Media Co. Files Memorandum in Tax Dispute Over Chicago Cubs Sale

TRIBUNE MEDIA COMPANY, F.K.A. TRIBUNE COMPANY & AFFILIATES, ET AL.,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

Petitioners' Trial Memorandum

UNITED STATES TAX COURT

Judge Buch

Joel V. Williamson, WJ0593
Scott M. Stewart, SS0756
James B. Kelly, KJ1064
Anthony D. Pastore, PA0387
Thomas Kittle-Kamp, KT0200
Peter M. Price, PP0193
John W. Home, HJ1614
Daniel S. Emas, EDO 186
Mayer Brown LLP
71 South Wacker Drive
Chicago, Illinois 60606

Counsel for Petitioners

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TABLE OF CONTENTS

I. INTRODUCTION

II. BASIC CASE INFORMATION

III. ISSUES TO BE TRIED

IV. SUMMARY OF PERTINENT FACTS

V. SUMMARY OF APPLICABLE LAW

VI. WITNESSES

VII. EVIDENTIARY ISSUES AND OTHER SIGNIFICANT DISPUTES

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I. INTRODUCTION

This case arises from a partnership transaction between Tribune Company (“Tribune”)¹ and an entity owned by the Ricketts family, Ricketts Acquisition LLC (“RAC”),² that closed on October 27, 2009. At the center of this transaction (the “Cubs Transaction”) were the assets of the Chicago Cubs Major League Baseball club (the “Cubs”). The Cubs Transaction had its genesis in Tribune's strategic decision to concentrate on its core media businesses and to monetize and reduce future capital investment with respect to non-core assets, which included its real estate investments, minority investments, and the Cubs.

Having made its decision with respect to the Cubs, Tribune engaged in an extended bidding process in which it set out a leveraged partnership as its proposed structure. This structure offered Tribune business benefits, including (i) rights as a partner in the Cubs, which Tribune expected would enhance its continuing valuable broadcast rights with its media businesses and (ii) an opportunity to participate in the potential growth of the Cubs' value. The structure also offered the tax benefits at issue here.

As with any major business transaction, the Cubs Transaction required extensive negotiations and complex agreements. But at its core, the transaction was relatively simple:

• Tribune contributed the Cubs assets, along with associated liabilities, to the partnership, Chicago Baseball Holdings LLC (“CBH”). RAC contributed $150 million in cash to CBH.

• CBH borrowed money on a senior and subordinated basis and Tribune guaranteed repayment of the debt (the “Guarantees”).

• CBH made a special distribution of cash to Tribune (the “Distribution”).

• After the Distribution, Tribune and RAC held membership interests in CBH of 5 percent and 95 percent, respectively.

The resulting partnership and Guarantees were expected to last at least until 2018 and in fact did. The following diagram summarizes the Cubs Transaction.

The central tax issue in this case is straightforward. Under the Code and Regulations, (1) the Distribution is tax-deferred to the extent of Tribune's allocable share of CBH's indebtedness, Treas. Reg. § 1.707-5(b)(1), and (2) to the extent the Distribution exceeds Tribune's allocable share, the Cubs Transaction is taxable in 2009 as a “disguised sale” under Treas. Reg. § 1.707-3(b). The question for the Court is how much of CBH's debt is allocable to Tribune.

Partnership debt is allocated to partners under the constructive liquidation test of Treas. Reg. § 1.752-2(b)(1). The constructive liquidation test assumes a highly unlikely scenario: the partnership's assets become worthless, all of its debts come due, and it is liquidated. The test then asks which partners would be obligated to pay the partnership's debts in that scenario. To the extent a partner would so “bear[ ] the economic risk of loss” of the partnership debt — to use the regulations' term of art — it is allocated the debt. Id. Of course, even in cases of extreme distress, a partnership nearly always possesses assets that could at least partially satisfy its debt obligations. By assuming a constructive liquidation, the regulations strip away this complication and allow both taxpayers and the IRS to readily figure out which partners are ultimately liable for debt, and determine the corresponding basis arising from this obligation.³

In applying the constructive liquidation test, the regulations disregard whether a partner can actually pay its obligations: “[I]t is assumed that all partners and related persons who have obligations to make payments actually perform those obligations, irrespective of their actual net worth.” Treas. Reg. § 1.752-2(b)(6). This assumption, however, is subject to an anti-abuse rule, which is anchored to the constructive liquidation test's concept of “economic risk of loss.” Under Treas. Reg. § 1.752-2(j)(1), a party's payment obligation may be disregarded “if facts and circumstances indicate that a principal purpose of the arrangement between the parties is to eliminate the partner's economic risk of loss with respect to that obligation or create the appearance of the partner . . . bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.” Treas. Reg. § 1.752-2(j)(1) (emphasis added).

Neither the constructive liquidation test nor the anti-abuse rule considers the financial strength of the partnership or its ability to pay its debts. The constructive liquidation test assumes the partnership is worthless, and the anti-abuse rule only targets arrangements with a principal purpose of eliminating a partner's economic risk of loss determined under the constructive liquidation test. Both are agnostic as to the probability that a partner's obligation to pay the partnership's debts will come due.

Under the constructive liquidation test, Tribune bears the economic risk of loss with respect to CBH's debt by virtue of its Guarantees. If CBH's assets were worthless, its debts came due, and it liquidated, Tribune would be legally obligated under the Guarantees to pay all $673.75 million of CBH's debt. As a result, that entire amount is allocated to Tribune under § 752.

This case thus turns on whether the Guarantees are disregarded under the anti-abuse test. But as the record will show, no party involved in the Cubs Transaction negotiated a single agreement or provision for the purpose of protecting Tribune from liability on the Guarantees if they came due. To the contrary, the record will show that Tribune remained fully liable under the Guarantees and able to pay if they were called. The anti-abuse rule does not apply to disregard the Guarantees.

Surprisingly, Respondent's position that the Guarantees violate the anti-abuse rule puts him at war with the very regulations he is entrusted to enforce. From the beginning, Respondent has argued that two aspects of the Guarantees mean that they violate the anti-abuse rule: (1) the Guarantees are guarantees of collection, not payment, meaning that the lenders must exhaust their remedies against CBH before calling the Guarantees, and (2) CBH's lenders were well secured on their loans, making it unlikely that Tribune would have to perform on its Guarantees. But Respondent's own anti-abuse regulation specifically demonstrates the irrelevance of each of these factors.

The regulations include an example that illustrates the application of the anti-abuse rule of Treas. Reg. § 1.752-2(j). This example was relied upon in Canal Corp. v. Comm'r, 135 T.C. 199 (2010). In the example, there are two partners. The partners invest $100,000 in total equity ($20,000 from Partner A and $80,000 from partner B); the partnership borrows $150,000 in recourse loans from a bank; and the partnership buys depreciable property for $250,000. Treas. Reg. § 1.752-2(j)(4) Example. Partner A has an obligation to restore any deficit in its capital account, and is allocated all losses once B's capital account is reduced to zero. Id. Partner “B guarantees payment of the $150,000 loan to the extent the loan remains unpaid after the bank has exhausted its remedies against the partnership” — in other words, this is a guarantee of collection. Id.

The example notes that, despite A's nominal obligation to restore any deficit in its capital account, A is a subsidiary with capital limited to $20,000 to allow its consolidated group to enjoy flow-through losses while “limiting its monetary exposure.” Id. Applying the constructive liquidation test, with all the partnership equity wiped out, A would be unable to contribute additional money to pay the partnership's debts when they came due. The example thus concludes that A's limited capital, “when considered together with B's guarantee, indicate a plan to circumvent or avoid A's obligation to contribute to the partnership. . . . Accordingly, the $150,000 liability is a recourse liability that is allocated entirely to B.” Id.

The significance of this example cannot be overstated: it specifically demonstrates that both of Respondent's positions are invalid. First, the liability in the anti-abuse example is allocated to the partner who provided a guarantee of collection, specifically refuting Respondent's theory that a guarantee of collection is a device that insulates Tribune from liability under the anti-abuse rule. Second, it confirms what the regulations already make clear: the well-secured nature of the debt is legally irrelevant. The debt in the example was significantly over-secured. The partnership asset was worth $250,000, with debt limited to $150,000 — thus, the debt was only 60% of the asset's fair market value. Nevertheless, the guarantor of collection was allocated all $150,000 of the debt, even though as a matter of fact available partnership assets were more than sufficient to satisfy the debt.

Having failed to think carefully about the actual application of the regulations to the facts presented here, Respondent also forgets that the anti-abuse rule of Treas. Reg. § 1.752-2(j) is a principal purpose test. Respondent thus focuses on factors that have nothing to do with “a principal purpose” of eliminating Tribune's economic risk of loss, nor do they in fact eliminate Tribune's economic risk of loss. For example:

• Respondent has argued that the Guarantees are invalid because they were incurred during Tribune's bankruptcy proceeding. But he ignores that the Bankruptcy Court ordered that the Guarantees were entitled to administrative expense priority and that the Guarantees shall not be discharged or affected by any plan of reorganization. He also ignores that Tribune had sufficient cash reserves to make good on the Guarantees.

• Respondent has pointed to an Operating Support Agreement (“OSA”) as somehow constituting an “arrangement” under the anti-abuse rule. The OSA was merely a credit facility negotiated with Major League Baseball (“MLB”) and available to CBH to ensure that the team could continue to play if it ran into financial difficulties. Funds loaned under the OSA could be used only to support team operations, could not be used to service debt, and were limited to $35 million. The OSA was not negotiated to protect Tribune and had nothing to do with Tribune's economic risk of loss.

• Respondent has argued that the Guarantees are invalid because a Standard & Poor's (“S&P”) credit rating report and letter do not emphasize them — while vigorously resisting the admission into evidence of later S&P credit ratings reports that view the Guarantees as imposing “significant financial risk” to Tribune and take them into account in rating the company's credit.⁴

In the end, all of Respondent's arguments about the Guarantees boil down to the observation that CBH was unlikely to default, its assets were highly valuable, and the Guarantees were unlikely to be called. None of these contentions is relevant under the constructive liquidation test and the anti-abuse rule. And they cannot be salvaged, as Respondent seeks to do, by invoking general substance-over-form principles or the general partnership anti-abuse rule of Treas. Reg. § 1.701-2(b).

Respondent's remaining contentions — that subordinated debt issued in the transaction was really equity, that the gain was not properly computed, and that some minor expenses should have been capitalized — are equally unavailing. Respondent's deficiency determination should be rejected.

II. BASIC CASE INFORMATION

A. Attorneys for Petitioner

Each of the Petitioners is represented by the following attorneys from Mayer Brown LLP:

Petitioners Northside and CBH are represented by the following attorney from Foley & Lardner LLP:

B. Amounts in Dispute

On June 28, 2016, Respondent issued a Notice of Deficiency to Tribune for Tribune's 2009 tax year (the “Tribune Notice”).⁵ The Tribune Notice increased Tribune's recognized built-in gains by $705,679,530. As a result, the Tribune Notice determined a deficiency of $181,661,831. The Tribune Notice also determined a 40% gross valuation misstatement penalty under I.R.C. § 6662(h) of $72,664,732 and a 20% penalty under § 6662(a) in the alternative to the § 6662(h) penalty. All of these determinations are in dispute.

Also on June 28, 2016, Respondent issued a Notice of Final Partnership Administrative Adjustment to Northside with respect to CBH's 2009 tax year (the “CBH FPAA”).⁶⁷ The CBH FPAA made the following adjustments, all of which are in dispute: (1) reduction of CBH's total capital contribution by $446,703,405; (2) reduction of CBH's recourse liability by $673,750,000; and (3) increase of CBH's non-recourse liability by $425,000,000.⁸ The CBH FPAA also determined a § 6662(h) penalty with respect to any partner-level liability resulting from the partnership-level proceedings, or, in the alternative, a § 6662(a) penalty applied to that amount. These penalty determinations are in dispute.⁹

Because Tribune was in bankruptcy in 2009, it has no partnership items with respect to CBH for that year, and therefore cannot be a party to CBH's TEFRA partnership proceeding. Partnership items are treated as nonpartnership items with respect to a partner in bankruptcy during the year in which the items arise. Treas. Reg. § 301.6231(c)-7(a).

C. Settlement Status

The parties are not engaged in settlement negotiations.

D. Current Estimate of Trial Time

The case is calendared for trial at a Special Session of the Tax Court beginning at 9:00 a.m. on Monday, October 28, 2019. Petitioners estimate that the trial will last two weeks.

E. Status of Stipulations of Fact

The parties have agreed to five stipulations of facts. These stipulations include 339 paragraphs and 594 exhibits. The parties continue to propose and discuss stipulations. Petitioners expect to reach agreement on nearly all proposed stipulations.

III. ISSUES TO BE TRIED

The issues presently before the Court are briefly described below.

A. Whether Tribune's Guarantees are respected

The fundamental issue in this case is whether Tribune's Guarantees of CBH's debt should be respected, such that the partnership's debt is allocated to Tribune under § 752. As explained in section V.A. below, this question turns on the law governing contributions to and distributions from partnerships, the allocation of partnership recourse liabilities, the constructive liquidation test of Treas. Reg. § 1.752-2(b), and the anti-abuse rule of Treas. Reg. § 1.752-2(j). Applying this law, the Guarantees are respected, permitting Tribune to defer recognition of gain on most of the Distribution.

B. Whether the Subordinated Debt is bona fide debt

Respondent asserts that subordinated debt issued by CBH as part of the Cubs Transaction (the “Subordinated Debt”) is not bona fide debt, but rather should be treated as equity for tax purposes. If it were equity, the Subordinated Debt could not be a recourse liability allocated to Tribune. As explained in section V.B., under the relevant debt-equity principles, the Subordinated Debt is bona fide debt.

C. Whether Respondent can recast the Cubs Transaction using the substance-over-form doctrine

In the Tribune Notice, Respondent asserts that the Cubs Transaction should be recharacterized under the substance-over-form doctrine as an asset sale by Tribune. Although the parties have stipulated that CBH was a bona fide LLC, taxable as a partnership for tax purposes, and that Tribune and RAC were the members, Respondent has not formally disavowed his substance-over-form argument, and in fact submitted an expert report of Dr. Oliver Hart that suggests he may continue to urge a recharacterization of the transaction. As explained in section V.C., since the detailed statutory and regulatory scheme governing the distribution provides that it is non-taxable to the extent of the debt for which Tribune provided the Guarantees, the substance-over-form doctrine cannot be invoked to provide a different tax result.

D. Whether Respondent can recast the Cubs Transaction using the partnership anti-abuse rule of Treas. Reg. § 1.701-2(b)

Respondent invokes the general partnership anti-abuse rule of Treas. Reg. § 1.701-2(b) to recast the transaction as a taxable sale. As explained in section V.D., this general anti-abuse rule cannot apply where, as here, the transaction is respected under a more specific anti-abuse rule. Even if there were no specific rule, Treas. Reg. § 1.701-2 could not be used to recast the transaction as it only applies where a taxpayer intends to reduce its tax liability contrary to the intent of Subchapter K, and there is no such intent here. Finally, Treas. Reg. § 1.701-2 is invalid.

