the bene-

fit of the Charities as residuary legatees and letting them ease

up on the Roddys in negotiating the settlement.    He argues that

the parties in Hinds v. Mitchell had every incentive to tailor

their settlement in a manner that would minimize ultimate tax

liability and thus maximize their available funds.    The Commis-

sioner’s strongest argument is to point out that the parties in

Hinds v. Mitchell were adverse to each other only as to the

state-law causes of action.   When it came to the settlement’s tax

consequences, the parties and their attorneys understood (and we

so find) that any funds kept from the IRS would increase the

amount they could divide among themselves.      This is not a new

problem.   In Bagley v. Commissioner, 105 T.C. 396, 400-01 (1995),

affd. 121 F.3d 393 (8th Cir. 1997), we analyzed a settlement

between the two parties to a tort action involving tortious

interference with present employment, tortious interference with

future employment, libel, and invasion of privacy.    Under the

settlement, the defendant paid $1.5 million to Bagley, the plain-

tiff, to settle all claims. Id. at 403.    The defendant’s inter-

ests were minimizing cost, avoiding publicity, eliminating the
                                -29-

risk of punitive damages, retrieving some corporate documents,

and obtaining a full release.    We analyzed the problem of alloca-

ting damages in that case by placing the facts in Bagley in a

range bounded by Robinson v. Commissioner, 102 T.C. 116 (1994),

affd. in part and revd. in part 70 F.3d 34 (5th Cir. 1995), and

McKay v. Commissioner, 102 T.C. 465 (1994), vacated without pub-

lished opinion 84 F.3d 433 (5th Cir. 1996).    We began by acknow-

ledging that the allocation of a settlement by the parties is

“generally binding for tax purposes to the extent that the agree-

ment is entered into by the parties in an adversarial context at

arm’s length and in good faith.”    Bagley, 105 T.C. 407.     In

Robinson, however, the allocation didn’t control because it “was

uncontested, non-adversarial, and entirely tax-motivated, and did

not accurately reflect the underlying claims.” Id. at 407.     By

contrast, in McKay the settlement had been made by “hostile par-

ties who were in an adversarial position with respect to the al-

locations to be made in the settlement.” Id.

       In Bagley, we reasoned the facts were not like those in

McKay, where the taxpayer lacked the “freedom to structure the

settlement on his own,” whereas in Bagley the parties had been

“jointly participating in the drafting of the agreement.” Id. at

408.    This led us to conclude that the settlement documents were

not controlling.    Yet Bagley was also unlike Robinson, because
                               -30-

totally tax-motivated collusion was missing, too.   The answer was

somewhere in between:

           Based on these facts, we conclude that some
           of the $1.5 million is properly allocable to
           punitive damages. However, we do not agree
           with the amount [the Commissioner] allocated.
           The parties were negotiating for an amount in
           lieu of the overall amount petitioner might
           recover if the case went to trial. They were
           considering the risk of trial, as well as
           items unrelated to the money that petitioner
           might recover, such as the return of the
           Bagley documents and the confidentiality of
           the settlement.
Id. at 410.   We proceeded to list the various factors important

to Bagley’s former employer, including the avoidance of punitive

damages.

     We begin here with what the witnesses in the present case

said their motivations were.   Doris Allen, an attorney who repre-

sented two of the Third Generation Roddys and their families,

testified with some credibility that from the Roddys’ perspec-

tive, the sole ground for settlement was the constructive-sale

theory, and they would not have settled on any other theory.    She

also credibly testified that she thought at the time that the

strongest legal theory in the litigation was the constructive-

sale issue.   Jim Roddy, a Fourth Generation Roddy, testified that

the only theory the defendants thought might succeed was the

constructive-sale theory.

     Two attorneys for the Charities also testified, and both

credibly confirmed that the constructive-sale theory had been at
                                -31-

least a factor in the settlement.      David Black, who had represen-

ted the American Printing House For the Blind and then the admi-

nistratrix ad litem, testified that “the most straightforward”

cause of action for the administratrix to prevail on would have

been the constructive-sale theory.     This was due at least in part

to the lack of a need for any “proof of intent” or “establishment

of bad acts.”   Black also testified, however, that litigation

would have been ready to proceed on any of the causes of action

listed in the complaint.    Even as the Commissioner’s witness,

Black testified on direct examination that the plaintiffs in the

Hinds case were prepared to go forward on all counts which they

believed viable after discovery.    This would, of course, have

included the constructive-sale theory.

