Thursday, June 28, 2018
The needs and capabilities of a farming or ranching business (or any business for that matter) need to be integrated with business and estate plans, and the retirement needs, of each of the owners. A buy-sell agreement is a frequently used mechanism for dealing with these issues. For many small businesses, a well-drafted buy-sell agreement is perhaps just as important as a will or trust. It can be the key to passing on the business to the next generation successfully. For most farming and ranching operations, succession planning is now more important than estate tax planning. That makes a good buy-sell agreement an important document.
Buy-sell agreements – the basics of what they are and how they work, that’s the topic of today’s post.
A buy-sell agreement is typically a separate document, although some (or all) of its provisions may be incorporated in its bylaws, the partnership agreement, the LLC operating agreement and, on occasion, in an employment agreement with owner-employees. Major reasons for having a buy-sell agreement include: establishing continuity of business ownership; providing a market for otherwise illiquid closely held shares; establishing a funding source and a mechanism for share purchase; establishing certainty as to the value of the shares for estate purposes; and providing restrictions on operational matters, e.g. voting control and protection of S corporation status.
Establishment of Estate Tax Value
While very few farming and ranching operations (and small businesses in general) are subject to the federal estate tax because of the current level of the exemption, some are. For those that are, in addition to providing a market for closely held shares at a determinable price, the buy-sell agreement can serve as a mechanism for establishing the value of the interest for estate tax purposes – or otherwise establish value of the decedent’s interest at death.
There are six basic requirements for a buy-sell agreement to establish value of a deceased owner’s interest: (1) the interest must be subject to an option to purchase that is a binding obligation on the estate; (2) the purchase price must be established with certainty; (3) the interest must not be subject to lifetime transfers that could defeat the obligation to purchase; (4) there must be a “ bona fide business arrangement”; (5) the agreement cannot be a device to transfer at lower than fair market value; and (5) the agreement must be comparable to similar arrangements between persons in an arms-length transaction.
The estate must be obligated to sell; however, there is no requirement for the purchaser to buy. However, there is often an additional provision in such agreements to provide that if adequate funding is available, the survivors are obligated to purchase in order to provide estate liquidity, and often to protect the deceased shareholder’s family from the vagaries of the ongoing business.
To establish the purchase price with certainty an appropriate valuation method must be established. An independent party valuation will not only satisfy the requirements of § 2703 but also provide an estimate of the potential funding obligation and the liquidity expectations of the seller/estate. See Rev Rul. 59-60 as amplified by Rev. Rul. 83-120,1983-2 CB 170.
A key point is that, to be effective in establishing a value for estate tax purposes, the buy-sell agreement must provide that the corporation or shareholders are either obligated or have an option to purchase the shares of a holder who desires to sell within his lifetime, at the same price and on the same terms as provided for upon the death of the shareholder. A right of first refusal will not accomplish the same objective and will potentially contravene the requirements of I.R.C. §2031. From the selling shareholder’s viewpoint, either an option or right of first refusal may not be acceptable because of their failure to guarantee a market for the shares.
The long-established position of the IRS is that, “It is always necessary to consider the relationship of the parties, the relative number of shares held by the decedent, and other material facts to determine whether the agreement represents a bona fide business arrangement or a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth”. Rev.Rul 59-60, 1959-1 CB 137. See also Estate of True v. Comr., T.C. Memo 2001-167(2001), aff’d 390 F. 3d 1210 (2004), and Estate of Blount v. Comr., T.C. Memo 2004-116(2004).
Valuation methods. There are several general valuation methods for buy-sell agreements.
One method is the fixed value method. Under this method, the value of the interest being valued doesn’t change. It is not used much, and would not meet most IRS requirements under IRC §2703(b) and the regulations.
Another approach is one that uses an appraisal to value the underlying business interest. This method is also rarely used for operating businesses, but may be appropriate for certain types of business such as real estate. If this method is used it is often a triple appraisal approach, where the purchaser and estate each appoint an appraiser who appoints a third if the first two cannot agree. A drawback is that the valuation is left until the triggering event (death, disability, etc.), leaving the owners with little guidance for the necessary funding decisions.
The formula method uses book value from the financial statements of the business to value the interest. That is relatively easy to determine, but it will result in a significant deviation from fair market value unless adjusted for such matters as the company’s accounting method, differences between book and fair market value for real estate, equipment, other tangible assets and intangible assets. Other adjustments may include accounts receivable to reflect collectability, and an examination of the adequacy of reserve accounts.
Another formula method is one based on earnings which are then capitalized to arrive at a proper value. The selection of an appropriate capitalization rate is an important determination, and it must be recognized that a rate appropriate at the time of the agreement may not be appropriate later due to a change in business or the economic environment.
Agreed value is another frequently used method of valuation, usually combined with periodic adjustments by the parties. This is often coupled with a back-up valuation method to take effect within a certain period of time if a value has not been adopted.
Another commonly used provision is one that requires any outside purchaser of the business to adopt the buy-sell agreement. In the case of a limited liability company, the requirement may be to adopt the operating agreement before becoming a member. Either of these provisions serves to protect the remaining owners.
Who Will Be the Buyer?
When setting up a buy-sell agreement for your farm/ranch (or other) business, an important decision at the beginning is to determine who will be the purchaser. Not only is establishing a purchase price important, but determining how the purchase price will be paid is also important. This is a function of the type of buy-sell agreement that is utilized. With a “redemption’ type agreement, the corporation is the buyer. With a “cross-purchase” agreement, the other shareholders are the buyers. A buy-sell agreement can also be a combination of a redemption and cross-purchase agreement.
Since life insurance on the lives of the shareholders is often used to partially or fully fund a buy-sell agreement, the availability and affordability of insurance, the number of policies needed, and the source of funds to pay the premiums will often dictate the type of agreement selected. The amount will depend upon the valuation of the company, the limits on corporate or shareholder finances to pay the premiums, and the extent to which both the shareholders and the seller are willing to assume an unfunded liability if the buy-sell is not fully funded by insurance. Multiple policies may be required for a cross-purchase agreement unless a partnership can be utilized to hold the insurance (e.g. if three shareholders, there would be six separate policies; if four shareholders, twelve policies) so that beyond a few shareholders may make this approach impractical. However, a single policy on each shareholder would suffice when funding a corporate redemption. Another possible solution is a buy-out insurance trust which owns the policies.
If the farming business owns the policy, the business can borrow against any cash value if needed. If no trust or partnership is used, a cross-purchase agreement leaves the payment of premiums in the control of the individual shareholder, and potentially subjects any cash value to creditor claims. This factor alone may determine which form of agreement is most desirable.
If there is a disparity in ownership shares (and there often is), a minority shareholder may be required to fund the much higher interest of the majority shareholder(s) in a cross-purchase agreement. In a corporate redemption, however, the funding of the purchase, either from insurance or other corporate assets, is being born by the shareholders in proportion to their relative stock interests.
While life insurance will often solve the funding problem for purchasing a deceased shareholders stock, and disability insurance is available for permanent disability, insurance proceeds are generally not available in lifetime purchase situations. Thus, the funding capability of the parties is critical since there may not be an alternative funding method available that will satisfy all parties. However, in many situations non-insurance methods of funding coupled with installment payments of the purchase price will meet most of the major needs of the parties.
Today’s post was only a surface-level discussion on buy sell agreements. A good buy-sell agreement is an essential part of transitioning a business to the next generation of owners. But, it is complex and a great deal of thought must be given to the proper crafting of the agreement. Of course, there are associated tax considerations which were not covered in this post. In addition, there are numerous financial and personal factors that also come into play. Likewise, significant thought must be given to the events that can trigger the operation of the agreement.
Like other estate planning documents, a buy-sell agreement should be reviewed regularly even in the absence of any potentially triggering event, and particularly when there is any change in the business structure or ownership.
Tuesday, June 26, 2018
Last week, the U.S. Supreme Court, in South Dakota v. Wayfair, Inc., No. 17-494, 2018 U.S. LEXIS 3835 (U.S. Sup. Ct. Jun. 21, 2018), handed South Dakota a narrow 5-4 win in its quest to collect taxes from online sales. The Court held that the Constitution’s Commerce Clause did not bar South Dakota from statutorily requiring remote sellers without a physical presence in the state to collect and remit sales tax on goods and services that are sold to buyers for delivery inside the state of South Dakota. In so doing, the Court overruled 50 years of Court precedent on the issue.