E. Whether Respondent properly calculates Tribune's gain under his theories

Respondent has miscalculated the gain that Tribune would recognize on the Cubs Transaction in the event he were to prevail on his theories. As explained in section V.E., below, detailed regulations under §§ 707 and 752 provide how to calculate disguised sale gain.¹⁰

F. Whether Tribune properly deducted the Utay Expenses

Tribune paid $2.5 million in professional fees on behalf of Marc Utay in 2009 pursuant to a letter agreement. It deducted this amount from its 2009 income as expenses incurred in connection with an abandoned transaction. Respondent contends that this amount should be capitalized instead. As explained in section V.F., Tribune properly deducted these expenses.

G. Whether penalties apply

Pursuant to the parties' agreement to a bifurcated trial, the parties have agreed to exclude discussion of penalty issues from their trial memoranda.

IV. SUMMARY OF PERTINENT FACTS

A. History of the Cubs and Tribune

The Chicago Cubs, then known as the Chicago White Stockings, founded the National League of baseball with seven other teams in 1876. The team formally changed its name to “The Cubs” in 1907, the year it won its first World Series title. In 1981, Tribune bought the Cubs from William Wrigley III after six decades of Wrigley family ownership. Until 2009, Tribune was the sole owner of the Cubs.

Tribune was founded in 1847 with the publication of the Chicago Tribune newspaper and first became a public company in 1983. Over time, Tribune acquired or developed various assets. In 2009, Tribune's operations were divided into two primary categories: publishing and broadcasting. Tribune owned many newspapers, including the Chicago Tribune and the Los Angeles Times, over 20 television stations in major U.S. cities, and a radio station, along with other ventures or interests therein.

B. Background to the Transaction

In 2007, following a strategic review, Tribune's board of directors approved a restructuring involving a series of transactions that resulted in a newly formed Employee Stock Ownership Plan acquiring Tribune. The acquisition was leveraged, with Tribune incurring over $8 billion in new debt. After the restructuring was completed, Tribune converted to a Subchapter S corporation effective the first day of its 2008 tax year.

In connection with this restructuring, Tribune also began to explore transactions involving the Cubs, including a possible transaction with a strategic partner. Tribune retained J.P. Morgan Securities, Inc. (“JPMSI”) in May 2007 to act as a financial advisor for a transaction involving the Cubs.

Tribune ultimately decided that forming a partnership to own the Cubs best suited its business objectives. Contribution of the Cubs to a partnership was attractive to Tribune for a number of reasons, including that it allowed Tribune to (1) retain an ownership interest in a valuable enterprise; (2) receive a distribution financed by the partnership's debt — in effect borrowing through the partnership — and use the proceeds to repay Tribune's existing debt; (3) preserve valuable radio and television broadcast relationships between Cubs and WGN and protect its rights with respect to that relationship; (4) refocus on its core business, which related to publishing, broadcasting, and interactive content; and (5) reduce its exposure to the volatility and capital requirements associated with owning a major sports franchise. Tribune also decided to guaranty the partnership's debt. The guarantees would stand behind the debt of the partnership, whose success enhanced Tribune's broadcast rights, as well as allow the partial tax deferral of the debt-financed distribution to Tribune.

C. Tribune's Selection of a Partner

JPMSI began soliciting interest in two structures: (i) a single partnership holding all Cubs assets and (ii) two separate partnerships: one holding the Cubs team and the other holding Wrigley Field. Over 100 parties expressed interest in the single-partnership transaction and over 60 parties expressed interest in the two-partnership transaction. The bidders who passed an initial evaluation and application process were given descriptive memoranda.

Tribune solicited bids for the Cubs partnership in three phases. In the first phase, which took place in July 2008, Tribune received initial bids from 10 interested parties. In the second phase, which took place in November 2008, Tribune received definitive proposals from three parties: a bidding group represented by Hersch Klaff (“Klaff'), a bidding group represented by Marc Utay (“Utay”), and the Ricketts family.¹¹ In the third phase, which took place in January 2009, Tribune received revised versions of the three definitive proposals.

When evaluating bids, Tribune and its advisers considered multiple factors. These factors included, among other things, the net upfront after-tax cash component of the bid, the total present value of all forms of consideration for the proposed transaction, the certainty that the bidder would be able to secure the financing necessary to close the transaction, the likelihood of MLB approval for the transaction, and the tax benefits, if any, to be provided to Tribune in the event a particular bid was implemented. Although Tribune had proposed a particular partnership structure, Tribune considered bids that proposed alternative structures and was open to any structure that would maximize value for Tribune.

Following the three phases of bidding, Tribune decided that the Ricketts family's bid was the most attractive, although Tribune later resumed negotiations with Utay, one of the bidders that proposed an alternative structure.

During the bidding, on December 8, 2008, Tribune filed for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Tribune's wholly owned subsidiary Chicago National League Ball Club LLC (“CNLBC LLC”), which held and operated the Cubs at that time, was not part of Tribune's bankruptcy petition.

D. Negotiations with Utay

While Tribune was negotiating with the Ricketts family, as described in more detail in section IV.E., Tribune later resumed negotiations with Utay. Tribune first reengaged with Utay in May 2009 when the progress of the negotiations with the Ricketts family had slowed. Tribune entered an agreement with Utay by which Tribune agreed to reimburse certain of Utay's costs incurred in investigating the proposed partnership and making a bid. Tribune paid $2.5 million on behalf of Utay pursuant to this agreement for professional services performed by legal and accounting professionals.

Tribune negotiated with both Utay and the Ricketts family until August 2009. Ultimately, Tribune and its advisers determined that the Ricketts family's proposal was the most favorable to Tribune.

E. Negotiations and Terms of the Cubs Transaction

i. Overview of Negotiations between the Parties

Following Tribune's selection of the Ricketts family's bid in January 2009, the parties began to negotiate the specific terms of the transaction. Tribune and the Ricketts family, primarily through their counsel and other advisors, also negotiated the specific terms of numerous agreements necessary to execute the Cubs Transaction. On July 10, 2009, Tribune and the Ricketts family signed a term sheet that provided the basic terms for the partnership transaction and, on August 21, 2009, the parties' agreement was formalized in detail in a Formation Agreement, which included terms related to partnership financing and a distribution to Tribune, as well as the form of additional agreements necessary to effect the transaction.

ii. Overview of CBH Capital Structure

Pursuant to the Formation Agreement, Tribune would contribute the Cubs assets to the partnership and RAC would contribute $150 million in cash. The partnership would borrow $425 million of term loans (the “Senior Term Loans”) from a consortium of banks, which also agreed to make available a $25 million revolving loan. On the same day, CBH would issue $250 million in private placement notes to certain third-party institutional investors (the “Senior Notes”) and use the proceeds to pay down a portion of the Senior Term Loans. The Senior Term Loans, the Senior Notes, and the revolver together comprised the Senior Debt (its lenders, collectively, the “Senior Lenders”). CBH would also obtain $248,750,000 of unsecured, subordinated loans (the “Subordinated Debt”). Tribune would provide Guarantees of the Senior Debt and the Subordinated Debt. The Formation Agreement also provided that CBH would make the Distribution to Tribune and included a formula to compute the Distribution.¹²

iii. Negotiating the Guarantees

The terms of the Guarantees were heavily negotiated between Tribune and the lenders. After Tribune's counsel prepared the first draft of the Senior Debt Guaranty, at least ten more drafts were sent between the parties. Most were drafted by the Senior Lenders or finance counsel for Tribune.

After extensive back-and-forth with counsel for the lenders, the final Guarantees were each twice as long as the draft proposed by Tribune, with changes in nearly every section and entirely new sections. The lenders aggressively pursued their interests in the negotiations and added a number of lender-friendly provisions to the Guarantees. For example, counsel for the lenders inserted language requiring that

• Any obligations under the Guarantees would be administrative expense priorities in Tribune's bankruptcy.

• Tribune waive numerous potential defenses to payment.

• CBH payments returned to CBH for any reason (e.g., bankruptcy) remain subject to the Guaranty.

• Delay in enforcing lender rights would not operate as a waiver.

• Tribune pay the lenders' costs in enforcing the Guaranty.

• The lenders be exculpated from potential liability to Tribune.

The parties also negotiated the terms of a valuation mechanism in the event of foreclosure without a timely sale (or diligent pursuit of a sale), so that Tribune could fix its liability under the Guarantees if a sale were delayed. Furthermore, counsel for the Senior Lenders requested (and received) a legal opinion that the Senior Debt Guaranty was valid and enforceable.¹³

The Subordinated Debt Guaranty was based on the draft Senior Debt Guaranty. The Subordinated Debt lender thus began negotiations with the benefit of protections negotiated by the Senior Lenders. Nevertheless, at least four additional drafts were exchanged between the parties.

Neither during the negotiation of the Guarantees, nor during the negotiation of any other agreement in the Cubs Transaction, did any party involved seek to include an agreement or provision for the purpose of limiting Tribune's risk of having to pay on the Guarantees.

iv. Terms of the Guarantees

The parties understood that the Guarantees would make Tribune ultimately liable for CBH's debt. The Guarantees covered principal, interest, and any make-wholes or premiums on the Senior Debt and Subordinated Debt. Because they were guarantees of collection, Tribune would be liable on the debt after CBH had failed to make a payment and the lenders had exhausted all legal rights and remedies against the partnership and failed to fully collect. There has never been a default of the Senior Debt or Subordinated Debt, so Tribune has never made a payment under the Guarantees. The Guarantees were emphasized in the debt marketing materials, including presentations and private placement memoranda.

Tribune's economic risk of loss under the Guarantees is not limited by contract, statute, or anything else. There is no loss-limiting arrangement, indemnification, or right of reimbursement from any other guarantor. Tribune does obtain subordinated subrogation rights if it makes a payment on the Guarantees, but these rights (1) only run against CBH and (2) only arise once the Senior Debt has been paid (for the Senior Debt Guaranty) or both debts have been paid (for the Subordinated Debt Guaranty). Tribune cannot assign its obligation to another entity without the lenders' approval, and the lenders have the right to direct Tribune to assign the Guarantees to any person who acquires all or substantially all of the assets of Tribune.

v. CBH's Subordinated Debt

On the same day the Formation Agreement was executed, Marlene Ricketts agreed to fond the Subordinated Debt for purposes of closing the transaction. However, the debt's terms and formal documentation, drafted by the family's counsel and other advisors, were also driven by the family's contemplation that some of the debt might be issued to third parties.

The terms of the Subordinated Debt were legally enforceable and commercially reasonable. As Petitioners' expert Prof. Israel Shaked opines, a third-party would have provided debt financing to CBH with substantially similar terms and interest rate as the Subordinated Debt. The loan has a fixed maturity date fifteen years from the date of issuance and bears interest at an annual rate of 6.5% of the outstanding principal. Interest can be paid in-kind by adding to the principal amount. The lender also has the option to receive a portion of the interest paid in cash and the rest paid in-kind. The Subordinated Debt did not carry with it any management rights. The Subordinated Debt provided the lender with other valuable consideration in the form of perquisites. These included the right to use Wrigley Field for family, corporate, or charitable functions, access to premium seating and luxury suites, and invitations to all Cubs special events.

The terms were documented in a Subscription Agreement and a Promissory Note issued to RAC Education Trust Finance, LLC (“RAC Finance”).¹⁴ These documents provide strong lender protections by incorporating terms of the Senior Debt documents by reference. Importantly, acceleration of the Senior Debt upon default constitutes an event of default on the Subordinated Debt. In the event of default, the lender would enforce the Subordinated Debt, allowing it to call the Guarantees and require payment from Tribune, an unrelated party.

CBH's Senior Debt lenders viewed the Subordinated Debt as bona fide, as evidenced by credit protections they vigorously negotiated vis-a-vis the Subordinated Debt lenders. For example, if CBH were to incur more than $298.75 million of Subordinated Debt (exclusive of paid-in-kind interest added to principal) it would trigger a default on the Senior Debt. This confirms the Senior Lenders viewed the Subordinated Debt as additional leverage on CBH, rather than additional equity. As explained by Prof. Shaked, however, CBH was nevertheless adequately capitalized at closing, with a debt-to-equity ratio of approximately 4:1.

Before the Cubs Transaction closed, the Ricketts family engaged in informal discussions with potential unrelated investors in the Subordinated Debt and distributed detailed marketing materials to them. Discussions with potential investors continued after closing, and some of those investors expressed interest to CBH. Had a portion of the Subordinated Debt been placed, Tribune and RAC's respective ownership shares of CBH would have remained the same. Although some potential investors expressed interest, the Ricketts family ultimately chose not to sell any of the Subordinated Debt.

At issuance, the Subordinated Debt lender reasonably expected full repayment of the debt according to its terms, as indicated by contemporary financial forecasts and further explained by Prof. Shaked. And as explained in the report of Petitioners' expert David Moes, subsequent payment performance has confirmed this expectation.

F. Tribune's Bankruptcy Proceeding

i. Bankruptcy Court Approval of the Cubs Transaction

Before closing, Tribune sought approval from the Bankruptcy Court for the Cubs Transaction. Bankruptcy law required Tribune to do so because the transaction was outside Tribune's normal course of business. It was also necessary for Tribune's subsidiary that owned most of the Cubs assets — CNLBC LLC — to file a bankruptcy petition and seek approval for the transaction.

The Bankruptcy Court ultimately approved the transaction.¹⁵ As part of its order authorizing the Cubs Transaction, and as stipulated by the parties,¹⁶ the Bankruptcy Court

• Determined that the negotiations and preparation of the Formation Agreement, the Guarantees, and other transaction documents were conducted and concluded at arm's length and in good faith by all parties.

• Determined that the Guarantees are valid and enforceable pursuant to their terms and applicable law.

• Ordered that the Guarantees shall not be discharged or affected by any plan of reorganization confirmed in Tribune's bankruptcy proceeding.

• Ordered that the Guarantees would be deemed “administrative expense priority” claims under §§ 503(b) and 507(a)(2) of the Bankruptcy Code.