     Taking that testimony into account, we find that settling

the constructive-sale theory was the dominant, but not exclusive,

motivation of the Roddys.   This finding is also supported by the

evidence that, at an early point in the administration of the

Estate, both the Executor and the Charities had concerns about

the propriety of the 1993 transactions and their potential to

give rise to both constructive-sale and breach-of-fiduciary-duty

causes of action.   Indeed, the Bank was worried enough to seek

legal advice on both these issues and supported the appointment

of an administratix ad litem to pursue both.
                               -32-

     We also acknowledge the strength of the Commissioner’s

argument that the constructive-sale and various breach-of-

fiduciary-duty causes of action were intertwined.   The Third

Generation Roddys, and especially William Jess Mitchell, owed a

number of duties to Eugenia in various capacities--as her

attorney-in-fact, as trustees of the Williams Trust, and as

officers and directors of Roddy Coke and Johnson City Coke.     And

the Estate’s original complaint alleged that the Roddys breached

these duties in 1993 by securing for themselves the ability to

sell both their own and eventually Eugenia’s stock to Coca-Cola

Enterprises while receiving a control premium--a premium so large

that it deprived Eugenia of full value from the deal.

     But we must also acknowledge that all those involved thought

that the constructive-sale theory suffered from far fewer weak-

nesses than any of the tort theories.   Proposed finding 49 in the

Estate’s opening brief states that “the executor’s attorneys ad-

vised [the Charities] that the executor would not prevail in any

such litigation [i.e., the tort litigation],” and proposed find-

ing 55 states, “In October and November 1998, the residuary bene-

ficiaries raised concerns to the petitioner’s personal represen-

tative (executor) involving the bequest of the [Roddy Coke] stock

to the Roddy family.”   While the Commissioner objects to both of

these, he does not offer any specific rebuttal, and we find them

to be proved.
                               -33-

     The most important weakness of the various tort theories was

that the Roddys had a plausible argument that the 1993 transac-

tions were fundamentally fair to Eugenia in that the Right of

First Refusal payments and the other payments she received

constituted an acceptable alternative to paying a large capital-

gains tax and seeing what was left of the proceeds go to the

Charities.   They could point to the similar deal they negotiated

with the Roddy patriarch, J.P. Roddy, Sr.

     Eugenia was, moreover, never formally judged incompetent.

There was credible testimony that the Roddys and their lawyers

strongly believed that absent a finding that Eugenia was incompe-

tent, any action based on a breach-of-duty theory would have been

subject to a statute-of-limitations defense.     Indeed, the Es-

tate’s attorneys originally rejected the idea of pursuing the

breach claim in part because of this.

     We also find on the basis of the credible evidence in the

record4 that the parties thought that trial of the fiduciary-duty

causes of action might lead to a judgment that the stock or pro-

ceeds from its sale must be disgorged.     See Freeman v. Martin,

181 S.W.2d 745, 746 (Tenn. 1944).     This means that even the

     4
        We use phrases like “credible evidence” in discussing
state law because our focus in allocating the settlement proceeds
is not on what the law is (obviously a legal, not a factual,
question), but on what the parties and their lawyers thought the
law was when agreeing to the settlement.
                                 -34-

settlement value of the tort causes of action had a hefty

restitutionary component.

     And, finally, we note that the economic burden of the

settlement fell entirely on the members of the Tenants in Common

Agreement--the Fourth Generation Roddys, who were named defen-

dants only in the amended complaint’s cause of action for con-

structive sale.   We find this very significant, because it shows

that all the damages paid under the Settlement Agreement were

being paid by only some of the Roddys, who presumably had an

incentive not to bear the costs of the settlement entirely on

their own without good reason.

     Nevertheless, even the Fourth Generation Roddys were Roddys,

and so (if possessed of any filial affection) they would benefit

at least intangibly from the releases of their elders in the

Third Generation from all the causes of action in which those

Roddys were the named defendants.       Even J.P. Roddy, Jr.’s estate

was released from any liability, and he had had the primary obli-

gations to Eugenia for some of the years involved.

     Weighing these various factors is not something we can do

with great precision.   But persuaded especially by where the

economic burden of the settlement lay, and the parties’ reason-

able estimation of the probabilities of success on the different

causes of action, we find that 90 percent of the settlement

proceeds is allocable to the constructive-sale theory, with the
                              -35-

remainder allocable to the tort theories (or, more precisely, the

damages-other-than-monetary-equivalent-of-the-stock theories).

Thus, 90 percent of the settlement proceeds should be considered

to be only a return of the value of the stock to the Estate and

not compensation for any profits or income to Eugenia.

     Petitioner having agreed to a refund of the lesser of this

amount or the stipulated value of the shares, and to reflect the

parties’ various other concessions and stipulations,

                                     Decision will be entered under

                              Rule 155.