Other states will certainly take note of the Court’s decision, and some (such as Iowa) were banking on the Court ruling in the manner that it did and passed legislation similar to the South Dakota legislation that will take effect in the future. But, as I wrote last fall, a victory for South Dakota could do damage to the Commerce Clause and the concept of due process and contemporary commerce.
An update on state taxation of internet sales, the possible implications of the Court’s recent decision and what the impact could be on small businesses – that’s the focus of today’s post.
In 1967, the U.S. Supreme Court determined that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States” in holding that Illinois could not subject a mail order seller located in Missouri to use tax where the seller had no physical presence in Illinois. National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967). In holding the law unconstitutional, the Court reasoned that subjecting the seller’s interstate business to local “variations in rates of tax…and record-keeping requirements” would violate the purpose of the Commerce Clause “to ensure a national economy free from…unjustifiable local entanglements.”
Twenty-five years later, the Court reaffirmed the limitations of the Commerce Clause on state regulatory authority in Quill Corporation v. North Dakota, 504, U.S. 298 (1992). In Quill, the Court held that a mail order house with no physical presence in North Dakota was not subject to North Dakota use tax for “property purchased for storage, use, or consumption within the State.” The Court followed closely its holding in National Bellas Hess, Inc. because doing so “encourage[d] settled expectations and …foster[ed] investment by businesses and individuals.” As applied to internet sales, Quill (which predated the internet) does not exempt all internet sales from state sales taxes – just sales by sellers who don’t have a physical presence in a particular state. National retailers have a presence in many states.
More recently, in 2015, the Court examined a Colorado “tattletale” law that required out-of-state sellers with no physical presence in the state “to notify…customers of their use tax liability and to report” sales information back to Colorado. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2013). The trial court enjoined enforcement of the law on Commerce Clause grounds. On appeal, the Tenth Circuit held that it couldn’t hear the challenge to the law because the Tax Injunction Act (28 U.S.C. §1341) divested it of jurisdiction and the matter belonged in state court and, ultimately, the U.S. Supreme Court. The Tenth Circuit remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. The U.S. Supreme Court reversed and remanded the decision of the Tenth Circuit on the jurisdiction issue and, on remand, the Tenth Circuit, invalidated the Colorado law on Commerce Clause grounds. Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. 2016).
In the U.S. Supreme Court’s reversal and remand of the Tenth Circuit’s decision in Direct Marketing Association, Justice Kennedy wrote a concurring opinion that essentially invited the legal system to find an appropriate case that would allow the Court to reexamine the Quill and National Bellas Hess holdings. Hence, the South Dakota legislation.
South Dakota Legislation and Litigation
S.B. 106 was introduced in the 2016 legislative session of the South Dakota legislature. It requires the collection of sales taxes from certain remote sellers – those with “gross revenue” from sales in South Dakota of over $100,000 per calendar year or with 200 or more “separate transactions” in the state within the same timeframe. Interestingly, S.B. 106 authorized the state to bring a declaratory judgment action in circuit court against any person believed to be subject to the law. The law also authorized a motion to dismiss or a motion for summary judgment in the court action, and provided that the filing of such an action “operates as an injunction during the pendency of the” suit that would bar South Dakota from enforcing the law.
S.B. 106 was signed into law on March 22, 2016, and the state Department of Revenue soon thereafter began issuing notices to sellers that it thought were in violation of the law. Several out-of-state sellers that received notices did not register for sale tax licenses as the law required. Consequently, the state brought a declaratory judgment action against the sellers in circuit court, and sought a judicial declaration that the S.B. 106 requirements were valid and applied to the sellers. The state also sought an order enjoining enforcement of S.B. 106 while the action was pending in court, and an injunction that required the sellers to register for licenses to collect and remit sales tax.
The sellers tried to remove the case to federal court based on federal question jurisdiction, but the federal court rejected that approach and remanded the case to the South Dakota Supreme Court. South Dakota v. Wayfair, Inc., 229 F. Supp. 3d 1026 (D. S.D. Jan. 17, 2017). On remand, the South Dakota Supreme Court invalidated S.B. 106 on Commerce Clause based on the U.S. Supreme Court precedent referenced above. State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. 2017). The state of South Dakota announced shortly after the South Dakota Supreme Court’s decision that it would file a petition for certiorari with the U.S. Supreme Court by mid-October. They did, the U.S. Supreme Court granted the petition and heard the case which lead to last week’s opinion.
U.S. Supreme Court Decision
Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That was the key point of the Court’s 1967 Bellas Hess, Inc. decision. As noted above, in that case the Court stated that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” Apparently, that is not the case anymore, at least according to the majority in Wayfair – Justices Kennedy, Thomas, Ginsburg, Alito and Gorsuch. Under the new interpretation of the Commerce Clause, states can impose sale tax obligations on businesses that have no physical presence in the state. But is that completely true? Can the Court’s opinion be construed as giving the states a “blank check” to tax out-of-state businesses? Maybe not.
In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court ruled that a state tax would be upheld if it applied to an activity having a substantial nexus with the state; was fairly apportioned; did not discriminate against interstate commerce; and, was fairly related to the services that the state provided. Later, in the Quill case, the Court determined that a physical presence in the taxing jurisdiction was what satisfied the Brady “substantial nexus” requirement.
In Wayfair, the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” test of Brady remains. Likewise, the other three requirements of Brady remain – fair apportionment; no discrimination against interstate commerce, and; fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – limited application (based on transactions or dollars of sales); not retroactive; the state was a member of the Streamlined Sales and Use Tax Agreement; the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
The dissent in Wayfair, authored by Chief Justice Roberts, noted that there was no need for the Court to overturn Quill. The Chief Justice noted that, “E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule. Any alteration to those rules with the potential to disrupt the development of such a critical segment of the economy should be undertaken by Congress.” That’s precisely the point of the Commerce Clause, and Chief Justice Roberts pointed it out – the Court had no business wading into this issue. In fact, several members of the Congress filed briefs with the Court in the case to inform the Court that various pieces of legislation were pending that would address the issue.
The question then is what, if any, type of a state taxing regime imposed on out-of-state sellers would be determined to violate the Commerce Clause post-Wayfair. Of course, the answer to that question won’t be known until a state attempts more aggressive taxation on out-of-state sellers than did South Dakota, but a few observations can be made. Presently, 23 states are “full members” of the Streamlined Sales and Use Tax Agreement. For those states, the Wayfair majority seemed to believe that had the effect of minimizing the impact on interstate commerce. Also, it would appear that any state legislation would have to have exceptions for small businesses with low volume transactions and sales revenue. Whether a series LLC (in some states such as Iowa) or subsidiaries of a business could be created, each with sales below the applicable threshold, remains to be seen.
Now, it appears that state legislatures crafting tax statutes need not give much, if any, thought to the reason for the tax or who the parties subject to the tax might be. The only consideration appears to be the relative burden of the tax. With Wayfair, states have gained more power – the power to tax people and businesses for whom the state provides no services and who cannot vote the people out of office that created the tax. That would not appear to square with traditional concepts of due process.
The whole notion of a state taxing a business that has no physical presence in the state is incompatible with the principles of federalism that bar states from taxing (whether income, property or sales tax, for instance) non-resident individuals or businesses (with a few, minor exceptions). As noted earlier, a state that imposes such a taxing regime would be able to generate revenue from taxpayers who use none of the services provided by the taxing jurisdiction.
Post Wayfair, where will the line be drawn? Wayfair involved state sales tax. Will states attempt to go after a portion of business income of the out-of-state business via income tax? That seems plausible. However, the Interstate Income Act of 1959 (15 U.S.C. §381-384), requires that a business (or individual – the business form does not matter because corporations have long held personhood status under the Constitution (see, Bank of the United States v. Deveaux, 9 U.S. 61 (1809); Burwell v. Hobby Lobby Stores, Inc., 134 S. Ct. 2751 (2014)) have some sort of connection with a state before its income can be taxed (at least with respect to the solicitation of orders for tangible personal property). Is that legislation now unconstitutional too? Or, is there a distinction remaining between taxing receipts as opposed to income?
Only time will tell.