The Guarantees' status as administrative expense priorities was important. Tribune's administrative expenses had priority in bankruptcy ahead of all unsecured claims arising from Tribune's pre-petition debt. 11 U.S.C. § 507(a). And, by statute, administrative expenses must be paid in a Chapter 11 proceeding: the debtor is expected to pay these expenses as they are incurred and, in any event, accrued administrative expenses must be paid in full no later than when the debtor emerges from bankruptcy. 11 U.S.C. § 1129(a)(9)(A). Tribune always anticipated emerging from bankruptcy and paying its administrative expenses.

ii. Tribune's Capacity to Pay the Guarantees in Bankruptcy

Tribune had cash on hand to pay these administrative expenses, if they had come due. During the bankruptcy, Tribune held cash well in excess of its maximum potential liability on the guarantees (roughly $698.75 million).¹⁷ Indeed, Tribune and its debtor affiliates never held less than $1.3 billion in cash, as shown by the monthly operating reports that Tribune filed with the Bankruptcy Court:

ECF No.	Date	Available Cash
2896	November 22, 2009	$1,337,528,000
3235	December 27, 2009	$1,383,325,000
3662	January 31, 2010	$1,424,555,000
3891	February 28, 2010	$1,396,116,000
4181	March 28, 2010	$1,467,959,000
4604	April 25, 2010	$1,500,893,000
4855	May 23, 2010	$1,522,823,000
5146	June 27, 2010	$1,554,206,000
5544	August 1, 2010	$1,599,291,000
5832	August 29, 2010	$1,629,244,000
6130	September 26, 2010	$1,652,134,000
6594	October 24, 2010	$1,729,497,000
7261	November 21, 2010	$1,747,159,000
7636	December 26, 2010	$1,783,745,000
8207	January 30, 2011	$1,801,209,000
8522	February 27, 2011	$1,775,854,000
8766	March 27, 2011	$1,828,321,000
8984	April 24, 2011	$1,847,083,000
9301	May 22, 2011	$1,870,011,000
9552	June 26, 2011	$1,914,538,000
9728	July 31, 2011	$1,928,761,000
9836	August 28, 2011	$1,952,794,000
10067	September 25, 2011	$1,969,680,000
10284	October 23, 2011	$1,988,068,000
10476	November 20, 2011	$2,020,149,000
10691	December 25, 2011	$2,047,509,000
11042	January 29, 2012	$2,062,115,000
11244	February 26, 2012	$2,123,298,000
11466	March 25, 2012	$2,182,994,000
11671	April 22, 2012	$2,194,621,000
11847	May 20, 2012	$2,245,330,000
12094	June 24, 2012	$2,331,624,000
12345	July 29, 2012	$2,375,806,000
12464	August 26, 2012	$2,410,637,000
12613	September 23, 2012	$2,408,915,000
12746	October 21, 2012	$2,468,247,000
12860	November 18, 2012	$2,537,988,000
13119	December 30, 2012	$2,987,283,000

iii. Tribune's Emergence from Bankruptcy

Several years after the transaction, Tribune proposed a “plan of reorganization.” A plan of reorganization is the culmination of the bankruptcy process. It establishes how much value each creditor will recover from the bankruptcy estate. A plan of reorganization must provide for full cash payment of administrative expenses when the plan becomes effective unless the administrative expense creditors have “agreed to a different treatment.” 11 U.S.C. § 1129(a)(9).

The Bankruptcy Court confirmed Tribune's plan of reorganization on July 23, 2012. In its confirmation order, the Bankruptcy Court confirmed that Tribune's obligations under the Guarantees “shall continue in full force and effect” after the bankruptcy. Order at 27, In re Tribune Co., No. 08-13141 (Bankr. D. Del. July 23, 2012), ECF No. 12074. Tribune exited bankruptcy on December 31, 2012. Following bankruptcy, Tribune was a Subchapter C Corporation. It exited with gross assets of $8.67 billion and net assets of $4.54 billion, both far in excess of its obligations under the Guarantees.

If the Guarantees were called after the bankruptcy, Tribune would satisfy them pursuant to the plan of reorganization. By confirming the plan, the Bankruptcy Court necessarily determined that Tribune could pay the Guarantees after bankruptcy without endangering the company. The Bankruptcy Court will confirm a plan of reorganization only if the plan is “feasible.” Specifically, the court must find that “[c]onfirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor.” 11 U.S.C. § 1129(a)(11). The bankruptcy court made this determination in Tribune's case, dismissing an argument that the plan of reorganization was not feasible. See In re Tribune Co., 464 B.R. 126, 184-85 (Bankr. D. Del. 2011).

The court's determination was warranted. According to Tribune's financial disclosure, Tribune projected operating cash flows upon emerging from bankruptcy of $517 million, $484 million, and $495 million in 2012, 2013, and 2014, respectively. The Bankruptcy Court reviewed the financial disclosure and found that it provided “adequate information,” a prerequisite to Tribune's soliciting acceptance of the plan of reorganization. See Order at 3, In re Tribune Co., No. 08-13141 (Bankr. D. Del. July 23, 2012), ECF No. 11419 (citing 11 U.S.C. § 1125(b)). Thus, just as it was clear that Tribune could have paid the Guarantees in bankruptcy, the Bankruptcy Court also necessarily determined that Tribune would remain able to pay the Guarantees after the bankruptcy.

G. MLB Approval

As with any change of control of an MLB team, the contribution of the Cubs assets to CBH required league approval. This includes sign-off from the Office of the Commissioner of Baseball (the “BOC”) as well as the vote of three-fourths of the club owners, based on their review of a BOC memorandum detailing the transaction and its structure. For the Cubs Transaction, this approval thus involved third-party reliance on representations regarding the transaction features in dispute in this case: the Guarantees, the Subordinated Debt, and the CBH partnership. Neither the BOC nor any of the club owners questioned the reality of any of these features.

In weighing approval, the BOC considers a number of factors, including the club's financial viability following the transaction. This consideration is warranted — MLB clubs have gone bankrupt.¹⁸ For example, in March 2009 the entity that owned the Texas Rangers baseball team defaulted on its debt. The club entered Chapter 11 bankruptcy and were sold in a bankruptcy auction.

The BOC reviewed many of the Cubs Transaction agreements and participated in the negotiation of the terms of some, including Tribune's Guarantees. In addition, MLB influenced the transaction in the following ways:

i. The Debt Service Rule

The BOC was required to certify the transaction's compliance with league rules regarding the amount of debt a club can take on. The collective bargaining agreement between the 30 MLB clubs and the MLB Players Association (the “Basic Agreement”) includes a Debt Service Rule (“DSR”) that seeks to ensure clubs' debt does not endanger them from paying their players. The DSR limits the level of debt an MLB team may maintain based on the team's earnings before interest, taxes, depreciation, and amortization (“EBITDA”). At the time of the Cubs Transaction, unsecured, related-party debt was not included in the calculation of debt subject to the DSR (“Total Club Debt”), so CBH's Subordinated Debt did not affect CBH's DSR compliance.

ii. The OSA

As a condition of obtaining MLB approval, CBH agreed to obtain a $35 million subordinated loan commitment agreement (“Operating Support Agreement” or “OSA”) from a Ricketts-related entity to support the Cubs' operating expenses, if necessary.¹⁹ MLB agreed to supplement CBH's EBITDA with the $35 million for purposes of the DSR. CBH has never drawn on the OSA.

Funds borrowed under the OSA, by the OSA's own terms, could not be used “directly or indirectly” to pay principal or interest of any of CBH's debt. Rather, the loan proceeds would either (i) be deposited into a segregated account to support CBH's operations or (ii) in certain circumstances, be paid directly to third parties to satisfy CBH operating expenses then due. In addition, the Senior Lenders' security interest specifically excluded the OSA and any OSA loan proceeds.

iii. MLB Support Loans

MLB reserved the right to loan money to CBH to cover operating expenses, including up to $35 million in principal of loans that “prime” CBH's other lenders.²⁰ Any such loans would be senior to and have priority over CBH's Senior Debt and Subordinated Debt and would be secured by liens ranking ahead of the liens granted to the lenders of CBH's Senior Debt. In addition, MLB reserved the right to make unlimited loans fully subordinated to CBH's Senior Debt.

iv. Standstill Period

MLB, through negotiations with the Senior Lenders, included a provision in the transaction that prohibited CBH's lenders from enforcing their debt for up to 180 days following notice of an event of default (“Standstill Period”). This provision's purpose was to allow the club to function as a going concern, without the threat of bankruptcy or foreclosure, for the duration of a season, while CBH could seek a workout of its loans or, if necessary, sell the club. The Standstill Period did not prohibit CBH's lenders from enforcing the Guarantees to collect on any shortfall on the debt following a sale of the club, nor did it inhibit in any way enforcement of the Guarantees following the Standstill Period.

H. Partnership Operations

Respondent and Petitioners have stipulated that CBH is a bona fide LLC taxable as a partnership for federal income tax purposes and that Tribune and RAC were the members of CBH as of October 27, 2009.²¹²² The partners' actions since 2009 bear this out.

As part of the transaction, RAC and Tribune's Cubs-related subsidiaries entered a partnership operating agreement setting forth, among other things, the rights of the members and the rules governing the partnership's operations (the “LLC Agreement”). The LLC Agreement vested the authority to manage and control the business in a Board of Directors (the “CBH Board”). The initial CBH Board included one member appointed by Tribune and four members appointed by RAC.

i. CBH Board Management

Tribune was actively involved in CBH's management following its formation. Tribune's appointed director — Nils Larsen from 2009 through 2013 and Edward Lazarus from 2013 through 2019 — regularly participated in CBH Board meetings and votes. They were involved in such important board decisions as approving strategic plans proposed by management; authorizing major investments, including Wrigley Field renovations and construction of the spring training facility in Mesa, Arizona; authorizing amendments to the partnership's loan documents, including extensions of the maturity date of the Senior Debt; determining the Chairman's salary; and approving CBH's employee welfare and retirement plans. Tribune's director also kept CBH apprised of Tribune's financial condition, including its financial health upon emergence from bankruptcy.

Generally, the CBH Board operated by majority vote; however, a number of actions also required Tribune's written approval. These veto rights of Tribune became critical in 2013, when Tribune's consent was required for CBH to reorganize entities and obtain an additional $75 million commitment of senior financing in connection with the renovation of Wrigley Field. Respondent's own expert, Prof. Oliver Hart, describes whether to invest in improving Wrigley Field as a “key operational decision.” Hart Report at 26. In exchange for its consent, Tribune extracted meaningful concessions with respect to contemporaneous media rights negotiations between Tribune and CBH.

ii. Capital Calls and Buyout

On three occasions, the CBH Board determined that additional capital was needed to fund the multiyear renovations of Wrigley Field. Pursuant to the LLC Agreement, the CBH Board, including Tribune's appointed director, requested in aggregate an additional $300 million in capital contributions from the partners. Tribune contributed the required capital in proportion to its membership interest — an amount totaling $15 million.

Ultimately, Tribune participated in material growth in CBH's value, including appreciation attributable to the Cubs' 2016 World Series title. Tribune's partnership interest was subject to a call option at fair market value in 2018 and 2024, and a put option at fair market value in 2021 and 2027.²³ RAC exercised its call option in 2018. Pursuant to the call, Tribune sold its 5 percent interest in CBH in January 2019 for $107.5 million, implying a total value for CBH of $2.15 billion.

I. Financial Accounting Treatment and Other Analyses of the Transaction

Tribune's accounting for the Cubs Transaction recognized the reality of both Tribune's 5% interest in CBH and Tribune's Guarantees. For GAAP accounting purposes, Tribune determined that the Cubs Transaction resulted in a divestiture of the Cubs assets and that its 5% interest in CBH should be treated as a “cost method investment.” Tribune disclosed the Guarantees and its maximum potential exposure thereunder in its financial statements. Applying GAAP guidance, Tribune did not recognize a liability on its balance sheet for GAAP accounting purposes with respect to the Guarantees. See Expert Report of Prof. Merle Erickson. Tribune treated the Subordinated Debt as debt for GAAP accounting purposes in connection with its analysis of its interest in CBH.

Later, in analyzing Tribune as a reorganized company, S&P issued ratings reports viewing the Guarantees as “a significant financial risk for [Tribune]” and consolidating a portion of CBH's debt on Tribune's balance sheet in determining Tribune's credit measures. See, e.g., Second Stipulation of Facts, Ex. 97-P, Research Update: Tribune Co. Assigned 'BB-' Issuer Rating at 4.

Furthermore, expert reports submitted by both Petitioner and Respondent support the conclusion that the Guarantees had economic value. Petitioners have submitted (i) a report from Prof. Anil Shivdasani that concludes that the Guarantees had economic value and provides an estimate of their value as of the closing of the Cubs Transaction and (ii) a report from Prof. William Chambers concluding that the Guarantees had significant value to the lenders. The report of Respondent's expert Prof. Douglas Skinner estimates the economic value of the Guarantees ranged between $6.12 million and $18.86 million.²⁴

J. Subordinated Debt Financial Accounting Treatment and Payment Performance

CBH, in its audited GAAP financial statements, treated the Subordinated Debt as debt for all purposes and recorded its current interest payments on the Subordinated Debt as “interest expense” in the same manner as it treated the interest it paid on its third-party loans.

At all times through 2018, CBH performed on the Subordinated Debt in accordance with its terms, making all required interest payments.²⁵ Between 2009 and 2016 CBH paid almost $80 million of Subordinated Debt interest in cash. The remaining interest accrued during that period was paid in-kind.²⁶

K. Tax Treatment of the Transaction

On CBH's 2009 tax return, it reported the Distribution as a cash distribution of $713,748,223 to Tribune.²⁷ This amount consisted of cash transferred to Tribune, expenses paid by CBH on behalf of Tribune, and certain other expected future transfers. The net fair market value of assets and liabilities contributed by Tribune was $734,735,065, as agreed to by the parties.²⁸ Tribune's tax basis in the assets it contributed to CBH was $148,544,336.

Because the Distribution exceeded the CBH debt Tribune was ultimately liable for ($673,750,000), Tribune recognized $33,830,135 of disguised sale gain from the transaction, as calculated in section V.E.ii. CBH assumed $35,241,562 in qualified liabilities associated with the Cubs assets. Tribune incurred $15,293,748 in capitalized transaction costs in connection with the Cubs Transaction.²⁹

After the transaction, Tribune's opening capital balance in CBH for tax purposes was $20,986,843. CBH filed a partnership tax return each year and issued Schedules K-1 to its partners. Each year Tribune was a partner it received remedial allocations of income under the remedial allocation method described in Treas. Reg. § 1.704-3(d) to account for the difference between the fair market value and the adjusted basis of the Cubs assets at the time they were contributed to CBH.

V. SUMMARY OF APPLICABLE LAW

A. Tribune's Guarantees Permitted a Partially Tax-Deferred Distribution

The primary issue in this case is whether the Guarantees should be respected and CBH's debt therefore allocated to Tribune. This question turns on the law governing contributions to and distributions from partnerships, the allocation of partnership recourse liabilities, and the anti-abuse rule of Treas. Reg. § 1.752-20). Applying these principles, the Guarantees are respected. As a result, Tribune's gain from the Distribution is tax-deferred to the extent of the guaranteed debt.

1. Applicable Law

a. Contributions to and distributions from partnerships

Generally, a partner recognizes no gain or loss upon contributing property to a partnership in exchange for a partnership interest. I.R.C. § 721(a). Similarly, a partner generally recognizes no gain or loss upon receiving a non-liquidating distribution of property, other than money in excess of the partner's basis. I.R.C. § 731(a).

Despite these general rules, § 707(a)(2)(B) provides that a partner's contribution of property to the partnership and a related partnership distribution can nevertheless be taxable to the partner if certain conditions are met. Specifically, a partner's transfer of property to a partnership and the partnership's transfer of money to the partner can be treated as a “disguised sale” of property, but “only if based on all the facts and circumstances [t]he transfer of money or other consideration would not have been made but for the transfer of property.” Treas. Reg. § 1.707-3(a)(3), (b)(1). For this purpose, transfers of property and money that occur within a two-year period are presumed to be a sale of property unless the facts and circumstances clearly establish otherwise. Treas. Reg. § 1.707-3(c)(1).

In enacting § 707, Congress specifically intended that a partner could in effect borrow through the partnership without being subject to disguised sale treatment — just as borrowing against an asset outside the partnership would not be taxable. H.R. Rep. No. 98-861, at 862 (1984). Consistent with congressional intent, Treasury promulgated Treas. Reg. § 1.707-5(b) to address this situation. Under that provision, if a partner transfers property to a partnership, the partnership incurs a liability, and the proceeds of that liability are allocable to a transfer of money to the partner made within 90 days of incurring the liability, then the transfer of money is only subject to the disguised sale rules to the extent the distribution exceeds the partner's allocable share of the partnership liability, Treas. Reg. § 1.707-5(b)(1).

b. Allocation of partnership recourse liabilities

For purposes of applying Treas. Reg. § 1.707-5(b)(1), each partner's share of a recourse liability is determined under the “constructive liquidation” test of Treas. Reg. § 1.752-2. Under this test, a partner's share of a recourse liability equals the portion for which it bears the economic risk of loss. Treas. Reg. § 1.752-2(a).

A partner “bears the economic risk of loss for a partnership liability to the extent that, if the partnership constructively liquidated, the partner or related person would be obligated to make a payment to any person (or a contribution to the partnership) because that liability becomes due and payable.” Treas. Reg. § 1.752-2(b)(1). Under such a “constructive liquidation,”

Treas. Reg. § 1.752-2(b)(1). The regulation thus assumes a purely hypothetical event in which all assets are worth nothing and all debts are due, then asks: Who would be liable for the debt in liquidation? That party bears the “economic risk of loss” to the extent it would be liable, and is therefore allocated partnership debt.

As taxpayers generally do not enter partnerships that they expect to go belly up, the test necessarily rests on assumptions outside the ordinary course of events. One leading treatise recognizes that the constructive liquidation test, by resorting to such a counterfactual hypothetical, “may seem strange” even to those “accustomed to the conflicting twists of federal tax law.” McKee, Nelson & Whitmire, ¶8.02[2]. The treatise explains the reason for such a test:

The answer lies in the simple fact that, with respect to any type of liability, the partnership itself bears the economic risk of loss unless its assets become worthless. The only time a partner will be called upon to come out of pocket with respect to a partnership liability is when the partnership is unable to pay all or a portion of that liability. Thus, any examination of the partners' obligations at a time when the partnership's assets have value would necessarily produce an artificial and potentially skewed analysis as to how the partners bear the economic risk of loss. By crediting partners with outside basis attributable to a liability to the extent the partners would be obligated to make payments in the event of a total loss of value in the partnership's assets, the § 752 Regulations duplicate the consequences of the worst-case hypothetical situation.

Id.

c. The anti-abuse rule of Treas. Reg. § 1.752-2(j)

1. The Regulations

For purposes of the constructive liquidation test, “it is assumed that all partners and related persons who have obligations to make payments actually perform those obligations, irrespective of their actual net worth, unless the facts and circumstances indicate a plan to circumvent or avoid the obligation.” Treas. Reg. § 1.752-2(b)(6). That exception references Treas. Reg. § 1.752-2(j), the anti-abuse rule. The anti-abuse rule says, in relevant part, that

[a]n obligation of a partner . . . to make a payment may be disregarded or treated as an obligation of another person . . . if facts and circumstances indicate that a principal purpose of the arrangement between the parties is to eliminate the partner's economic risk of loss with respect to that obligation or create the appearance of the partner . . . bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.

Treas. Reg. § 1.752-2(j)(1) (emphasis added). This includes where “the facts and circumstances evidence a plan to circumvent or avoid the obligation.” Treas. Reg. § 1.752-2(j)(3).

In allocating partnership recourse debt, the anti-abuse rule is tied to the constructive liquidation test's concept of “economic risk of loss.” The anti-abuse rule requires a finding of two critical elements: (i) a principal purpose to (ii) eliminate a partner's economic risk of loss or create the appearance of an economic loss when the substance of the arrangement is otherwise.

The anti-abuse rule is illustrated by an example in the Regulations:

A and B form a general partnership. A, a corporation, contributes $20,000 and B contributes $80,000 to the partnership. A is obligated to restore any deficit in its partnership capital account. The partnership agreement allocates losses 20% to A and 80% to B until B's capital account is reduced to zero, after which all losses are allocated to A. The partnership purchases depreciable property for $250,000 using its $100,000 cash and a $150,000 recourse loan from a bank. B guarantees payment of the $150,000 loan to the extent the loan remains unpaid after the bank has exhausted its remedies against the partnership. A is a subsidiary, formed by a parent of a consolidated group, with capital limited to $20,000 to allow the consolidated group to enjoy the tax losses generated by the property while at the same time limiting its monetary exposure for such losses. These facts, when considered together with B's guarantee, indicate a plan to circumvent or avoid A's obligation to contribute to the partnership. The rules of section 752 must be applied as if A's obligation to contribute did not exist. Accordingly, the $150,000 liability is a recourse liability that is allocated entirely to B.

Treas. Reg. § 1.752-2(j)(4) (emphasis added). In this example, the liability for the loan is attributed on the basis of B's guarantee, even though B is only liable under the guarantee once the bank has exhausted its remedies against the partnership. In other words, B is a guarantor of collection. Critically, the example's disregard of A's obligation is predicated on the parent's intent in using a thinly capitalized subsidiary — “to circumvent or avoid A's obligation to contribute to the partnership.” Id.

2. Canal Corp. v. Commissioner

Only one reported case has analyzed this anti-abuse rule: Canal Corp. v. Comm'r, 135 T.C. 199 (2010). In Canal, the Tax Court held that Treas. Reg. § 1.752-2(j) can cause an obligation to be disregarded where, under the assumptions of the constructive liquidation test, the party purporting to be liable would not actually pay its obligation. Canal Corp., 135 T.C. at 212-14, 17.

In Canal, the petitioner's subsidiary contributed assets to a partnership in exchange for a 5% partnership interest and a cash distribution of the proceeds of a bank loan to the partnership. Id. at 207. The 95% partner guaranteed the partnership loan and the petitioner's subsidiary agreed to indemnify any amount paid on that guarantee. Id. The petitioner's subsidiary used the proceeds of the cash distribution to pay a dividend to the petitioner, repay amounts owed to the petitioner, and loan $151 million to the petitioner in exchange for a promissory note. Id. at 207-08.

After the transaction, the subsidiary was thinly capitalized, with a claimed net worth of $157 million, but a true net worth of zero, as found by the court. Id. at 214. The subsidiary held only its partnership interest, the note from its parent, and a corporate jet, and it was subject to certain liabilities of its affiliates. Id. The Court found that “[n]othing restricted [the petitioner] from canceling the note at its discretion at any time to reduce the asset level of [the indemnifying subsidiary] to zero.” Id. at 214. The petitioner did in fact cancel the note just two years after the transaction at issue. Id. As a result, the court found that the subsidiary's “intercompany note served to create merely the appearance, rather than the reality, of economic risk for a portion of the . . . debt,” and that the subsidiary's “agreement to indemnify . . . lacked economic substance and afforded no real protection to [the other partner].” Id. at 214.

The Canal court noted that the one example in the regulations illustrating the anti-abuse rule of Treas. Reg. § 1.752-20) demonstrates that a payment obligation of a thinly capitalized subsidiary indicates a plan to circumvent or avoid an obligation and thus allows the Commissioner to disregard it. Id. at 215 (citing Treas. Reg. § 1.752-2(j)(4), discussed section V.A.i.c.1., immediately prior). The Court concluded that “[a] thinly capitalized subsidiary with no business operations and no real assets cannot be used to shield a parent corporation with significant assets from being taxed on a deemed sale.” Canal Corp., 135 T.C. at 215.

d. The likelihood that an obligation will come due is irrelevant to the allocation of partnership debt

As the Commissioner correctly argued in Canal Corp., the regulations addressing the allocation of partnership recourse debt preclude an analysis of the likelihood that a particular obligation will come due. Respondent's Reply Brief, Canal Corp. v. Comm'r, Dkt. No. 14090-06, Index No. 106 at 36-38 (Mar. 26, 2010). They do so because the constructive liquidation test itself, as explained in section V.A.i.b., makes the extraordinarily unlikely assumption that all partnership assets are worthless (Treas. Reg. § 1.752-2(b)(1)) — and then, having begun with this extraordinary assumption, allocates liabilities under the further assumption that “all partners and related persons who have obligations to make payments actually perform those obligations, irrespective of their actual net worth, unless the facts and circumstances indicate a plan to circumvent or avoid the obligation.” Treas. Reg. § 1.752-2(b)(6).

The anti-abuse provision disregards a partner's obligation only if the obligation is part of a plan to “eliminate the partner's economic risk of loss” See Treas. Reg. § 1.752-2(j)(1) (emphasis added). As discussed above in Section V.A.i.c., a partner could eliminate its risk, for example, by providing the guarantee through a subsidiary stripped of assets, rendering the subsidiary judgment proof. The regulations similarly disregard a partner's obligation if it is part of a plan to create the “appearance of . . . economic risk of loss” as determined by the constructive liquidation test, when the substance is “otherwise,” i.e., an obligation is disregarded if the partner appears to bear economic risk of loss, but in substance does not. See Treas. Reg. § 1.752-2(j)(1) (emphasis added). Finally, the regulations discuss a “plan to circumvent or avoid the obligation.” Treas. Reg. § 1.752-2(j)(3) (emphasis added). In short, the regulatory language is directed to arrangements designed (i.e., with “a principal purpose”) to eliminate the economic risk of loss that would otherwise be assigned to a partner under the constructive liquidation test.

This is why, as IRS counsel correctly argued in Canal “[t]he regulations do not take into account the expected value of the partnership,” Respondent's Reply Brief, Canal Corp. v. Comm'r, Dkt. No. 14090-06, Index No. 106 at 38 (Mar. 26, 2010), but rather the test “assumes a worst-case scenario or catastrophic event including the partnership (assets) having zero value.” Id. at 36.³⁰ This is also why the Tax Court in Canal rested its legal analysis on “whether [the indemnifying subsidiary] had sufficient assets to cover the indemnity regardless of how remote the possibility it would have to pay.” Canal Corp., 135 T.C. at 213 (emphasis added). And this is why the Canal court did not review financial information or expert analyses to evaluate the partnership's probability of default.

The constructive liquidation regulations provide a simple, mechanical rule that applies to all partnerships, without the need to undertake a complex and subjective analysis of their financial strength. Consistent with this, none of the eight examples in Treas. Reg. § 1.752-2(f) illustrating the application of the rules relating to allocating recourse liabilities analyzes the financial strength of the partnership or its ability to pay its obligations. Relatedly, the anti-abuse rules do not ask how likely it is that a payment obligation will come due, but rather, ask whether there is an arrangement with “a principal purpose” of eliminating “economic risk of loss” on the obligation if it does come due.³¹

A likelihood analysis would contravene bedrock principles of regulatory construction, since it would impermissibly read the anti-abuse rule of Treas. Reg. § 1.752-2(j) to nullify the constructive liquidation test of Treas. Reg. § 1.752-2(b). One regulatory provision may not be read to render another superfluous. Interpretations that displace other regulations are “plainly at odds” with this “familiar axiom” of statutory and regulatory construction. Abbott Labs. v. United States, 84 Fed. Cl. 96, 106 (2008). For that reason, courts have not hesitated to reject such interpretations. See, e.g., Jewett v. Comm'r, 455 U.S. 305, 316 (1982); Cammarano v. United States, 358 U.S. 498, 505 (1959); Abbott Labs., 84 Fed. Cl. at 106. If a partner's obligation could be disregarded based on a subjective assessment of whether the obligation were likely to be called, it would render the constructive liquidation test superfluous.

Instead, the anti-abuse rule properly gives effect to the constructive liquidation test. Thus, the first question, under the constructive liquidation test (Treas. Reg. § 1.752-2(b)(1)), is whether the partner is legally obligated to make a payment. The second question, under the anti-abuse rule (Treas. Reg. § 1.752-2(j)), is whether an arrangement has been employed with “a principal purpose” of freeing the partner from the financial consequences that follow from the obligation it has assumed. Both aspects of the regulations operate as a complete and harmonious regulatory scheme.

ii. Petitioners' Position

a. Tribune bears the economic risk of loss of the guaranteed debt

Under the constructive liquidation test, Tribune would be liable for both the Senior Debt and Subordinated Debt in full. A constructive liquidation would require immediate payment by the partnership of both debts, but because the partnership would have no assets, the lenders would invoke the Guarantees for full payment by Tribune.

It is beyond dispute that the Guarantees are valid and enforceable by all parties involved and would therefore be honored. The Bankruptcy Court determined in a transaction approval order under 11 U.S.C. § 363 that the Guarantees were negotiated “at arm's length and in good faith by all parties” and that they are valid and enforceable. Order at 4-5, 8, In re Tribune Co., No. 08-13141 (Bankr. D. Del. Sept. 24, 2009), ECF No. 2213. The Bankruptcy Court's judgment is impervious to collateral attack as a § 363 proceeding is an in rem proceeding and, as such, establishes property rights “good against the world. . . .” Matter of Met-L-Wood Corp., 861 F.2d 1012, 1017 (7th Cir. 1988). See also FutureSource LLC v. Reuters Ltd., 312 F.3d 281, 285-86 (7th Cir. 2002) (§ 363 approval is a judicial order and cannot be collaterally attacked in a subsequent proceeding). Such a collateral attack by Respondent here would be especially inequitable, as the IRS was party to the bankruptcy proceeding. See Entry of Appearance, In re Tribune Co., No. 08-13141 (Bankr. D. Del. May 7, 2009), ECF No. 1147. “Giving due regard to principles of judicial comity,” it is inappropriate to “second-guess the bankruptcy court's” conclusion in this case. See Gracia v. Comm'r, T.C. Memo. 2004-147, slip op. at *6.

The background of the Guarantees makes it clear they are binding and enforceable. As described above, the lenders heavily negotiated the terms of the Guarantees, and insisted on numerous additional protections. What is more, the Senior Lenders even requested (and received) a legal opinion that the Senior Guaranty was valid and enforceable.

b. The anti-abuse rule of Treas. Reg. § 1.752-2(j) does not apply

The anti-abuse rule of Treas. Reg. § 1.752-2(j) does not apply here, as there was never an arrangement with any purpose — let alone “a principal purpose,” as required by the regulation — of eliminating Tribune's economic risk of loss under the Guarantees. Critically, no party involved in the Cubs Transaction — neither Tribune, nor the Rickettses, nor the Senior Lenders, nor MLB — once sought to include any agreement or provision that would limit Tribune's liability under the Guarantees. In fact, the parties' negotiations reflect that ensuring Tribune would have to pay upon the Guarantees if they were called to do so was a goal — one that was achieved. Tribune's disclosure of the Guarantees on its financials demonstrate that its management thought it was possible they could be required to pay under the Guarantees. And S&P's later reports — the ones that Respondent is fighting tooth and nail to keep out of evidence — show that the Guarantees had real-world consequences to Tribune: S&P viewed the Guarantees as a “significant financial risk” for Tribune and therefore consolidated a portion of the partnership's debt onto Tribune's balance sheet in rating the company's credit.

Furthermore, as explained above in section IV.I., expert reports submitted by both Petitioner and Respondent support the conclusion that the Guarantees had economic value. Respondent's expert Prof. Skinner estimates the economic value of the Guarantees ranged between $6.12 million to $18.86 million.³²

Tribune bears no resemblance to the thin capitalization structures in the regulation's example and Canal. To the contrary, Tribune at all relevant times had assets far in excess of its potential obligations under the Guarantees. And any claims made under the Guarantees during Tribune's bankruptcy were legally required to be paid before Tribune's emergence, which was inevitable. Tribune emerged from bankruptcy with gross assets of $8.67 billion, over ten times the amount of the Senior Debt and Subordinated Debt guaranteed by Tribune, and net assets of $4.54 billion.

c. Respondent's anticipated arguments as to why the anti-abuse rule should apply do not hold water

Respondent, in the NOPAs, advanced several theories as to why the Guarantees should not be respected, but none show “a principal purpose . . . to eliminate [Tribune's] economic risk of loss” under the Guarantees, as required to disregard them under the anti-abuse rule. See Treas. Reg. § 1.752-2(j)(1). At trial, Petitioners will rebut the following and any other theories raised by Respondent to disregard the Guarantees.