Friday, June 22, 2018
When land is sold, is the gain on sale taxed as capital gain (preferential rate) or as ordinary income? As with most answers to tax questions, the answer is that “it depends.” Most of the time, when a farmer or ranchers sells land, the gain will be a capital gain. But, there can be situations where the gain will be ordinary in nature – particularly when farmland is subdivided or sold off in smaller tracts. That’s a technique, by the way of some farm real estate sellers, especially in the eastern third of the United States. Does selling the land in smaller tracts, or subdividing it create ordinary gain rather than capital gain?
A recent case illustrated the issue of what a capital asset is and the safe harbor that can apply when land is sold that has been subdivided or sold off in smaller tracts.
The character of gain on sale of land and a possible “safe harbor” – that’s the topic of today’s post.
What Is A Capital Asset?
I.R.C.§1221(a) broadly defines the term “capital asset” as all property held by the taxpayer. Eight exceptions from that broad definition are provided. The first exception, I.R.C. §1221(a)(1), states that property that is either inventory or like inventory cannot qualify as a “capital asset.” In particular, I.R.C. §1221(a)(1) says a capital asset does not include “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” Whether a landowner is holding land primarily for sale to customers depends on the facts. As the U.S. Circuit Court of Appeals for the Tenth Circuit put in in the classic case of Mauldin v. Commissioner, 195 F.2d 714 (10th Cir. 1952), “There is no fixed formula or rule of thumb for determining whether property sold by the taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must, in the last analysis, rest upon its own facts.” The Fifth Circuit has said essentially the same thing in Suburban Realty Co., v. United States, 615 F.2d 171 (5th Cir. 1980).
Subdividing Real Estate
When property is subdivided and then sold, the IRS may assert that the property was being held for sale to customers in the ordinary course of the taxpayer’s trade or business. If that argument holds, the gain will generate ordinary income rather than capital gain. However, there is a Code provision that can come into play. I.R.C. §1237 provides (at least) a partial safe harbor that allows a taxpayer “who is not otherwise a dealer”… to dispose of a tract of real property, held for investment purposes, by subdividing it without necessarily being treated as a real estate dealer.” If the provision applies, the taxpayer is not treated as a “dealer” just simply because the property was subdivided in an attempt to sell all or a part of it. But, the safe harbor only applies if there is a question of whether capital gain treatment applies. If capital gain treatment undoubtedly applies, I.R.C. §1237 does not apply. See, e.g., Gordy v. Comr., 36 T.C. 855 (1961).
What is a “dealer”? It’s not just subdividing land that can cause a taxpayer to be a “dealer” in real estate with gains on sale taxes as ordinary income. That’s the result if the taxpayer is engaged in the business of selling real estate; holds property for the purpose of selling it and has sold other parcels of land from the property over a period of years; or the gain is realized from a sale in the ordinary operation of the taxpayer’s business. In addition, it’s possible that a real estate dealer may be classified as an investor with respect to some properties sold and capital gains treatment on investment properties. But, as to other tracts, the dealer could be determined to be in the business of selling real estate with the sale proceeds taxed as ordinary income. See, e.g., Murray v. Comr., 370 F.2d 568 (4th Cir. 1967).
The “Safe Harbor”
I.R.C. §1237 specifies that gain from the sale or exchange of up to five lots sold from a tract of land can be eligible for capital gain treatment. Sale or exchange of additional lots will result in some ordinary income. To qualify for the safe harbor, both the taxpayer and the property must meet the requirements of I.R.C. §1237 and make an election to have the safe harbor apply. For the taxpayer to qualify for the election, the taxpayer cannot be a C corporation. Presumably, an LLC taxed as a partnership would qualify. For property to qualify, it must have not previously been held by the taxpayer primarily for sale to customers in the ordinary course of business; in the year of sale, the taxpayer must not hold other real estate for sale as ordinary income property; no substantial improvement that considerably enhances the property value has been made to the property (see I.R.C. §1237(b(3); Treas. Reg. §1.1237-1(c)); and the taxpayer must have held the property for at least five years. I.R.C. §1237(a).
If the requirements are satisfied, the taxpayer can elect to have the safe harbor apply by submitting a plat of the subdivision, listing all of the improvements and providing an election statement with the return for the year in which the lots covered by the election were sold.
In Sugar Land Ranch Development, LLC v. Comr., T.C. Memo. 2018-21, the taxpayers formed a partnership in 1998 to buy and develop land outside of Houston for the purpose of turning that land into housing developments and commercial developments. The partnership acquired various parcels of land totaling about 950 acres. The land had been a former oil field and so over the years the partnership cleaned up the land, built a levee, and entered into a development contract with the city of Sugar Land, Texas to set up the rules for developing the lots. All of this sounds like the characteristics of a “developer” doesn’t it?
By 2008, the partnership had done a lot of work developing the land. But, then the downturn in the real estate market hit and the partnership stopped doing any more work. It wasn’t until 2012 that the partnership sold any significant part of the land. In that year it sold two parcels (about 530 acres) to a homebuilding company. The homebuilding company paid a lump sum for each parcel, and also agreed to make future payments relating to the expected development. A flat fee was paid for each plat recorded, and the homebuilding company paid two percent of the final sales price of each house developed on one of the parcels.
The partners entered into a “Unanimous Consent” dated December 16, 2008, declaring that the partnership would no longer attempt to develop the land but would instead hold the land until the real estate market recovered enough to sell at a profit.
The partnership reported an $11 million gain from the sale of one parcel and a $1.6 million loss on the other parcel. It took the position that the land sold was a “capital asset” and so the gains and losses were capital gains and losses. The IRS disagreed. After all, it pointed out that the partnership acquired the property to develop it and merely delayed doing so because of the economic downturn.
Ultimately, the Tax Court agreed that the partnership had successfully changed its operations after 2008 from “developer” to “investor” such that the land it sold in 2012 was a capital asset and the gain was a capital gain. That made a big bottom-line tax difference.
The partnership in Sugar Land Ranch Development, LLC never actually subdivided the property at issue into separate lots, and the IRS still claimed it was acquired and held for development purposes. While capital gain classification is based on a facts and circumstances test, subdividing land for sale doesn’t necessarily mean that it’s no longer a capital asset. That’s the point of I.R.C. §1237 and the safe harbor. In addition, the facts can cause the reason for holding property to change over time. That, in turn, can change the tax result.
Wednesday, June 20, 2018
Contracts are a fundamental part of life. We all enter into various contracts on many occasions. But, sometimes a deal doesn’t live up to expectations. It’s those times that we might attempt to back out of the deal. But, is that possible? When can a deal be negated if the other party or parties to the agreement don’t want to cancel the deal?
Rescinding a contract – that’s the topic of today’s post.
Rescission refers generally to the cancellation of a contract. Rescission can occur as a result of innocent or fraudulent representation, mutual mistake, lack of legal capacity, an impossibility to perform a contract not contemplated by the parties, or duress and undue influence. Rescission may be mutual – all of the parties to the agreement agree (in writing) to terminate their respective duties and obligations under the contract. Rescission may also be unilateral – where one party to the agreement seeks to have the contract cancelled and the parties restored to the position they were in economically at the time the agreement was entered into.
An innocent as well as intentional misrepresentation may serve as the basis for a unilateral rescission of contract. To be successful on such a claim, the plaintiff must have justifiably relied on a false statement, which was material to the transaction. The rule prevents parties who later become disappointed at the outcome of their bargain from capitalizing on any insignificant discrepancy to void the contract.
Duty to investigate? There is a split of authority regarding a buyer’s duty to investigate a seller’s fraudulent statements, but the prevailing trend is toward placing a minimal duty on the buyer. With respect to land sale transactions, the general rule is that a seller’s defense that the buyer failed to exercise due care is disallowed if the seller has made a reckless or knowing misrepresentation. See, e.g., Cousineau v. Walker, 613 P.2d 608 (Alaska 1980); Fox v. Wilson, 211 Kan. 563 (1973). However, the defense is typically allowed if the buyer’s fault was so negligent that it amounted to a failure to act in good faith and in accordance with reasonable standards of fair dealing. So, in general, a purchaser of land may rely on material representations of the seller and is not obligated to ascertain whether such representations are truthful.