1. Guarantees of collection are respected under the Regulations

Respondent seeks to disregard the Guarantees under the anti-abuse rule of Treas. Reg. § 1.752-20) in part because they are guarantees of collection rather than guarantees of payment. Yet the sole example illustrating that anti-abuse rule, discussed in section V.A.i.c.1., above, recognizes the substance of a guaranty of collection. The liability in the example is allocated to partner B, the partner that has guaranteed the loan, “to the extent [it] remains unpaid after the bank has exhausted its remedies against the partnership.” Treas. Reg. § 1.752-2(j)(4). This language precisely describes a guaranty of collection. Namely, it requires that (1) the debt hasn't been paid, (2) the lender has “exhausted its remedies,” and (3) the lender has not collected the full amount of the debt. These are the same conditions to which the Tribune Guarantees are subject.

It makes sense that the Regulations respect guarantees of collection: courts routinely enforce them, including on dispositive motions without need for trial. See, e.g., AgServs. of Am., Inc. v. Midwest Inv. Ltd., 585 N.W.2d 571 (N.D. 1998); Beard v. McDowell, 331 S.E.2d 104 (Ga. Ct. App.1985); Leaseway Sys. Corp. v. Rushmore & Weber, Inc., 463 N.Y.S.2d 92 (App. Div. 1983). See also Foss v. Melton, 386 P.3d 553 (Mont. 2016). Furthermore, the Uniform Commercial Code recognizes guarantees of collection and provides a standard for determining whether the beneficiary of a guaranty of collection has exhausted its remedies. See, e. g., U.C.C. § 3-419(d).³³

Respondent has argued that it would be extremely difficult for the lenders to demonstrate they had exhausted their remedies against CBH. In fact, beneficiaries of guarantees of collection can and do prove that they have exhausted their remedies. See, e.g., Gannett Co. v. Tesler, 577 N.Y.S.2d 248, 248-49 (App. Div. 1991). New York law governs the Guarantees³⁴ in this case and provides clear standards for exhaustion under guarantees of collection. Formal compliance with the agreement's requirements to exhaust remedies is not necessary when such actions would be futile, as Respondent's own expert points out. See Gellis Report at 6. See also Leaseway, Inc., 463 N.Y.S.2d at 93-94; Inland Credit Corp. v. Gold, 448 N.Y.S.2d 690, 691 (App. Div. 1982).

2. CBH's financial strength is not relevant to the anti-abuse rule

Respondent also emphasizes that the Guarantees are unlikely to be called. As explained in section V.A.i.d., the probability that a guaranty will be called is simply irrelevant, as Respondent vigorously argued in Canal Corp. If the rule were otherwise, the regulations would not apply any time that the borrowing partnership was strongly capitalized, generated healthy cash flows, or provided strong collateral for the loans. In other words, the regulations would not apply to everyday transactions.

The example of Treas. Reg. § 1.752-2(j)(4), discussed immediately above in section V.A.ii.c.1., also illustrates this important point. In that example, the partnership held property worth $250,000 and was subject only to a $150,000 recourse loan. Treas. Reg. § 1.752-2(j)(4), Example. Even though the value of the property was significantly greater than the loan, the economic risk of loss was still allocated to the partner who made the guaranty of collection.

3. Neither the OSA nor MLB's supervision eliminated Tribune's risk (nor had such a purpose)

Respondent has argued or implied that the OSA, MLB's supervisory powers, or some combination thereof insulated Tribune from risk on the Guarantees. They did not. And they certainly did not have a “principal purpose” of doing so.

The OSA: First, MLB required the OSA to obtain compliance with the Debt Service Rule, an aspect of MLB's collective bargaining agreement with the players' union. The purpose of the OSA was to provide loans to the team if necessary to pay player salaries and keep the team playing, not to protect Tribune from liability under the Guarantees. Second, the express terms of the OSA prevent it from being used to make a payment on the debt, and the mechanics of the loans prevent any OSA funds from servicing debt, making other money available to service debt, or serving as collateral for CBH's loans. Third, OSA borrowing increases CBH leverage, and is therefore adverse to CBH's creditors, and thus Tribune, as guarantor. Finally, the OSA is limited in amount to $35 million.

MLB support loans: These loans would not eliminate Tribune's risk, but would instead increase CBH's leverage and risk of default, and thus increase Tribune's risk on the Guarantees. Furthermore, MLB loans are made for the purpose of keeping the team on the field and not eliminating Tribune's risk.³⁵

MLB's ability to direct capital contributions: MLB can “direct” a club to raise equity from its owners. But, as Respondent's own expert Prof. Skinner points out in his report, MLB teams have gone bankrupt in the past. More importantly, this power of MLB does not have anything to do with a “principal purpose” of eliminating Tribune's economic risk of loss or making Tribune appear to be liable when the substance is otherwise.

B. The Subordinated Debt Is Bona Fide Debt

Respondent contends that the Subordinated Debt should be recast as equity for tax purposes. If it were equity, the Subordinated Debt could not be a recourse liability allocated to Tribune. Applying the relevant debt-equity principles, however, the Subordinated Debt is bona fide debt.

i. Applicable Law

In evaluating whether an instrument is to be treated as debt or equity, the transaction's substance governs its tax treatment. PepsiCo Puerto Rico, Inc. v. Comm'r, T.C. Memo. 2012-269, at *49. In making this determination, the ultimate question the court must answer is whether there was a genuine intention to create a debt, with a reasonable expectation of repayment, and whether that intention comported with the economic reality of a debtor-creditor relationship. Nestle Holdings, Inc. v. Comm'r, T.C. Memo. 1995-441, 1995 WL 544886 at *24 (citing Litton Bus. Sys., Inc. v. Comm'r, 61 T.C. 367, 377 (1973)).

Courts consider various factors in making this determination, including (1) whether there is a written agreement demonstrating indebtedness, (2) whether the debt has a fixed maturity date, (3) whether the creditor has a right to enforce payment, (4) the intent of the parties, (5) whether there is an identity of interest between creditors and stockholders, (6) whether there is a thinness of capital structure in relation to debt, (7) the debtor's ability to obtain credit from outside sources, (8) the ability of the debtor to make repayment, and (9) the creditor's risk in making the advances. Nestle Holdings, T.C. Memo. 1995-441, 1995 WL 544886 at *24.

ii. Petitioners' Position

An analysis of the relevant factors for resolving debt-equity determinations confirms that the Subordinated Debt cannot properly be recast as equity.

a. The parties intended to establish a creditor-debtor relationship

The parties to the Subordinated Debt intended it to be true debt. This is clear from their extensive documentation of it. The parties' intent to create a creditor-debtor relationship is “[t]he critical factor in finding that an investment is in substance a loan. . . ." Hewlett-Packard Co. v. Comm'r, T.C. Memo. 2012-135, slip op. at *73. See also Hardman v. United States, 827 F.2d 1409, 1413 (9th Cir. 1987) (“We note that the purpose of this entire [debt-equity] inquiry is to decipher the true intent of the parties.”); PepsiCo Puerto Rico, T.C. Memo. 2012-269, at *54-55 (“the key to this [debt-equity] determination is primarily the taxpayer's actual intent, evinced by the particular circumstances of the transfer.”); Am. Underwriters, Inc. v. Comm'r, T.C. Memo. 1996-548, slip op. at *14 (same language).

The contemporary documentation and formalities adhered to in establishing a debt is important evidence of that intent. Nestle Holdings, T.C. Memo. 1995-441, 1995 WL 544886, at *25. The terms used in documents evidencing the debt help guide this inquiry. See Am. Underwriters, T.C. Memo. 1996-548, slip op. at *17 (“We look to the name of the certificate evidencing purported debt to determine the 'debt's' true label. The issuance of a debt instrument such as a promissory note points toward debt.”); Hardman, 827 F.2d at 1412 (that “[t]he document . . . contains language typical of a promissory note” supported finding it was debt); Monon R.R. v. Comm'r, 55 T.C. 345, 356-57 (1970). Indeed, “in numerous situations the form by which a transaction is effected does influence and may indeed decisively control the tax consequences.” PepsiCo Puerto Rico, T.C. Memo. 2012-269 at *50 (quoting Blueberry Land Co. v. Comm'r, 361 F.2d 93, 101 (5th Cir. 1966)). However, related-party debt does not need to be documented to the same degree as third-party debt. See Dynamo Holdings L.P. v. Comm'r, T.C. Memo. 2018-61 at *59 (“any shortcomings” in documentation of related-party debt “must be taken into account in the context of the business realities of the transaction”).

In this case, the parties' intent to establish a genuine debt is clear from the substantial documentation that treats the instrument as debt. This includes the Promissory Note establishing the debt; the Subscription Agreement, pursuant to which the note was purchased by the lender; and the Subordinated Debt Guaranty, by which Tribune guaranteed the debt. The agreements related to disbursement of the loan proceeds — including the Closing Escrow Agreement and Escrow Funding Notice — further confirm that the instrument constitutes debt. And although the Rickettses ultimately chose not to place the debt with any third parties, their advisors spent significant time and effort drafting marketing materials detailing the debt's features and terms, distributing them to interested parties, and engaging in follow-up discussions. The parties also entered an Agency Agreement with a financial institution for the latter to act as agent for all Subordinated Debt lenders.

The use of debt rather than equity in part for tax reasons does not negate the intention to create debt. In PepsiCo Puerto Rico, for example, the court found that the taxpayers, “engaging in legitimate tax planning, designed the advance agreements with an expectation that the instruments would be characterized as equity for U.S. Federal income tax purposes and as debt under Dutch tax law.” T.C. Memo. 2012-269 at *88. The court found that these actions “do not subvert or vitiate their clear intentions to create a legitimate hybrid instrument,” which intentions “comport with the substance of the transaction . . . [and] demonstrate[ ] the equity nature of the instruments.” Id. at *89, 91.³⁶ In other words, a tax motivation can support a taxpayer's assertion that an instrument is what it purports to be.

Once the Subordinated Debt was in place, both CBH and Tribune consistently treated it as debt on their respective audited financial statements. This favors debt treatment. See Illinois Tool Works Inc. v. Comm'r, T.C. Memo. 2018-121 at *38-39.

b. The Subordinated Debt has terms consistent with debt

The Subordinated Debt contained enforceable terms consistent with that of debt and the parties at all times have reasonably expected its repayment pursuant to those terms. The Tax Court has observed that “classic debt is 'an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor's income or lack thereof.'” Weaver Popcorn Co., Inc. v. Comm'r, T.C. Memo. 1971-281, 30 T.C.M. (CCH) 1204, 1212 (citing Gilbert v. Comm'r, 248 F.2d 399, 402-403 (2d Cir. 1957)). See also Bowater Inc. v. Comm'r, T.C. Memo. 1995-164, 1995 WL 160698 at *4. CBH's binding obligation to pay principal and interest upon a stated maturity date is thus strong evidence that the instrument is debt. See Monon R.R., 55 T.C. at 359 (“A definite maturity date on which the principal falls due for payment, without reservation or condition . . . is a fundamental characteristic of a debt.”).

For debt, “the touchstone of economic reality is whether an outside lender would have made the payments in the same form and on the same terms.” Segel v. Comm'r, 89 T.C. 816, 828 (1987). That is the case here. The Ricketts family received interest in the Subordinated Debt from third parties, and Prof. Shaked's expert report explains that a third-party lender would have provided debt financing to CBH with substantially similar terms and interest rate as the Subordinated Debt.

The debt's terms thus far surpass the threshold for determining whether related-party debt is bona fide. Courts recognize that “different creditors invariably undertake different degrees of risk and that, where debtor and creditor are related, the lender might understandably offer more lenient terms than could be secured elsewhere.” Nestlé Holdings, T.C. Memo. 1995-441, 1995 WL 544886 at *29 (quoting G.M. Gooch Lumber Sales Co. v. Comm'r, 49 T.C. 649, 659 (1968)). Rather, the inquiry is “whether the terms of the advances were a 'patent distortion of what would normally have been available'” to the borrower. Id. (quoting Litton Bus. Sys., Inc. v. Comm'r, 61 T.C. 367, 379 (1973)).

The Subordinated Debt has a 6.5% interest rate and a fixed maturity date of October 27, 2024, 15 years from the date of issuance. While some very long maturities have been viewed as indicative of equity (see, e.g., PepsiCo Puerto Rico, T.C. Memo. 2012-269 at *58, 66 (40-year maturity that could be extended)), that is not the case here. In Monon Railroad, in which the court determined that a 50-year maturity was reasonable, the court took “into consideration the substantial nature of the [debtor's] business, and the fact that it had been in corporate existence . . . 61 years prior to issuance of the debentures.” Monon R.R., 55 T.C. at 359. Similarly, in Nestle Holdings, Respondent failed to convince the Court that maturities of over 20 years were indicative of equity, as the Court found that the terms of the instrument were not a “patent distortion” of the terms available to the debtor on the capital markets. T.C. Memo. 1995-441, 1995 WL 544886 at *28-29. Compared to the debts in Monon R.R. and Nestle Holdings, the maturity here is far more reasonable as it is only 15 years; the debtor had been in business for over 130 years; and the guarantor, Tribune, had been in existence for over 160 years.

Although the terms of the Subordinated Debt permit CBH to pay part of the interest in-kind by issuing additional debt, the full principal and interest comes due at maturity, and the partnership has a binding obligation (backed by the Guaranty) to pay the full amount at that time. As explained in the expert report of Prof. Shaked, payment of debt in-kind is commercially reasonable and thus consistent with true debt. The Treasury Regulations recognize this, using the term “PIK” to refer to payment of debt with additional debt. See Treas. Reg. § 1.6045-1(n)(2)(ii)(F) (current ed.) (defining “payment-in-kind (PIK) feature” as a debt term providing that the holder may receive one or more additional debt instruments of the issuer as payment); and Treas. Reg. § 1.1272-1(j), Examples 7 and 8 (current ed.) (referring to “PIK instrument[s]”). Even Respondent's expert concedes that PIK features in debt are “by no means rare.” See Gellis Opening Report at 20.

c. The parties have at all times reasonably expected the Subordinated Debt to be repaid according to its terms

At issuance, full repayment of the Subordinated Debt in accordance with its terms was reasonably expected. The expert report of Prof. Shaked provides detailed analysis demonstrating that CBH was expected to generate sufficient cash to pay its debts, including both the Senior Debt and Subordinated Debt. See, e.g., Dynamo Holdings, T.C. Memo. 2018-61 at *63, 65-68 (borrower's ability to repay indicates bona fide debt).