Illustrative case. In a 2006 New York case, Boyle, et al. v. McGlynn, et al., 814 N.Y.S.2d 312 (2006), the plaintiff bought the defendant’s farm (including the residence) and later sought to have the sale contract rescinded based on the seller’s alleged fraud and misrepresentations for not disclosing that plans were in the works for the construction of large aerogenerators on an adjacent parcel. The plaintiffs submitted the affidavit of a neighbor of the defendant who detailed two conversations with the defendant that occurred months before the defendant put his farm on the market during which the wind energy development project was discussed. The defendant, at that time, stated that the presence of commercial aerogenerators on the adjacent tract would “force” him to sell his farm. When the plaintiff sought to rescind the contract, the defendant claimed he had no duty to the plaintiff and that the doctrine of caveat emptor (“buyer beware”) was a complete defense to the action.
The appellate court affirmed the trial court’s denial of the defendant’s summary judgment motion. The appellate court noted the plaintiff’s claim that the defendants were well aware of their desire to buy a property with a scenic view that was free of environmental controversy and land use battles, and that the status of the land where the aerogenerators were planned was specifically discussed with the defendant before the contract closed. The appellate court also noted that during this same conversation, the defendant told the plaintiff that the property was “protected.” In addition, the sale brochure for the property stated that the property as “backing up to one of the largest areas of undeveloped land in the County.” The defendant also apparently told the plaintiff that “what you see if what you get” and that the area was “secluded and protected.”
The appellate court further noted that while there was an article in a local paper about the development project before the purchase offer for the property was made, the appellate court also noted that the plaintiff did not live in the area. Likewise, no public documents concerning the project were filed with the local planning board until a month after the parties’ closing.
It is important to note that the purchaser's claims in Boyle were based on the purchaser's allegations of unclear oral conversations between the purchaser and the seller, and a statement in a real estate brochure used to market the property. The principle in Boyle could be applied in similar agricultural land sale transactions where plans are being made for the development of any activity that could be considered a nuisance. In addition to the wind energy development project at issue in Boyle, known future development of a large-scale animal confinement operation, ethanol plant or similar activity that produces odors, obscures view or could create unreasonably objectionable noise, light or traffic, may need to be disclosed to a buyer to avoid a rescission action.
Monday, June 18, 2018
The “Swampbuster” rules were enacted as part of the conservation provisions of the 1985 Farm Bill. In general, the rules prohibit the conversion of “wetland” to crop production by producers that are receiving farm program payments. A farmer that is determined to have improperly converted wetland is deemed ineligible for farm program payments. But, an exception exists for wetland that was converted to crop production before December 23, 1985 – the effective date of the 1985 Farm Bill.
Under the Swampbuster rules, “wetland” has: (1) a predominance of hydric soil; (2) is inundated by surface or groundwater at a frequency and duration sufficient to support a prevalence of hydrophytic vegetation typically adapted for life in saturated soil conditions, and (3) under normal circumstances does support a prevalence of such vegetation. 7 C.F.R. §12.2(a). In other words, to be a wetland, a tract must have hydric soils, hydrophytic vegetation and wetland hydrology.
However, there have been several prominent cases in recent years illustrating that the Natural Resources Conservation Service (NRCS) has trouble applying the definition as it attempts to determine whether a particular tract has wetlands. A recent decision of the United States Department of Agriculture (USDA) National Appeals Division (NAD) makes the point.
Wetlands under the farm program rules – that’s the topic of today’s post.
In B & D Land & Livestock Co. v. Schafer, 584 F. Supp. 2d 1182 (N.D. Iowa 2008), the plaintiff purchased the tract in issue in 1997. The tract had been farmed by the prior owner’s tenant from 1972 to 1986, and was enrolled in the Conservation Reserve Program (CRP) from 1987 to 1997. The plaintiff purchased the property in 1999, before the USDA determined that a portion of the tract was wetland. Despite that determination, the plaintiff removed some woody vegetation in 2000 because it was a nuisance to the plaintiff’s farming operation. The USDA determined that the plaintiff had “converted” 0.9 acres of wetland. However, the plaintiff claimed that the tract had been cropped before December 23, 1985, thereby making it prior converted cropland. Also, the plaintiff introduced evidence that a drainage tile had been installed before December 23, 1985, and that the tile, along with a road ditch, removed the wetland hydrology from the tract. But, USDA believed that the tile was not functioning as of December 23, 1985, because woody vegetation existed.
The plaintiff’s expert civil engineer, however, concluded that if the drainage tile had been plugged, when the USDA broke the tile during the on-site field investigation, the resulting hole would have filled full of water and saturated the ground and would have continued to be fed from water from further up the tile line. But, that did not occur. So, the plaintiff argued that the drainage tile coupled with the installation of a road ditch removed the presence of wetland hydrology from the tract. USDA disagreed, claiming that the presence of hydrophytic vegetation, by itself, demonstrated wetland hydrology was present.
The court didn’t buy the USDA’s argument. The court noted the statute clearly specifies that a “wetland” has three separate, mandatory requirements: (1) hydric soil; (2) wetland hydrology, and; (3) hydrophytic vegetation. In addition, the court noted that the presence of hydrophytic vegetation is not sufficient to meet the wetland hydrology requirement. In addition, the court determined that the USDA reached its conclusion by disregarding evidence contrary to its experts that were relevant on the issues involved.
Accordingly, the court ruled that the USDA hearing officer’s “final” determination must be overturned as arbitrary and capricious, an abuse of discretion, or contrary to law. As for attorney fees, the court stated that it would reserve the issue for consideration upon a specific application for attorney fees.
In a recent dispute involving a tract of land in Virginia, the USDA NAD again determined that the NRCS didn’t follow applicable rules when determining the existence of wetlands. In re Hood, No. 2017E000755 (USDA NAD, Jun. 14, 2018). The landowner participated in the NRCS Environmental Quality Incentives Program (EQIP) for almost a decade. The contract covered most of his 31-acre tract. In 2006, the NRCS determined that the landowner had converted 18.74 acres of wetland on the tract to cropland. The NRCS issued a certified wetland determination to that effect, but neither the landowner nor the NRCS took any other action at that time.
In 2016, the NRCS again reviewed the property for compliance with the wetland provisions. They conducted a site visit and again concluded that the landowner had converted 18.76 acres of wetland to cropland after November 28, 1990, by sheering stumps (the tract had formerly been used as a tree farm) and planting crops on former wetland. An appeal to the Farm Service Agency (FSA) County Committee which upheld the NRCS final technical determination and held the landowner ineligible for USDA farm program benefits. The landowner appealed the FSA decision to the NAD asserting that the FSA decision was wrong because the underlying 2006 NRCS wetland determination was inaccurate and “incompetent.” Specifically, the landowner claimed that the NRCS did not follow its soil map, and didn’t properly identify the actual soil on his tract. The landowner also claimed that the NRCS did not properly follow the “50/20” rule (a method to select dominant aspects for wetland evaluation. The landowner claimed that the FSA’s decision resulted from the erroneous 2006 wetland determination, and that current and former USDA personnel had advised him that his wetland was farmable because it lacked the characteristics for wetland and contained upland and non-wetland plants. The landowner also claimed that the tract was drained by the federal government in the 1930s via the installation of three ditches which lowered the water table, changed the land’s hydrology and made the tract dry. The landowner also claimed that the allegedly converted wetlands were atypical and the NRCS should have reevaluated them as such.
The landowner also asserted that the NRCS engaged in misconduct by targeting him by taking over 120 soil samples in search of a wetland as part of an ongoing feud that the NRCS had with him as a part-time FSA employee.
The USDA NAD Secretary determined that the FSA determination was erroneous. The landowner had sufficiently demonstrated that a natural event of water receding altered the hydrology of the land. This hydrological change, the NAD Secretary reasoned, established that the wetland determinations were no longer reliable indicators of site conditions on the land. The NAD Secretary specifically found that the United States Geological Survey (USGS) maps showed no wetlands or swampland related to the cleared part of the land or on any of the land not adjacent to the stream lying on the north/northwest of the property line. Indeed, the NRCS national cooperative soil survey maps, the NAD Secretary noted, showed that the land was comprised of non-hydric sandy loam soils.
The NAD Secretary did not have the authority to review the landowner’s claim that the FSA and/or NRCS committed misconduct. However, the NAD Secretary noted that the landowner could file a complaint with the USDA’s Office of Inspector General. The NAD Secretary noted that the FSA could seek NAD Director Review by filing a request within 30 days of the Secretary’s decision.