Prof. Shaked also opines that CBH was adequately capitalized with partnership equity relative to its debt load, which is yet another factor indicating that the Subordinated Debt was, in fact, debt. “The purpose of examining the debt-to-equity ratio in characterizing an advance is to determine whether a corporation is so thinly capitalized that it would be unable to repay an advance.” Hewlett-Packard Co. v. Comm'r, T.C. Memo. 2012-135, slip op. at *75. A thin capital structure would indicate equity. Id. See also Hardman, 827 F.2d at 1414 (fact that debtor “did not appear to be 'thinly' capitalized but, rather, appeared to be an ongoing, viable corporation with assets other than the property acquired” supported finding that debt was bona fide). CBH had an initial debt-to-equity ratio of approximately 4:1.³⁷

In addition, an analysis performed by Mr. Moes demonstrates CBH has actually complied with the terms of the notes. Actual timely payment of debt obligations is “a significant debt-equity factor” indicating that the debt is bona fide. Delta Plastics v. Comm'r, T.C. Memo. 2003-54, slip op. at *12. CBH made the required interest and principal payments for the Subordinated Debt and complied with all of its terms.

d. The Subordinated Debt's priority is consistent with that of debt

The Subordinated Debt ranks senior to any partner's partnership interest. Thus, at maturity, the Subordinated Debt lender would have rights to all principal and interest due under the debt superior to any claims the partners had against the partnership. And if the partnership were to default on the Senior Debt, that debt would be accelerated, which would in turn trigger a default of the Subordinated Debt, requiring the partnership to pay both debts before making any distributions to partners. The Subordinated Debt also ranks pari passu with obligations to the partnership's general unsecured creditors.

Although the Subordinated Debt did not enjoy priority over the Senior Debt, it enjoyed sufficient priority that the Senior Lenders were compelled to negotiate protections vis-a-vis the Subordinated Debt holders. For example, if CBH were to incur more than $298.75 million in Subordinated Debt (exclusive of paid-in-kind interest added to principal) it would constitute an event of default on the Senior Debt. Protections of this nature would be unnecessary if the Subordinated Debt were truly equity.

Superiority of claims under an instrument over the claims of equity holders indicates debt. Subordination to other debts does not mean that an instrument is equity and “[t]his is especially true when the advance is given a superior status to the claims of shareholders. "Am. Underwriters, T.C. Memo. 1996-548, slip op. at *22. Thus, in John Kelley Co., the Supreme Court affirmed the determination that debt was bona fide where “[t]he debenture holders had priority of payment over stockholders but were subordinated to all other creditors.” 326 U.S. 521, 523 (1946). And in Monon Railroad, the Tax Court found that where debenture holders had rights greater than the debtor's shareholders, “[t]he debentures holders may be [(and were)] recognized as creditors even though their claims [were] subordinated to those of general business creditors.” 55 T.C. at 360.

C. The Cubs Transaction Must Be Respected Under Substance-Over-Form Principles

In the Notice, Respondent contended that the Cubs Transaction should be recharacterized under the substance-over-form doctrine as a mere asset sale by Tribune and that Tribune's interest in CBH was, “in substance, a contingent payment for the life of [CBH].” Tribune Notice, Schedule 5A. This cannot be the true substance if Tribune is a bona fide partner. The parties subsequently stipulated that CBH was a bona fide LLC taxable as a partnership for tax purposes, and that Tribune and RAC were its members.³⁸ But it appears from the expert report of Prof. Oliver Hart that, the stipulation notwithstanding, Respondent still contends that Tribune was not a partner in CBH.

In any event, Respondent fundamentally misapprehends the substance-over-form doctrine. If, as the facts establish, Tribune and RAC entered into a partnership and it made a distribution to Tribune that was not immediately taxable under the governing partnership regulations, that is the end of the matter. Respondent cannot simply cry “Substance Over Form!” and impose a result contrary to that dictated by the statutory and regulatory scheme.

i. Applicable Law

The substance-over-form doctrine allows a court in certain circumstances to look past a transaction's form and impose taxation in accordance with the transaction's true substance. Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978). Thus, a transaction “must be given its effect in accord with what actually occurred and not in accord with what might have occurred.” Id. at 576. See also Hosp. Corp. of Am. v. Comm'r, 81 T.C. 520, 585-86 (1983) (“The question is not whether petitioner could have but whether it in fact did.”).

Under the doctrine, the Commissioner may look through the labels placed upon a transaction, determine what kind of transaction the parties actually engaged in (i.e., determine the transaction's true substance), and then impose tax based upon the rules governing the type of transaction that the parties actually engaged in. Thus, if the parties cast a loan in the form of a lease, but the transaction was truly a loan, the transaction may be taxed as a loan. See, e.g., John Hancock Life Ins. Co. (U.S.A.) v. Comm'r, 141 T.C. 1, 109-10 (2013). In this way, taxation is based upon a transaction's substance, not its form.

But the doctrine does not empower the Commissioner to ignore what actually happened — to disregard a transaction's true substance — in order to generate the tax result that the Commissioner finds most congenial. See Esmark, Inc. v. Comm'r, 90 T.C. 171, 200 (1988) (“the judicially recognized doctrines give us no satisfactory basis for taxing the transaction as if something else had occurred”), aff'd without published opinion, 886 F.2d 1318 (7th Cir. 1989); Grove v. Comm'r, 490 F.2d 241, 247 (2d Cir. 1973) (refusing to adopt Commissioner's position where doing so “would . . . [require the court] to recast two actual transactions . . . into two completely fictional transactions. . . .”). Thus, if a lease is cast in the form of a lease, and is truly a lease, it must be taxed as a lease — even though recasting it as a loan would produce more tax.

And where a transaction is actually carried out in compliance with a detailed statutory and regulatory regime, the taxation of the transaction is dictated by the governing provisions of the Code and Regulations. As the Sixth Circuit has explained, substance-over-form principles cannot be used to override the tax treatment of a real transaction actually structured in compliance with governing rules. Summa Holdings, Inc. v. Comm'r, 848 F.3d 779, 782 (6th Cir. 2017) (“If the government can undo transactions that the terms of the Code expressly authorize, it's fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. 'Form' is 'substance' when it comes to law.”). See also Benenson v. Comm'r, 887 F.3d 511, 523 (1st Cir. 2018) (“When, as here, we find that the transaction does not violate the plain intent of the relevant statutes, we can push the doctrine no further.”); Benenson v. Comm'r, 910 F.3d 690 (2d Cir. 2018).

ii. Petitioners' Position

As set forth above, detailed provisions of the Code and Regulations govern the tax treatment of “disguised sale” transactions. Where, as here, a taxpayer structures a business transaction in compliance with the explicit terms of the statute and regulations, the form and substance of the transaction are identical, and a judicial doctrine may not alter the intended effect of Congress and the Treasury. See Matter of Chrome Plate, Inc., 614 F.2d 990, 1000 (5th Cir. 1980) (“We may not act as a beneficent paternal rectifier of legislation which is not constitutionally deficient. In light of the provisions of § 334, there is simply no room to utilize the substance over form doctrine.”); United States v. Cumberland Pub. Serv. Co., 338 U.S. 451, 456 (1950) (“Congress having determined that different tax consequences shall flow from different methods by which the shareholders of a closely held corporation may dispose of corporate property, we accept its mandate.”); Dover Corp. v. Comm'r, 122 T.C. 324, 352 (2004) (“respondent was, of course, free to amend his regulations . . . But, in the absence of respondent's exercise of that authority, we must apply the regulation as written.”).

Tribune and RAC formed a bona fide partnership that actually borrowed money, Tribune actually guaranteed the associated debt, and Tribune actually received a distribution. Since the transaction in reality strictly complied with the statutory and regulatory requirements governing the taxation of “disguised sales” under subchapter K, there is not some different “true substance” that recasts the transaction as a “sale” divorced from the governing rules.

In this respect, there can be no question here that a true partnership was formed in which RAC became a 95% partner and Tribune became a 5% partner. They negotiated a number of agreements respecting their rights as partners, including, for example, the Cash Collateral Account and Security Agreement, which included provisions that determine when and how partnership profits may be distributed to partners. Each year the partnership distributed Schedules K-1 and Tribune reported remedial allocations of income as required by § 704(c) and Treas. Reg. § 1.704-3(d).

Tribune, as a 5% partner, had a genuine, ongoing role in the partnership. Tribune's appointed director consistently participated in CBH Board meetings and votes. Tribune also had veto rights that provided it critical leverage in negotiations when its consent was required for financing and restructuring in connection with the renovation of Wrigley Field. Tribune also provided $15 million in additional capital to CBH in response to capital calls.

The partnership transaction allowed Tribune to retain an interest in a highly regarded sports franchise and continue to participate in its growth. Tribune reasonably expected to benefit from the retained ownership, and that expectation was borne out in reality — Tribune eventually sold its 5% interest for $107.5 million, for an annual return on investment of approximately 20%. Prof. Shaked Rebuttal Report at 22. Tribune's partnership rights also enhanced Tribune's important Cubs media rights, an important asset to its core broadcasting business.

In short, the substance of the transaction accords with its form and the doctrine does not apply.³⁹

D. The General Partnership Anti-Abuse Rule Does Not Apply

Respondent has also claimed that he can use the general partnership anti-abuse rule of Treas. Reg. § 1.701-2 to recast the transaction as a taxable sale. This general anti-abuse rule cannot apply because: (i) the transaction is respected under a more specific anti-abuse rule; (ii) Treas. Reg. § 1.701-2, by its terms, can only be used to recast a transaction where a taxpayer intends to reduce its tax liability contrary to the intent of Subchapter K, which is not the case here; and (iii) Treas. Reg. § 1.701-2 is invalid.

i. Applicable Law

The Treasury Regulations contain a general partnership anti-abuse rule, which allows the Commissioner to recast a transaction for federal tax purposes as appropriate to achieve results consistent with subchapter K in certain circumstances. Treas. Reg. § 1.701-2(b). Specifically, the Commissioner can do so “if a partnership is formed or availed of in connection with a transaction a principal purpose of which is to reduce substantially the present value of the partners' aggregate federal tax liability in a manner that is inconsistent with the intent of subchapter K. . . .” Id.

The regulation instructs that the intent of subchapter K is “to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax.” Treas. Reg. § 1.701-2(a). According to the regulation, there are three requirements implicit in this intent: (1) the partnership must be bona fide and each partnership transaction

must be entered into for a substantial business purpose; (2) the form of each partnership transaction must be respected under substance-over-form principles; and (3) the tax consequences to each partner must properly reflect income, unless the provisions of subchapter K and the regulations thereunder contemplate otherwise. Id.

ii. Petitioners' Position

a. The general anti-abuse rule is superseded by the more specific anti-abuse rule

Treasury Regulation § 1.701-2 does not apply. Where a general and a specific provision conflict, the more specific provision governs. See, e.g., Long Island Care at Home, Ltd. v. Coke, 551 U.S. 158, 170 (2007); Williams v. Comm'r, 94 T.C. 464, 470 (1990) (“It is well established that a specific statutory provision will override a general provision . . . Otherwise, respondent could attempt to use section 446(b) to override any statutory provision that he believes does not clearly reflect income.”); Woods Investment Co. v. Comm'r, 85 T.C. 274, 283 (1985) (“We do not believe that the language of section 1.1016-6(a) should be read to override the more specific provisions contained in section 1.1502-32 . . .”). In applying the partnership anti-abuse rule of Treas. Reg. § 1.701-2, Respondent challenges whether the Distribution was properly treated as exempt from immediate taxation to the extent of the partner's allocable share of partnership debt. But this precise question is addressed by the disguised sale rules and the anti-abuse regulation relating specifically to allocation of liabilities. See Treas. Reg. § 1.752-2(j). As discussed extensively above, since Tribune stands fully willing and able to pay under the Guarantees and has no plan to circumvent those obligations, the Guarantees pass the test imposed by the specific anti-abuse rule of Treas. Reg. § 1.752-2(j).

Recasting the transaction under Treas. Reg. § 1.701-2 when its form is respected under Treas. Reg. § 1.752-2(j) would not only impermissibly allow the general anti-abuse rule to govern rather than the more specific one, it would also impermissibly fail to give effect to the more specific provision. This would be contrary to the canon of regulatory construction that requires one regulation to be construed so as not to render another superfluous. See, e.g., Abbott Labs., 84 Fed. Cl. at 106. Applying the partnership anti-abuse rule to avoid application of the specific anti-abuse provision is also impermissible because it would allow the Commissioner to escape the effect of Treas. Reg. § 1.752-2(j), contrary to the axiom that the Commissioner is bound by his own regulations. See, e.g. Estate of Delaune v. United States, 143 F.3d 995, 1005 (5th Cir. 1998) (the Commissioner may not escape the effect of a bona fide treasury regulation); Whiteside v. United States, 833 F.2d 820, 823 (9th Cir. 1987) (“The Secretary had broad authority to shape these regulations but having done so, he is bound by them.”).

b. Congress specifically intended this type of transaction to not be immediately taxable

Even if the general partnership anti-abuse rule were not superseded by more specific rules, it would apply only if there were a plan to reduce taxes in a manner inconsistent with subchapter K. Here, Congress, in implementing the relevant statutory provision, specifically envisioned this type of transaction and deemed it not immediately taxable. The anti-abuse rule thus does not apply.

The legislative history of § 707 indicates that, when enacting the disguised sale rules, Congress was concerned that the rules could be misinterpreted to assert immediate tax liability against a partner that in effect borrowed against an asset contributed by the partner to a partnership. Congress thus clarified the statute's intent in a House Conference Report, stating:

The Conferees wish to note that when a partner of a partnership contributes property to the partnership and that property is borrowed against, pledged as collateral for a loan, or otherwise refinanced, and the proceeds of the loan are distributed to the contributing partner, there will be no disguised sale under the provision to the extent the contributing partner, in substance, retains liability for repayment of the borrowed amounts (i.e., to the extent the other partners have no direct or indirect risk of loss with respect to such amounts) since, in effect, the partner has simply borrowed through the partnership.

H. R. Rep. No. 98-861, at 862 (1984) (emphasis added). Thus Treasury, in promulgating the rules regarding debt-financed distributions contained in Treas. Reg. § 1.707-5, was implementing the explicitly stated intent of Congress.

Since Tribune followed the treasury regulation promulgated to implement the intent of Congress, the reduction in immediate taxation is manifestly consistent with subchapter K.

c. The Cubs Transaction is consistent with the overall intent of subchapter K

The transaction also squares with the overall intent of subchapter K as stated by the partnership anti-abuse rule: “to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax.” Treas. Reg. § 1.701-2(a). This is the exact goal the transaction accomplishes, allowing Tribune to be taxed the same as it would have been taxed had it borrowed outside the partnership.

The transaction also meets the three requirements the anti-abuse rule describes as implicit in the intent of subchapter K, identified in Section V.D.i. As discussed in detail in Section V.C., the first two requirements — that the partnership be bona fide and the transaction be respected under substance-over-form principles — are clearly met.

There similarly is no question but that the tax consequences of the transaction properly reflect income. Indeed, it would be surprising to think that a transaction meeting the first two requirements would fail the proper reflection of income requirement. In any event, the regulations under §§ 707 and 752 prescribe the income tax consequences of a leveraged partnership distribution and simply follow the longstanding tax principle that “receipt of a loan is not income to the borrower.” Comm'r v. Indianapolis Power & Light Co., 493 U.S. 203, 207-08 (citing Comm'r v. Tufts, 461 U.S. 300, 307 (1983); James v. United States, 366 U.S. 213, 219 (1961); and Comm'r v. Wilcox, 327 U.S. 404, 408 (1946).

It should be noted that taxpayers' intent to reduce their tax burden is not, by itself, sufficient to bring the transaction within the scope of the rule. As discussed in the preamble to the regulation, “[h]aving a principal purpose to use a bona fide partnership to conduct business activities in a manner that is more tax efficient than any alternative means available does not establish that the resulting tax reduction is inconsistent with the intent of subchapter K. In those cases, the Commissioner cannot recast the transaction under the regulation.” 60 Fed. Reg. 23, 25 (Jan. 3, 1995). In fact, the subchapter K regulations explicitly recognize that a taxpayer may structure a transaction with the principal purpose of avoiding gain. See Treas. Reg. § 1.737-4(b), Example 2 (transaction respected as having substance and being consistent with the purpose of the Code where partners agreed to allocate liability “with a principal purpose of avoiding . . . gain.”).

d. The partnership anti-abuse rule is invalid

Further, the partnership anti-abuse rule is invalid because it is contrary to unambiguous congressional intent.⁴⁰ See, e.g., Mayo Found, for Med. Educ. And Research v. United States, 562 U.S. 44, 52-60 (2011); Chevron U.S.A. Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). “There is no language anywhere in Subchapter K that suggests that the application of the provisions of Subchapter K — which are quite specific and largely mechanical — varies depending on the existence of a purpose to reduce taxes.” McKee, Nelson & Whitmire, ¶ 1.05[5][a][i] (Aug. 2019). Thus, Treasury has no statutory authorization to impose a free-floating anti-abuse rule, wholly divorced from any specific statutory grant of power.

Respondent invokes the partnership anti-abuse rule as though it empowers him to decide, on a case-by-case basis, whether it is appropriate to apply the provisions of subchapter K — a veritable “I like this transaction, I like this transaction not” standard. Respondent's rulemaking authority is limited to setting forth standards to be applied in every case — Respondent cannot grant himself the authority to decide individual cases. See RLC Industries Co. v. Comm'r, 58 F.3d 413, 417-18 (9th Cir. 1995).

E. Respondent's Gain Calculation Is Incorrect

The parties dispute the amount of gain Tribune would recognize in 2009 if either the Guarantees were disregarded or Respondent were to prevail on the debt-equity issue.

i. Applicable Law

a. Disguised Sale Gain

In a transaction treated as a disguised sale, a partner who contributes property to a partnership and receives a cash distribution is treated as selling the property, in whole or in part, to the partnership. Treas. Reg. § 1.707-3(a)(1). The portion of the property being treated as sold is determined by comparing the fair market value of the property to the amount of consideration. See Treas. Reg. § 1.707-3(f), Example 1.

The following example illustrates this principle.⁴¹ A, B, and C form an equal partnership to which A contributes Blackacre with a basis of $300 and a value of $900, while B and C each contribute $750 in cash. A receives an immediate cash distribution of $150. A is treated as selling 1/6 of Blackacre to the partnership ($150 distribution divided by $900 value equals 1/6). Accordingly, 1/6 of A's basis ($50) is allocated to the sale, so A recognizes a $100 gain.

b. Liabilities Assumed

In general, relief from a liability is treated as an amount realized in a sales transaction. The disguised sale rules, however, distinguish between “qualified liabilities” and “nonqualified liabilities.” The definition is highly technical, but generally a liability incurred in the ordinary course of running a business would be a qualified liability. See Treas. Reg. § 1.707-5(a)(6). If a partner in a potential disguised sale transaction does not receive a cash distribution, qualified liabilities are not treated as gain. Treas. Reg. § 1.707-5(a)(5)(i). On the other hand, relief from nonqualified liabilities is treated as gain to the extent the contributing partner has been relieved from liability. Treas. Reg. § 1.707-5(a)(1).

c. Qualified Liabilities and Cash Distribution

If a partner contributing the assets and qualified liabilities to a partnership receives a cash distribution that would be treated as a disguised sale, then the partner must treat as additional consideration a portion of the qualified liabilities in calculating his gain. Treas. Reg. § 1.707-5(a)(5)(i). The portion so treated is the lesser of (i) the amount that would have been treated as consideration if it were not a qualified liability and (2) the product of multiplying the contributing partner's “net equity percentage” by the liability amount. Id. The “net equity percentage” is the quotient of the disguised sale proceeds (apart from the qualified liability) divided by the excess of the fair market value of the property over any qualified liability encumbering the property. Treas. Reg. § 1.707-5(a)(5)(ii).

Consider an example.⁴² A contributes Blackacre to a partnership in exchange for a 50% interest in the partnership and a $50 cash distribution. Blackacre has a fair market value of $1,000 and a mortgage of $800. The mortgage is a qualified liability. A's basis in Blackacre is $500. The partnership's assumption of the mortgage results in additional consideration in the amount equal to the lesser of (i) the amount that would have been treated as consideration if it were not a qualified liability ($400, the portion of the mortgage that would not be allocable to A's 50% interest); and (ii) the product of A's net equity percentage ($50/$200, or 25%) multiplied by the liability amount ($800), for a total of $200. A would be treated as having sold 25% of Blackacre for $250 ($50 cash and $200 of the liability), resulting in a recognized gain of $125 ($250 minus 25% of A's $500 basis).

d. Partnership Liabilities

If a partnership takes out a loan against assets and distributes the proceeds to the partner that contributed the assets, “the transfer of money or other consideration to the partner is taken into account only to the extent that the amount of money or the fair market value of the other consideration transferred exceeds that partner's allocable share of the partnership liability.” Treas. Reg. § 1.707-5(b)(1). The rationale is that this partner should be treated the same as a partner that took out the mortgage the day before contributing it to the partnership (in which case it would not be a qualified liability).

A partner's allocable share of a recourse liability is determined using the “constructive liquidation” test of Treas. Reg. § 1.752-2(b)(1).⁴³ If no partner bears economic risk of loss for the liability under the constructive liquidation test, then that liability is a “nonrecourse liability.” Treas. Reg. § 1.752-1(a)(2). A partner's share of a nonrecourse liability “is determined by applying the same percentage used to determine the partner's share of the excess nonrecourse liability under § 1.752-3(a)(3).” Treas. Reg. § 1.707-5(a)(2)(ii). Under § 1.752-3(a)(3), “excess nonrecourse liability” is “determined in accordance with the partner's share of the partnership profits,” or as specified in the partnership agreement if reasonably consistent with allocations of some other item of partnership income or gain.

e. Disguised Sale Gain to S Corporation

In general, an S corporation is not subject to taxation. IRC § 1363(a). Instead, taxable income and other tax attributes pass through to the S corporation's shareholders, similar to partnership taxation. IRC §§ 1366-1380.⁴⁴

One exception to this general rule is a corporate-level tax on unrealized gains (“net unrealized built-in gain”) that existed on the date the C corporation converted to S status if such gain is recognized within ten years of the conversion (“recognition period”). IRC § 1374(a), (d). Such gain (“recognized built-in gain”) is recognized on the disposition of assets held prior to the corporation's conversion to the extent of their appreciation before the conversion date. IRC § 1374(d)(3). Built-in gains are offset by corresponding built-in losses (“recognized built-in losses”). IRC § 1374(d)(2), (4). The net of recognized built-in gains reduced by recognized built-in losses (“net recognized built-in gain”)⁴⁵ over the recognition period cannot exceed the S corporation's total net unrealized built-in gain at the beginning of the period. IRC § 1374(c)(2).

Recognized built-in gain includes any gain from a transaction “treated as a sale or exchange for Federal income tax purposes.” Treas. Reg. § 1.1374-4(a)(1). This includes disguised sale gain of the kind at issue here, to the extent currently taxable. See Treas. Reg. § 1.707-3(a)(1) (treating such transactions “as a sale of property”). The parties do not dispute that any built-in gain recognized by Tribune from the Cubs Transaction would be taxable under IRC § 1374(a).

ii. Petitioners' Position

Petitioners begin by explaining the gain calculation Tribune reported on its tax return. From there, Petitioners calculate Tribune's hypothetical gain assuming Respondent were to prevail in disregarding Tribune's Guarantees, treating the Subordinated Debt as equity, and treating the Utay expenses as capitalized.⁴⁶

a. Calculation of Disguised Sale Gain — As Filed

Tribune contributed the Cubs assets to CBH in exchange for a 5% interest in the partnership, and received the Distribution of $713,748,223. Tribune had basis in the assets of $148,544,336. CBH assumed $35,241,562 in qualified liabilities from Tribune. Tribune guaranteed partnership debt totaling $673,750,000. And Tribune had $15,293,748 in capitalized transaction costs.

First, the amount by which the cash received exceeds the guaranteed amount is subject to the disguised sale rules. This totals $39,998,222 ($713,748,223 minus $673,750,000).

The amount of qualified liabilities treated as proceeds is the lesser of:

• The amount treated as proceeds if they were not qualified ($35,241,562 * 95%): $33,479,484; and

• The product of the qualified liabilities ($35,241,562) multiplied by Tribune's net equity percentage ($39,998,222 ÷ $734,735,065 = 5.44%): $1,918,514.

Accordingly, Tribune receives total disguised sale proceeds of $41,916,736 ($39,998,222 + $1,918,514). The total fair market value of the contributed assets is $769,976,627 ($734,735,065 + $35,241,562). The percentage of the assets treated as sold is determined by dividing the total value of the proceeds by the total fair market value of the assets contributed. Tribune is therefore treated as having sold 5.44% of the assets.

Thus, Tribune computed its gain as follows:⁴⁷

Distribution subject to disguised sale rules	$39,998,222
5.44% of qualified liabilities	+ $1,918,514
5.44% of basis in assets	- $8,086,601
Disguised Sale Gain	= $33,830,135

b. Calculation of Disguised Sale Gain — Ignoring the Guarantees and Subordinated Debt

If the Guarantees were disregarded, the Subordinated Debt treated as equity, and the Utay expenses capitalized, then Tribune's disguised sale gain would instead be calculated as follows. CBH would have borrowed only the $425,000,000 in Senior Debt, which would be a non-recourse liability,⁴⁸ all of which would be treated as distributed to Tribune under the disguised sale rules. See Treas. Reg. § 1.707-3. Tribune would have incurred capitalized transaction costs of $17,793,749.⁴⁹

Under this scenario, Tribune's share of the debt is equal to 5%, which is both its share in CBH's profits and its share of “excess nonrecourse liability” agreed to in the LLC Agreement. Accordingly, Tribune's allocable share of the Senior Debt is $21,250,000.⁵⁰ This means that $692,498,223 of the Distribution is treated as disguised sale proceeds ($713,748,223 - $21,250,000).⁵¹

The amount of qualified liabilities treated as proceeds is the lesser of:

• The amount treated as proceeds if they were not qualified ($35,241,562 * 95%): $33,479,484; and

• The product of the qualified liabilities ($35,241,562) multiplied by Tribune's net equity percentage ($692,498,223 ÷ $734,735,065 = 94.2%): $33,215,672.

Accordingly, Tribune receives disguised sale proceeds totaling $725,713,895 ($692,498,223 + $33,215,672). Tribune is treated as having sold 94.2% of the assets ($725,713,895 ÷ $769,977,627).

Thus, the gain would be computed as follows:

Distribution subject to disguised sale rules	$692,498,223
94.2% of qualified liabilities	+ $33,215,672
94.2% of basis in assets	- $140,005,144
94.2% of capitalized transaction costs	- $16,770,861
Disguised Sale Gain	= $568,937,88952

iii. Respondent's Position

a. Respondent's Calculation of Disguised Sale Gain — If Petitioners Prevail on All Other Issues

Respondent has not challenged Petitioners' gain calculation assuming that

Petitioners prevail with respect to the Guarantees, the Subordinated Debt, and the Utay expenses issue. Petitioners' gain calculation was not disputed in the Tribune Notice and Respondent has never indicated that he disputes the gain calculation if Petitioners otherwise prevail.

b. Respondent's Calculation of Disguised Sale Gain — Ignoring the Guarantees and the Subordinated Debt

In the Tribune Notice, Respondent determines Tribune's gain from the transaction as follows:⁵³

95% of Enterprise value of Cubs assets sold	$844,740,000
95% of qualified liabilities	+ $33,479,484
95% of basis in assets	-$138,709,819
Disguised Sale Gain	= $739,509,665

Respondent's gain calculation makes several legal and factual errors.

1. Legal errors in Respondent's gain calculation

Respondent makes four legal errors in his calculation of gain.

First, Respondent determines the gain using the fair market value of the assets contributed to CBH,⁵⁴ rather than the Distribution to Tribune. It is axiomatic that gain is determined based on the consideration received. See Treas. Reg. § 1.707-3(a)(1).

Second, Respondent determines the percentage treated as a sale by reference to the parties respective interests in the partnership (95/5). But the portion of the property being sold in a disguised sale is determined by comparing the fair market value of the assets contributed to the partnership to the fair market value of the consideration. Treas. Reg. § 1.707-3(1), Example 1.

Third, Respondent does not reduce the gain by Tribune's allocable share of the Senior Debt, as determined by Respondent in the Tribune Notice ($21,250,000). Tribune Notice, Schedule 5B, 5e — Non-Recourse Liabilities.

Fourth, Respondent does not reduce the gain by Tribune's capitalized transaction costs.

2. Factual errors in Respondent's gain calculation

Respondent also makes three factual errors, which result in a further overstatement of gain.⁵⁵

First, Respondent overstates the agreed fair market value of the assets contributed. Rather than using the agreed fair market value, Respondent instead uses what is referred to as the “Headline Value” of the Cubs Transaction in the term sheets. As explained in Mr. Moes's report, the parties agreed to several adjustments to the “Headline Value” to arrive at an agreed fair market value of the contributed assets of $734,735,065. Respondent ignores these agreed adjustments and imputes them as value contributed to CBH.

Second, Respondent similarly overstates the value of the consideration received by Tribune. Again, Respondent has ignored the agreed adjustments to Tribune's Distribution and imputes consideration to Tribune with no explanation.

Third, Respondent uses Tribune's initial estimated tax basis (reported in its 2009 Schedule K-1) rather than Tribune's final tax basis in the assets contributed to CBH. As a result, Respondent understates Tribune's basis in the assets by approximately $2.53 million.

F. Tribune Properly Deducted The Utay Expenses

In 2009, Tribune paid $2.5 million in professional fees on behalf of Marc Utay pursuant to a letter agreement reached in negotiating a potential partnership that would hold and operate the Cubs assets. Tribune properly deducted this amount from its 2009 income. Respondent contends that this amount should be capitalized instead of deducted.

i. Applicable Law

Professional fees paid in connection with abandoned transactions are deductible as an abandonment loss under § 165(a) in the year the transaction is abandoned. A.E. Staley Mfg. Co. v. Comm'r, 119 F.3d 482, 491-92 (7th Cir. 1997); Santa Fe Pacific Gold Co. v. Comm'r, 132 T.C. 240, 278-79 (2009). On the other hand, no deduction is allowed for an amount paid for permanent improvements or betterments made to increase the value of any property. I.R.C. § 263(a)(1). Such amounts must be capitalized. Regarding the determination of whether an amount is a capital expenditure, the Supreme Court has stated that “[a]though the mere presence of an incidental fixture benefit — 'some future aspect' — may not warrant capitalization, a taxpayer's realization of benefits beyond the year in which the expenditure is incurred is undeniably important in determining whether the appropriate tax treatment is immediate deduction or capitalization.” INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 87-88 (1992) (emphasis in original).