When the government’s position is not substantially justified, attorney fees and other expenses can be awarded. In the Iowa case referred to above, the plaintiff’s lawyer did, indeed, make an application for $57,768.59 in fees and $683.00 in costs, $3,414.17 in expenses, and $13,380.43 in other fees and costs. Those fees, costs and expenses were the result of work performed on the case that the USDA chose to drag out for over eight years. The Equal Access to Justice Act (EAJA) allows for an award of attorney fees in cases where the plaintiff prevails against the U.S. Government and satisfies three requirements – (1) a final judgment has been rendered; (2) the plaintiff prevailed; and (3) the government’s position was not substantially justified. The USDA denied the plaintiff’s request for fees, claiming instead that their position was substantially justified, that special circumstances made an award of fees unjust, and that the plaintiff’s lawyer put excessive hours in on the case at too high an hourly rate and didn’t have any particular expertise in wetland matters.
The court noted that fees and other expenses are to be awarded under the EAJA unless the government’s position was substantially justified or special circumstances would make awarding fees and costs unjust. To be substantially justified, the government’s position must only have a reasonable basis in law and fact. That’s a rather low threshold. Basically, if the government can come up with any reasonable interpretation of statutory law, they win and no award of fees and costs will be required. In addition, even if the government loses in court, that doesn’t create a presumption that the government’s position was not substantially justified. But, the government still has the burden of proof to establish that its position was substantially justified.
The court held that the government had absolutely no reasonable basis for its “conflation of the separate “hydrophytic vegetation” and “wetland hydrology” requirements for a “wetland,” and improperly placing the burden on B&D to demonstrate why wetlands were not present based on criteria not identified in the statute or regulations.” The court also noted that USDA disregarded “saturation” evidence, disregarded evidence that wetland hydrology had already been removed because of pre-existing drainage and the adjacent road and the ditch. The court, in a particularly pointed comment, stated:
“At each stage of the proceedings, the government sought to uphold its prior “wetlands” determination, without regard to any evidence or law to the contrary, suggesting an entrenched bureaucracy’s refusal to admit error, not an interest in proper application of the law.”
The court also held that no special circumstances existed to deny an award of fees and costs. As for the government’s claim that the plaintiff’s attorney billed too many hours at too high an hourly rate, the court noted that the statutory rate specified $125/hour as a maximum rate unless the attorney had particular expertise. The plaintiff’s attorney had billed some work on the case at $175/hour and other work at $185/hour. The attorney justified the fee rate based on an inflation adjustment to the statutory rate and the attorney’s specialized skill in wetland matters. The court agreed on both points. USDA complained that the plaintiff’s lawyer didn’t need to put time in on a brief for injunctive relief because USDA had promised that it wasn’t necessary because they would continue to pay federal farm program benefits. The court wouldn’t bite, stating “the court…cannot…say…that the government’s assurances were so unequivocal or binding on the government that no preliminary injunction was warranted, particularly in light of the credible threat of bankruptcy for the plaintiff posed by any enforcement action by the government during the pendency of this action.”
In the Iowa case, the USDA basically harassed the plaintiff with bogus wetland violation claims for many years which placed the plaintiff within the potential peril of bankruptcy. In addition, the USDA continued to maintain its bogus claims in an attempt to avoid paying the plaintiff’s attorney fees. In the Virginia matter, the USDA/NRCS was conducting itself similarly and the NAD Secretary would have none of it.
The government’s conduct in both of these matters is something that the U.S. Court of Appeals for the Eighth Circuit was concerned with in Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir 1999). In that case, the court stated, in rejecting the USDA’s interpretation of the statute governing wetland drainage activities, that “…there is no worse statute than one misunderstood by those who interpret it.”
The USDA is now under new leadership, but lower level field staff remain from prior Administrations. Perhaps the requirement to pay attorney fees and costs for unreasonable positions will cause them to take more care to follow their own regulations when delineating wetlands.
Thursday, June 14, 2018
Self-employment tax is a concern for many farmers and ranchers, with many having an as an objective the avoidance of self-employment tax through whatever planning techniques can be utilized. That’s especially the case for those farmers and ranchers that are fully “vested” in the Social Security system.
But, what about the farmer that leases out machinery and equipment to someone else? Is the income from machinery and equipment leases subject to self-employment tax? Such an arrangement may be entered into, for example, to assist another person get established in farming or supply a need that another person has with respect to that other person’s farming operation.
As is the case with many answers to tax questions, the answer is “it depends.” Today’s post takes a look at leases of farm machinery and equipment and the self-employment tax implications.
Under I.R.C. §1402(a) “net earnings” from self-employment” means the gross income derived by an individual from any trade or business that the individual conducts. However, rental income is generally reported on Schedule E of Form 1040. From there, it flows to page one of the Form 1040. As such, it is not subject to self-employment tax. A rental activity is just that – it’s a rental activity. Under I.R.C. §1402(a)(1), “rentals from real estate” are excluded from the I.R.C. §1402(a) definition of “net earnings from self-employment.”
Exception for Personal Property Leases
The I.R.C. §1402(a)(1) exception from self-employment tax for “rentals from real estate” says, in full, “there shall be excluded rentals from real estate and from personal property leased with the real estate…” [emphasis added]. But, the non-application of self-employment tax only applies to the rental of real estate or the rental of personal property in connection with real estate.
Inapplicability of Exception
If the personal property is not tied to a land lease, the income from leasing personal property is subject to self-employment tax if the rental activity is conducted as a regular business activity of the taxpayer. See, e.g., Stevenson v. Comr., T.C. Memo. 1989-357. Indeed, a notation at the top of Schedule E indicates that if the taxpayer has a business of renting personal property then the income should be reported on Schedule C. Those same instructions also direct a taxpayer to use Schedule C to report income an expense associated with renting personal property if the rental activity is a business activity of the taxpayer. The rental activity constitutes a business if it is engaged in with the primary purpose of making a profit and the activity is engaged in with regularity and continuity. See, e.g., Comr. v. Groetzinger, 480 U.S. 23 (1987).
But, if an activity is engaged in on a one-time only basis the income derived from the activity will not be subject to self-employment tax because the activity is not engaged in on a basis that is regular and continuous. See, e.g., Batok v. Comr., T.C. Memo. 1992-727. Thus, if the rental of personal property is merely casual the Schedule E instructions state that the rental receipts should be reported as “Other Income” on page 1 of Form 1040. Any related deductions are to be reported on the total deduction line (Total Adjustments) on the bottom of page 1 of Form 1040 and the notation “PPR” is to be entered on the dotted line next to the amount. That is what indicates a personal property rental.
For a farmer that owns machinery and equipment and leases it to someone else or to their own farming business entity, the risk is real that the rental income will be subject to self-employment tax. That will be the result if the rental activity in engaged in with regularity and continuity such that the activity rises to the level of a trade or business. Self-employment tax can be avoided if the lease of the personal property is tied in with a land lease. Alternatively, a farm taxpayer could transfer the machinery and equipment to a pass-through entity with the income flowing through to the taxpayer without self-employment tax. In that situation, however, compensation from the entity would be required for any personal services provided.
An additional consideration is that, at least in some states, paying rent to lease farm equipment and machinery is subject to sales tax at the state level. Also, income from a rental activity may trigger the application of the passive loss rules under I.R.C. §469. That last point is a topic for discussion in a subsequent post.
Tuesday, June 12, 2018
Normally, property is valued in a decedent's estate at its fair market value as of the date of the decedent's death. The Code and Treasury Regulations bear this our. See I.R.C. §1014). But, neither the Code nor the regulations rule out the possibility that post-death events can have a bearing on the value for assets in a decedent’s estate. The real question is what post-death events are relevant for determining the actual date-of-death value of property for estate tax purposes.
Post-death events and their impact on valuation, that’s the topic of today’s post.
Cases on the Valuation Issue
The cases reveal that consideration may be given to subsequent events that are reasonably foreseeable at the date of death. Those events have a bearing on date-of-death value.
Numerous cases illustrate that it is simply not true that, except for the alternate valuation election under I.R.C. §2032, changes in valuation after death are immaterial. The following cases are illustrative:
- In Gettysburg National Bank v. United States, 1:CV-90-1607, 1992 U.S. Dist. LEXIS 12152 (D. M.D. Pa. Jul. 17, 1992), property was sold to a third party in an arm’s length transaction 16 months after the decedent’s death (13 months after its appraisal for estate tax purposes) for less than 75 percent of the value at which it was included in the gross estate. The court allowed the estate to reduce its value, stating that the subsequent sale may be relevant evidence that the appraised fair market value was incorrect.
- In Estate of Scull v. Comr., C. Memo. 1994-211, sales of artwork at auction 10 months after the valuation date were the best indicators of fair market value for federal estate tax purposes notwithstanding that the market had changed in the interim, and the court applied a 15 percent discount to reflect appreciation in the market between the date of the decedent’s death and the auction.
- In Rubenstein v. United States, 826 F. Supp. 448 (S.D. Fla. 1993), the court determined that the best evidence of a claim’s value is the amount for which the claim was settled after the decedent’s death.
- In Estate of Andrews v. United States, 850 F. Supp. 1279 (E.D. Va. 1994), the court reasoned that reasonably foreseeable post-death facts relating to a publication contract under negotiation when the decedent died were germane to the determination of what a willing buyer would pay for the right to use the decedent’s name.
- In Estate of Necastro v. Comr., C. Memo. 1994-352, environmental contamination was discovered five years after the decedent’s death and the court allowed the estate to file a claim for refund, reducing the value from the value as reported, which was based on facts known at the date of death; the revaluation resulted in a reduction of over 33 percent from the value of the property determined before the contamination was discovered. The court’s opinion did not, however, address the substantive issue whether facts discovered after death may influence valuation if willing buyers and sellers would not have known the relevant facts as of the valuation date.
- In Estate of Jephson v. Comr., 81 T.C. 999 (1983), the court concluded that “[e]vents subsequent to the valuation date may, in certain circumstances, be considered in determining the value as of the valuation date.”
- In Estate of Keller v. Comr., C. Memo. 1980-450, the court stated that a “sale of property to an unrelated party shortly after date of death tends to establish such value at date of death. The property sold involved a farm and growing crop where both the sale of the farm and the harvesting of the crop occurred post-death.
- In Estate of Stanton, C. Memo. 1989-341, the court stated that the sale of the property shortly after death is the best evidence of fair market value. Under the facts of the case, the selling price of comparable property sold six months after the decedent’s death was also considered with a downward adjustment to reflect the greater development potential of the comparable property and the 10 months of appreciation that occurred after the decedent’s death in the actual estate property owned and sold.
- In Estate of Trompeter v. Comr., 279 F.3d 767 (9th Cir. 2002), the Tax Court was reversed for failing to sufficiently articulate the basis for its decision regarding omitted assets and the rationale for the valuation discount selected, but the court nevertheless considered the value of assets using post-death developments, including redemption for $1,000 per share of stock valued at $10 per share 16 months earlier, and a coin collection returned at roughly half the value subsequently assigned to it by the taxpayer’s estate in an effort to enjoin auction of that asset.
- In Morris v. Comr., 761 F.2d 1195 (6th Cir. 1985), the court considered speculative post-death commercial development events for purposes of valuing farmland in the decedent’s estate as of the date of the decedent’s death. The decedent’s farmland was approximately 15 miles north of downtown Kansas City and approximately five miles west of the Kansas City International Airport. At the time of death, plans were in place for a sewer line to service the larger of the two tracts the decedent owned. Also, residential development was planned within two miles of the same tract. In addition, significant roadways and the site for the planned construction of a major interstate were located close to the property. While none of these events had occurred as of the date of death, the court found them probative for determining the value of the farmland as of the date the decedent died. The decedent’s son, the owner of the farmland as surviving joint tenant, tried to introduce evidence of the failed closing of some post-death sales to support his claim that the post-death events were speculative. But, the court disagreed, establishing the value of the farmland at $990,000 rather than the estate’s valuation of $332,151.
The court’s opinion makes it look like that evidence to confirm an appraiser’s date-of-death prediction of future events is more likely to be received than evidence adduced to prove wrong an appraiser’s prediction concerning future events. In any event, however, the case stands for the proposition that post-death events are relevant for establishing death-time value – even if they are somewhat speculative.
- In Okerlund v. United States, 365 F.3d 1044 (Fed. Cir. 2004), the court dealt with the issue of stock valuation in a closely held company for stock that was gifted shortly before the company founder died and the company (a milk processing operation) suffered a salmonella outbreak. The taxpayers argued that these events should result in a lower gift tax value of the stock, with the issue being the relevance of post-death events on the value of the gifts. The court stated that “[i]t would be absurd to rule an arms-length stock sale made moments after a gift of that same stock inadmissible as post-valuation date data….The key to use of any data in a valuation remains that all evidence must be proffered in support of finding the value of the stock on the donative date.” The court ultimately affirmed the trial court’s denial of a lower gift tax valuation based on the reality that the risk factors (the founder’s death and matters that could materially affect the business) had already been accounted for in the valuation of the stock.
Clearly, post-death events and other facts that are reasonably predictable as of the date of death or otherwise relevant to the date of death value can serve as helpful evidence of value and allow either an increase (to obtain a higher income tax basis) or decrease (to reduce federal estate tax) in value as a matter or record. For farmland (and other real estate) the market is not static as of the date of death. Thus, appraisers can reasonably look to the arc of sales extending from pre-death dates to post-death dates in arriving at the date-of-death value.
Friday, June 8, 2018
Wind “farms” can present land-use conflict issues for nearby landowners by creating nuisance-related issues associated with turbine noise, eyesore from flicker effects, broken blades, ice-throws, and collapsing towers, for example.
Courts have a great deal of flexibility in fashioning a remedy to deal with nuisance issues. A recent order by a public regulatory commission is an illustration of this point.
Wind Farm Nuisance Litigation
Nuisance litigation involving large-scale “wind farms” is in its early stages, but there have been a few important court decisions. A case decided by the West Virginia Supreme Court in 2007 illustrates the land-use conflict issues that wind-farms can present. In Burch, et al. v. Nedpower Mount Storm, LLC and Shell Windenergy, Inc., 220 W. Va. 443, 647 S.E.2d 879 (2007), the Court ruled that a proposed wind farm consisting of approximately 200 wind turbines in close proximity to residential property could constitute a nuisance. Seven homeowners living within a two-mile radius from the location of where the turbines were to be erected sought a permanent injunction against the construction and operation of the wind farm on the grounds that they would be negatively impacted by turbine noise, the eyesore of the flicker effect of the light atop the turbines, potential danger from broken blades, blades throwing ice, collapsing towers and a reduction in their property values. The court held that even though the state had approved the wind farm, the common-law doctrine of nuisance still applied. While the court found that the wind-farm was not a nuisance per se, the court noted that the wind-farm could become a nuisance. As such the plaintiffs’ allegations were sufficient to state a claim permitting the court to enjoin the creation of the wind farm.
In another case involving nuisance-related aspects of large-scale wind farms, the Kansas Supreme Court upheld a county ordinance banning commercial wind farms in the county. Zimmerman v. Board of County Commissioners, 218 P.3d 400 (Kan. 2009). The court determined that the county had properly followed state statutory procedures in adopting the ordinance, and that the ordinance was reasonable based on the county’s consideration of aesthetics, ecology, flora and fauna of the Flint Hills. The Court cited the numerous adverse effects of commercial wind farms including damage to the local ecology and the prairie chicken habitat (including breeding grounds, nesting and feeding areas and flight patterns) and the unsightly nature of large wind turbines. The Court also noted that commercial wind farms have a negative impact on property values, and that agricultural and nature-based tourism would also suffer.
A recent settlement order of the Minnesota Public Utilities Commission (Commission)requires a wind energy firm to buy-out two families whose health and lives were materially disaffected by a wind farm complex near Albert Lea, Minnesota. As a result, it is likely that the homes will be demolished so that the wind farm can proceed unimpeded by local landowners that might object to the operation. That’s because the order stated that if the homes remained and housed new residents, those residents could not waive the wind energy company’s duty to meet noise standards even if the homeowners were willing to live with violations of the Minnesota Pollution Control Agency’s ambient noise standard in exchange for payment or through some other agreement.
In re Wisconsin Power and Light, Co., No. ET-6657/WS-08-573, Minn. Pub. Util. Commission (Jun. 5, 2018) has a rather lengthy procedural history preceding the Commission’s order. On October 20, 2009, the Commission issued a large wind energy conversion system site permit to Wisconsin Power and Light Company (WPL) for the approximately 200-megawatt first phase of the Bent Tree Wind Project, located in Freeborn County, Minnesota. The project commenced commercial operation in February 2011. On August 24, 2016, the Commission issued an order requiring noise monitoring and a noise study at the project site. During the period of September 2016 through February 2018 several landowners in the vicinity filed over 20 letters regarding the health effects that they claim were caused by the project. On September 28, 2017, the Department of Commerce Energy Environmental Review Analysis Unit (EERA) filed a post-construction noise assessment report for the project, identifying 10 hours of non-compliance with Minnesota Pollution Control Agency (MPCA) ambient noise standards during the two-week monitoring period.
On February 7, 2018, EERA filed a phase-two post construction noise assessment report concluding that certain project turbines are a significant contributor to the exceedances of MPCA ambient noise standards at certain wind speeds. The next day, WPL filed a letter informing the Commission that it would respond to the Phase 2 report at a later date and would immediately curtail three turbines that were part of the project, two of which were identified in the phase 2 report. On February 20, 2018, the landowners filed a Motion for Order to Show Cause and for Hearing, requesting that the Commission issue an Order to Show Cause why the site permit for the project should not be revoked, and requested a contested-case hearing on the matter.
On April 19, 2018, WPL filed with the Commission a Notice of Confidential Settlement Agreement and Joint Recommendation and Request, under which WPL entered into a confidential settlement with each landowner, by which the parties agreed to the terms of sale of their properties to WPL, execution of easements on the property, and release of all the landowners’ claims against WPL. The agreement also outlined the terms by which the agreement would be executed. The finality of the agreement was conditioned upon the Commission making specific findings on which the parties and the Department agreed. These findings include, among others: dismissal of the landowners’ February 2018 motion and all other noise-related complaints filed in this matter; termination of the required curtailment of turbines; transfer of possession of each property to WPL; and a requirement that compliance filing be filed with commission. The Commission determined that resolving the dispute and the terms of the agreement were in the public interest and would result in a reasonable and prudent resolution of the issues raised in the landowner’s complaints. Therefore, the Commission approved the agreement with the additional requirement that upon the sale of either of the landowners’ property, WPL shall file with the Commission notification of the sale and indicate whether the property will be used as a residence. If the property is intended to be used as a residence after sale or upon lease, the permittee must file with the Commission several things - notification of sale or lease; documentation of present compliance with noise standards of turbines; documentation of any written notice to the potential residence of past noise studies alleging noise standards exceedances, and if applicable, allegations of present noise standards exceedances related to the property; and any mitigation plans or other relevant information.
The order issued in the Minnesota matter is not entirely unique. Several decades ago, the Arizona Supreme Court ordered a real estate developer to pay the cost of a cattle feedlot to move their feeding operations further away from the area where the developer was expanding into. Spur Industries, Inc. v. Del E. Webb Development Co., 108 Ariz. 178, 494 P.2d 700 (1972).
However, the bottom-line is that the matter in Minnesota is an illustration of what can happen to a rural area when a wind energy company initiates development in the community.
Wednesday, June 6, 2018
Much of tort law centers around the concept of negligence. The negligence system is designed to provide compensation to those who suffer personal injury or property damage. It’s also a fault-based system in most instances. When negligence is based on fault, the injured party (plaintiff) must be able to prove that their injury was the defendant’s fault. Without that proof, the defendant will not be liable. In addition, the plaintiff must prove each element of their negligent tort case by a preponderance of the evidence
Establishing fault and, as a result, liability – that’s the focus of today’s post.
For a person to be deemed legally negligent, certain conditions must exist. These conditions can be thought of as links in a chain. Each condition must be present before a finding of negligence can be obtained.
Legal duty. The first condition is that of a legal duty giving rise to a standard of care. To be liable for a negligent tort, the defendant's conduct must have fallen below that of a “reasonable and prudent person” under the circumstances. A reasonable and prudent person is what a jury has in mind when they measure an individual's conduct in retrospect - after the fact, when the case is in court. The conduct of a particular tortfeasor (the one causing the tort) who is not held out as a professional is compared with the mythical standard of conduct of the reasonable and prudent person in terms of judgment, knowledge, perception, experience, skill, physical, mental and emotional characteristics as well as age and sanity. For those held out as having the knowledge, skill, experience or education of a professional, the standard of care reflects those factors.
Breach. If a legal duty exists, it is necessary to determine whether the defendant's conduct fell short of the conduct of a “reasonable and prudent person (or professional) under the circumstances.” This is called a breach, and is the second element of a negligent tort case.
Causation. Once a legal duty and breach of that duty are shown to exist, a causal connection (the third element) must be established between the defendant's act and (the fourth element) the plaintiff's injuries (whether to person or property). In other words, the resulting harm to the plaintiff must have been a reasonably foreseeable result of the defendant's conduct at the time the conduct occurred. Reasonable foreseeability is the essence of causality (also known as proximate cause).
Damages. If the plaintiff is able to establish that the defendant breached a duty that was owed to the plaintiff, the plaintiff must also prove that the breach of the duty caused damages. The damages must be more than trivial and must be proved.
A recent case involving a dairy operation from the state of Washington illustrates the importance of being able to prove damages and that those damages were causally related to the defendant’s conduct. In White River Feed Co. v. Kruse Family, LP, No. 76562-1-I, 2018 Wash. App. LEXIS 1031(Wash. Ct. App. Apr. 30, 2018), the plaintiff claimed that the defendant supplied contaminated feed that caused illness in the plaintiff’s milking cows. During April of 2013 the plaintiff fed the cows the plaintiff’s own “green-chop” as well as the defendant’s custom grain feed blend. The dry cows (i.e., cows that were not milking) and the bulls were fed only “green-chop.” The “green-chop” had been incorporated into the rations on April 17. The third grain delivery had been fed as soon as it had been delivered on the 18th. On April 19, the milking cows showed a decreased appetite and developed diarrhea. By April 22, the plaintiff’s veterinarian, had been called to examine and treat the milking cows.
The veterinarian initially diagnosed the cows with an ionophore toxicity. Further investigations, however, revealed that the cows had salmonella poisoning. Grain from the calf barn, which the plaintiff stated came from the April 18 feed delivery, tested negative for salmonella. The “green-chop” was never tested as it had all been fed to the herd. The plaintiff’s veterinarian concluded with an eighty percent probability that the milking cows had become ill from the defendant’s grain. Most of the veterinarian’s opinion was based upon the fact that the dry cows and bulls had not become ill because they had not been fed any grain. The plaintiff’s veterinarian did acknowledge, however, that the calves were fed the grain and did not become ill. However, he hypothesized that the milk in their diet kept them from eating the grain or the industry practice of feeding calves the “crumbs” from the cows limited the salmonella.
The illness caused the plaintiff loss of twenty to twenty-five head which either died or were culled and another thirty head were sold for beef due to substantial weight loss In addition to claiming damages for the loss of cows, the plaintiff reported a decrease in milk production and loss of fetuses in the infected cows. The plaintiff sued for damages from the salmonella illness, and the defendant countered with claims of breach of contract and unjust enrichment for the outstanding accounts. The defendant also requested a jury trial and moved for summary judgment based on their own veterinarian’s expert opinion. The defendant’s veterinarian stated that the data was insufficient to pinpoint salmonella from the grain as the cause of the illness. Due to the negative test results, the fact the calves or any other farms experienced the same illness, and low moisture content of the grain, the defendant’s expert believed that no expert could have arrived at the diagnosis that the plaintiff’s veterinarian did.
The trial court granted the defendant’s summary judgment motion. The plaintiff moved for reconsideration, and submitted a declaration of an opinion from another veterinarian. This declaration stated that the negative results from the test may not be representative of the entire batch of feed. The trial court denied the motion to reconsider, The appellate court affirmed. The appellate court did not give much weight to the hypothetical projections of the initial veterinarian’s diagnosis. Also, the appellate court questioned why the veterinarian ignored the negative test results for salmonella or did not test for non-feed sources of salmonella that the other expert stated could be a cause. In addition, the court found that the expert opinion was abstract evidence rather than an issue of fact that could overcome the motion for summary judgment.
Proving damages is an essential element of a negligent tort case. Even though the defendant may have owed a duty to the plaintiff, breach that duty and the breach caused the plaintiff’s damages, if those damages can’t be proven or can’t be shown to be causally related to the defendant’s conduct, the plaintiff will not prevail on the claim. In the farm and ranch setting there can be many intervening factors that may cut-off the defendant’s liability. Make sure to think through each element before bringing suit.
Monday, June 4, 2018
Federal law regulates the handling of agricultural commodities in commerce by establishing marketing orders with the purpose of insuring that consumers receive an adequate supply of a commodity at a stable price. Marketing orders have long been used in the fruit, nut, vegetable and milk industries and typically require that a handler (dealer) pay a fixed minimum price to the producer of a commodity. In addition, the marketing of a commodity must follow a system of rules.
Separate legislation has established mandatory assessments for promotion of particular agricultural products. An assessment (or “check-off”) is typically levied on handlers or producers of commodities with the collected funds to be used to support research promotion and information concerning the product. Such check-off programs have been challenged on First Amendment free-speech grounds. Indeed, a recent case from California involved a mandatory assessment for the generic marketing of grapes. A group of grape producers that believed they produced high quality grapes objected to being required to pay for the advertising of grapes in general.
Mandatory assessments for generic advertising of ag commodities – that’s the focus of today’s post.
In United States v. United Foods, Inc., 533 U.S. 405 (2001), the U.S. Supreme Court held that mandatory assessments for mushroom promotion under the Mushroom Promotion, Research, and Consumer Identification Act violated the First Amendment. The assessments were directed into generic advertising, and some handlers objected to the ideas being advertised. In an earlier decision, Glickman v. Wileman Brothers & Elliott, Inc., 521 U.S. 457 (1997), the Court had upheld a marketing order that was part of a greater regulatory scheme with respect to California tree fruits. In that case, producers were compelled to contribute funds for cooperative advertising and were required to market their products according to cooperative rules. In addition, the marketing orders had received an antitrust exemption. None of those facts was present in the United Foods case, where the producers were entirely free to make their own marketing decisions and the assessments were not tied to a marketing order. The Supreme Court did not address, however, whether the check-offs at issue were government speech and, therefore, not subject to challenge as an unconstitutional proscription of private speech.
The government speech issue was before the court in 2005. In Johanns v. Livestock Marketing Association, 544 U.S. 550 (2005), the Supreme Court upheld the beef check-off as government speech. Under the Beef Checkoff, a $1.00/head fee is imposed at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board.
The case involved (in the majority’s view) a narrow facial attack on whether the statutory language of the legislation authorizing the beef check-off created an advertising program that could be classified as government speech. That was the only issue before the Court. At the time, the government speech doctrine was relatively new not well-developed but, prior Supreme Court opinions not involving agricultural commodity check-offs indicated that to constitute government speech, a check-off must clear three hurdles - (1) the government must exercise sufficient control over the content of the check-off to be deemed ultimately responsible for the message; (2) the source of the check-off assessments must come from a large, non-discrete group; and (3) the central purpose of the check-off must be identified as the government’s.
Based on that analysis, it was believed that the beef check-off would clear only the first and (perhaps) the third hurdle, but that the program would fail to clear the second hurdle. Indeed, the source of funding for the beef check-off comes from a discrete identifiable source (cattle producers) rather than a large, non-discrete group. The point is that if the government can compel a targeted group of individuals to fund speech with which they do not agree, greater care is required to ensure political accountability as a democratic check against the compelled speech. That is less of a concern if the funding source is the taxpaying public which has access to the ballot box as a means of neutralizing the government program at issue and/or the politicians in support of the program. While the dissent focused on this point, arguing that the Act does not establish sufficient democratic checks, Justice Scalia, writing for the majority, opined that the compelled-subsidy analysis is unaffected by whether the funds for the promotions are raised by general taxes or through a targeted assessment. That effectively eliminates the second prong of the government speech test. The Court held that the other two requirements were satisfied in as much as the legislation vested substantial control over the administration of the check-off and the content of the ads in the Secretary.
The court did not address (indeed, the issue was not before the court) whether the advertisements, most of which are credited to “America’s Beef Producers,” give the impression that the objecting cattlemen (or their organizations) endorse the message. Because the case only involved a facial challenge to the statutory language of the Act, the majority examined only the Act’s language and concluded that neither the statute nor the accompanying Order required attribution of the ads to “America’s Beef Producers” or to anyone else. Thus, neither the statute nor the Order could be facially invalid on this theory. However, the Court noted that the record did not contain evidence from which the Court could determine whether the actual application of the check-off program resulted in the message of the ads being associated with the plaintiffs. Indeed, Justice Thomas, in his concurring opinion, noted that the government may not associate individuals or organizations involuntarily with speech by attributing an unwanted message to them whether or not those individuals fund the speech and whether or not the message is under the government’s control.
After the Supreme Court’s decision in the beef-checkoff case, the U.S. Circuit Court of Appeals for the Ninth Circuit decided a case involving the California Pistachio check-off. Paramount Land Company, LP v. California Pistachio Commission, 491 F.3d 1003 (9th Cir. 2007). The court determined that the First Amendment was not implicated because, consistent with Johanns, the Secretary of the California Department of Food and Agriculture retained sufficient authority to control both the activities and the message under the Pistachio Act. The court reasoned that the fact that the Secretary had not actually played an active role in controlling pistachio advertising could not be equated with the Secretary abdicating his regulatory role.
In another California case, a court held that milk producer assessments used for generic advertising to stimulate milk sales were constitutional under the Johanns rationale. Gallo Cattle Co. v. A.G. Kawamura, 159 Cal. App. 4th 948, 72 Cal. Rptr. 3d 1 (2008).
In more recent litigation, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Vilsack, No. CV-16-41-GF-BMM-JTL, D. Mont. Dec. 12, 2016), the plaintiff (cattle producers) claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was constitutionally defective. The court, as part of the findings and recommendations of a U.S. Magistrate Judge, determined that the plaintiff had standing and had stated a claim upon which relief could be granted. The cattle producers claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The cattle producers objected to being forced to fund a generic message that “beef is beef” regardless of where the cattle from which the beef was derived or born. That message, the cattle producers claimed, was contrary to their interests of capitalizing on marketing their superior beef products produced from cattle produced in the United States.
The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision were finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. Upon further review, the federal trial court upheld the preliminary injunction. Ranchers- Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV 16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017).
On further review, the U.S. Court of Appeals for the Ninth Circuit affirmed. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). The Ninth Circuit determined that the trial court had properly evaluated the beef-checkoff under the standards set forth in Johanns and Paramount.
In Delano Farms Company v. California Table Grape Commission, No. S226538, 2018 Cal. LEXIS 3634 (Cal. Sup. Ct. May 24, 2018), the plaintiffs were several California grape growers. They claimed that the defendant violated the plaintiffs’ First Amendment free speech rights by collecting mandated fees to pay for a range of services including advertising and marketing. Specifically, the plaintiffs claimed the collection of assessments by the defendant under the California Ketchum Act subsidized promotional speech on behalf of California table grapes as a generic category that violated their rights to free speech, free association, due process, liberty and privacy under the California Constitution (Article I, Section 2). They took this position because the claimed to have developed specialty grapes that they wanted to market in their own manner without also being forced to pay for generic grape advertising that sponsored a viewpoint that they disagreed with.
The trial court ruled that the defendant was a governmental entity, and therefore its speech was government speech that could be funded by assessments collected from the plaintiffs under a constitutional analysis that is significantly deferential and is not subject to heightened scrutiny. As such, the trial court determined that the speech did not implicate Article 1, Section 2.
On appeal, the California Supreme Court affirmed. The Court noted that the relevant circumstances established sufficient government responsibility for and control over the messaging at issue such that the advertising constituted government speech that the plaintiffs could be required to subsidize without any implication of their constitutional rights under Article 1, Section 2. Specifically, the Court noted that the California legislature developed and endorsed the central message that the defendant promulgated with respect to California fresh grapes generically. The articulation and broadcasting of that message was entrusted to market participants acting through the defendant. The Court viewed this as meaningful oversight by the public and other governmental actors and included oversight mechanisms serving to ensure that the defendant’s messaging remained within the statutory parameters. The Court also stated that there is no right not to fund government speech, and also determined that the Ketchum Act did not bar the plaintiffs from speaking.
Mandatory assessments for generic advertising for ag commodities is understandably frustrating for some producers. However, the U.S. Supreme Court has provided a measuring stick for evaluating the constitutionality of such programs. If the administration of the particular check-off is substantially controlled by the government, and the government controls the contents of the ads at issue, the assessments are likely to be upheld as government speech.