In 2004, Treasury promulgated Treas. Reg. § 1.263(a)-5 in an attempt to clarify some of the distinctions between deductible expenses and capital expenditures. Under the regulations, amounts paid to facilitate certain transactions, including contributions to partnerships under § 721, must be capitalized. Treas. Reg. § 1.263(a)-5(a). Under this regulation, an amount is paid to facilitate a transaction if the amount is paid in the process of investigating or otherwise pursuing the transaction. Treas. Reg. § 1.263(a)-5(b)(1).

An amount paid to terminate or to facilitate one transaction is treated as an amount paid to facilitate a second transaction “only if the transactions are mutually exclusive.” Treas. Reg. § 1.263(a)-5(c)(8) (emphasis added). This rule limits the scope of expenses that are required to be capitalized. It does not state that every time a taxpayer faces two mutually exclusive transactions, amounts paid to terminate or facilitate one that is abandoned are necessarily capitalized with respect to the one that is closed.⁵⁶

ii. Petitioners' Position

The $2.5 million Tribune paid to Utay for professional fees incurred in investigating and bidding on an abandoned partnership was currently deductible in 2009 pursuant to § 165(a) and was not required to be capitalized under § 263(a).

It has long been settled that professional fees paid to investigate changes in capital structure that are not consummated are deductible in the year the proposed change is abandoned. See Rev. Rul. 67-125, 1967-1 C.B. 31. This is also the case where, as here, those fees are paid by the taxpayer to the would-be counterparty in the form of a termination fee and a competing transaction is consummated instead. See A.E. Staley, 119 F.3d at 490-92; Santa Fe Pacific, 132 T.C. at 276-79 (termination fee paid to white knight for failed acquisition deductible under § 165(a)). Treasury Regulation § 1.263(a)-5 is not to the contrary.

The fees in question clearly relate to the process of investigating and pursuing the abandoned Utay partnership. And since that transaction was abandoned in 2009 the amount became currently deductible the same year. See Rev. Rul. 67-125. The fees were not related to “investigating or otherwise pursuing” the partnership with RAC under any reasonable plain reading of the language.

Allowing for current deduction of fees arising from the Utay bid, which did not progress past the bidding stage, is also consistent with the regulations' illustration that amounts paid to facilitate the stock acquisition of a subsidiary are not capitalized until after the bid is complete and the acquiring corporation's board approves the terms of the transaction. Treas. Reg. § 1.263(a)-5(1), Example 16.

VI. WITNESSES

A. Fact Witnesses

Petitioners anticipate calling up to 18 fact witnesses to testify at trial.⁵⁷ The following section identifies those witnesses and provides a brief summary of each's anticipated testimony.

Chandler Bigelow. At the time of the Cubs Transaction, Chandler Bigelow was Senior Vice President and Chief Financial Officer of Tribune. Mr. Bigelow was involved in Tribune's decision to market the Cubs assets and Tribune's review of bids for potential transactions. He will testify about Tribune's goals for potential transactions with respect to the Cubs assets; the Guarantees; and Tribune's involvement in CBH following the closing of the Cubs Transaction, including the capital calls Tribune responded to and the sale of Tribune's interest in CBH.

Nicholas Chakiris. Nicholas Chakiris was Assistant Controller for Tribune. Mr. Chakiris was involved in Tribune's accounting analysis of the Cubs Transaction. He will testify about Tribune's financial accounting for the Cubs Transaction, including Tribune's financial accounting analysis of its Guarantees and its partnership interest in CBH.

Robert DuPuy. At the time of the Cubs Transaction, Robert DuPuy served as President and Chief Operating Officer of Major League Baseball. Mr. DuPuy was personally involved in the Cubs Transaction, as well as the development of the Debt Service Rule. Mr. DuPuy will testify about MLB's approval of the Cubs Transaction; the origin and purpose of the Debt Service Rule and the Operating Support Agreement; the powers of the Commissioner of Baseball; the role of an MLB club's Control Person; instances in which clubs became distressed; and that MLB viewed the Subordinated Debt as debt.

David Eldersveld. David Eldersveld was Tribune's Senior Vice President/Deputy General Counsel and Corporate Secretary at the time of the Cubs Transaction. He participated in the negotiations of the Cubs Transaction on behalf of Tribune. Mr. Eldersveld will testify about the bidding process for a transaction involving the Cubs; Tribune's evaluation of competing bids; Tribune's negotiations regarding the Cubs assets; the Guarantees, including the risks they posed to Tribune; CBH's Subordinated Debt; and Tribune's involvement in CBH following the closing of the Cubs Transaction.⁵⁸

Brooks Gruemmer. Brooks Gruemmer was a partner in the law firm McDermott, Will & Emery, who represented Tribune in connection with the Cubs Transaction. Mr. Gruemmer was involved in negotiations of the transaction and in preparing agreements to effect the transaction. He will testify regarding the negotiations over the Guarantees and the adjustments to the Distribution.

Ryan Harris. Ryan Harris was an attorney in the law firm McDermott, Will & Emery, who represented Tribune in connection with the Cubs Transaction. Mr. Harris was involved in negotiations of the transaction and in preparing agreements to effect the transaction. He will testify regarding the negotiations over the Guarantees and the adjustments to the Distribution.

Crane Kenney. From 2003 to 2009, Crane Kenney was the principal executive in charge of Cubs operations on behalf of Tribune. Since the Cubs Transaction, Mr. Kenney has served as President of Business Operations for the Cubs. As part of this role, he reports to the CBH Board and plays a lead role in board meetings. He will testify about presentations to bidders regarding the Cubs assets; the business risks that could expose Tribune to liability under the Guarantees; the operation of the CBH Board; Tribune's involvement in CBH's management, including the role of Tribune's director on the CBH Board; Tribune's full participation in CBH's $300 million of capital calls; and the sale of Tribune's interest in CBH.

Nils Larsen. At the time of the Cubs transaction, Nils Larsen served as Executive Vice President — Chief Investment Officer of Tribune, in which position he was involved in negotiating and closing the transaction. After the transaction he served as Tribune's director on the CBH Board from the closing of the transaction until 2013. Mr. Larsen will testify about Tribune's goals in pursuing a potential transaction involving the Cubs assets; the bidding process for such a transaction; Tribune's negotiations regarding the Cubs assets; the basic structure of the Cubs Transaction; the Guarantees, including the risks they posed to Tribune; CBH's Subordinated Debt; and Tribune's participation in CBH's management, including his role as a director.

Edward Lazarus. Edward Lazarus served as General Counsel and Chief Strategy Officer of Tribune from 2013 to 2018. During that time, he served as Tribune's director on the CBH Board. Mr. Lazarus will testify about Tribune's involvement in CBH's operations, including his participation on the CBH Board, Tribune's approval rights with respect to critical business decisions of CBH, Tribune's full participation in CBH's capital calls, and the sale of Tribune's partnership interest in CBH.

Daniel Mueller. Mr. Mueller is a partner with Deloitte Tax LLP. He will testify to authenticate certain documents and to explain the contents of certain Deloitte Tax LLP workpapers related to CBH's tax returns and its remedial allocations.

Craig Parmelee. Mr. Parmelee is the Managing Director and Global Head of Practices at S&P Global Ratings. On behalf of S&P, Mr. Parmelee performed a credit-rating analysis of some of the debt CBH incurred in connection with the Cubs Transaction. Mr. Parmelee will testify about his credit-rating analysis, including his consideration of Tribune's Guarantees of CBH's debt.

Andrew Perkins. Mr. Perkins is a senior manager with Deloitte Tax LLP. He will testify to authenticate certain documents and to explain the contents of certain Deloitte Tax LLP workpapers related to CBH's tax returns and its remedial allocations.

Thomas Ricketts. At the time of the Cubs Transaction, Thomas Ricketts served as Chairman and CEO of Incapital LLC, a securities firm he founded in 1999 that has underwritten hundreds of billions of dollars' worth of corporate bonds. Among the Ricketts family members, Thomas Ricketts led communications vis-a-vis Tribune and the Senior Lenders.⁵⁹ Since the Cubs Transaction, Mr. Ricketts has served as Chairman of the CBH Board.

Mr. Ricketts will provide an overview of the entire transaction from the perspective of the Ricketts family, including testimony regarding the Rickettses' bid for the Cubs Transaction; the family's vigorous negotiations with Tribune and the Senior Lenders; CBH's financing, including Tribune's Guarantees thereof; MLB's role with respect to CBH, including approving the transaction; and the Ricketts family's contemplated issuance of Subordinated Debt to unrelated parties. He will also testify regarding events following the Cubs Transaction, including regarding CBH's management, such as making financing and capital improvement decisions; CBH's capital calls and investment in response thereto; and the Rickettses' buyout of Tribune's five percent interest in CBH.

Patrick Shanahan. Mr. Shanahan was Vice President, Tax, at Tribune at the time of the Cubs Transaction. He will testify about Tribune's gain for tax accounting and financial reporting purposes with respect to the Cubs Transaction and Tribune's involvement in CBH's management, including Tribune's approval rights with respect to critical business decisions of CBH, Tribune's full participation in CBH's capital calls, and the sale of Tribune's interest in CBH.

Jeanne Shoesmith. Ms. Shoesmith is a Director at S&P Global Ratings. On behalf of S&P, Ms. Shoesmith performed multiple credit-rating analyses of Tribune's debt after Tribune emerged from bankruptcy in 2012. In doing so, Ms. Shoesmith concluded that Tribune's Guarantees of CBH's debt posed a “significant financial risk” to Tribune. Ms. Shoesmith will testify about her credit-rating analyses, including how Tribune's Guarantees impacted those analyses.

Alexander Sugarman. Mr. Sugarman was employed by Galatioto Sports Partners (“GSP”), which advised the Ricketts family on the Cubs Transaction. Mr. Sugarman will testify about the financial projections prepared by GSP and about the efforts to market the Subordinated Debt to third-party investors.

Mark Whitaker. Mark Whitaker was a partner in the law firm Nixon Peabody at the time of the transaction. He represented the Rickettses in connection with negotiation of the Senior Debt and Subordinated Debt financing. Mr. Whitaker will testify about CBH's negotiations with the Senior Debt lenders and MLB with respect to CBH's financing, regarding (i) that no party sought in the negotiations to limit Tribune's risk under the Guarantees; (ii) the counter-parties' stated purpose with respect to some of the agreements reached through these negotiations, including the Operating Support Agreement; and (iii) the Senior Lenders' treatment of the Subordinated Debt as bona fide debt.

Brian Whittman. Brian Whittman managed a team of professionals at Alvarez & Marsal involved in all aspects of Tribune's bankruptcy proceeding, including business plan development, contract and claim negotiations, and negotiation of a plan of reorganization. He was personally involved on a daily basis in matters arising throughout the bankruptcy proceeding, including matters arising as a result of the Cubs Transaction. Mr. Whittman will testify to facts about Tribune's bankruptcy; the financial health and cash position of Tribune before and after the Cubs Transaction; and the effect, as a factual matter, of the Bankruptcy Court's treatment of the Guarantees as administrative expenses upon Tribune's activities as debtor in possession, including its reorganization and emergence from bankruptcy.

B. Expert Witnesses

Petitioners will qualify eight experts and offer their reports into evidence.

William J. Chambers. Prof. Chambers is an Associate Professor of Finance (Emeritus) at Boston University's Metropolitan College. He taught graduate and undergraduate courses in investment analysis and portfolio management, financial markets and institutions, multinational finance, and corporate finance. Prior to joining Boston University, he spent 22 years in the credit rating division of S&P, now operating as S&P Global Ratings. For several years during his time at S&P he oversaw and was responsible for the credit ratings for all corporate entities domiciled outside the United States. He was also actively involved in the development, approval, and implementation of credit rating criteria and procedures. Prof. Chambers prepared an opening expert report and a rebuttal report.

Opening Report. In his opening report, Prof. Chambers evaluated the creditworthiness of CBH as of the closing of the Cubs Transaction. Prof. Chambers concluded that CBH would have attracted an issuer credit rating of “BB” using S&P symbology, and “Ba2” using Moody's nomenclature. As part of this analysis, Prof. Chambers determined that Tribune's Guaranty of the Senior Debt had significant value, particularly in a severely distressed scenario.

Prof. Chambers further opined that CBH could have obtained a loan from a third-party lender on substantially similar economic terms as those of the Subordinated Debt. Prof. Chambers concluded that the Subordinated Debt holders would have realized a significantly higher recovery in the event of default by virtue of Tribune's Guaranty of the Subordinated Debt, such that CBH's Subordinated Debt would most likely have been assigned an issue credit rating of “BB+” using S&P's symbology, “significantly higher than it otherwise would be in the absence of the Subordinated Loan Tribune Guaranty.”

Rebuttal Report. In his rebuttal report, Prof. Chambers concludes that the analyses of Respondent's expert, Prof. Skinner, including with respect to CBH's value and credit rating and the character of the Subordinated Debt, are seriously flawed and misleading. Prof. Chambers also points out that a number of Prof. Skinner's factual statements are incorrect or lacking in sufficient analysis or substantiation.

Merle Erickson. Prof. Erickson is a Professor of Accounting at The Booth School of Business at The University of Chicago. He specializes in the areas of accounting and taxation and has taught those subjects at The Booth School of Business for more than twenty years. In his teaching and consulting activities, he focuses on (among other things) complex tax and GAAP accounting issues associated with corporate control transactions, financing arrangements, and investment decisions. Prof. Erickson prepared an opening expert report.

Prof. Erickson examined how ratings agencies evaluated Tribune's disclosures about the guarantees of CBH's debt. He concluded that ratings agencies considered the Guarantees. In particular, S&P concluded that the Guarantees were a significant financial risk for Tribune and consolidated a portion of CBH's debt when evaluating Tribune's leverage ratios.

Prof. Erickson also concluded that Tribune properly accounted for the Guarantees in its financial statements. He explained that Tribune's accounting was consistent with accounting guidance and that other firms providing guarantees disclose them but do not recognize a liability for them, as Tribune did, or recognize a liability substantially less than the amount of the debt subject to the guaranty. Additionally, Prof. Erickson examined CBH's GAAP accounting treatment and determined it treated the Subordinated Debt as debt and treated interest payments on the Subordinated Debt as interest expense.

Thomas Hubbard. Prof. Hubbard is the Elinor and H. Wendell Hobbs Professor of Management at the Kellogg School of Management at Northwestern University, where he has taught since 2005. He teaches courses in business strategy and the economics of organization, among other areas. He specializes in the field of industrial organization, which examines how firms compete and how firms are organized. His work applies theories from the economics of organization, including property rights theory. Prof. Hubbard prepared a rebuttal report.

In his rebuttal report, Prof. Hubbard concludes that the analytical framework of Respondent's expert Prof. Oliver Hart does not support his conclusion that the Cubs Transaction is indistinguishable in economic terms from a sale. Instead, Prof. Hart's own framework supports the opposite conclusion: that the Cubs Transaction generated an organization structure distinct from that of a sale.

Ron Kahn. Mr. Kahn is a Managing Director at Lincoln International LLC and has been the Head of Lincoln's Debt Advisory Group for 18 years. In this capacity, he and those working under his direction have structured and arranged hundreds of debt financings for mergers and acquisitions, leveraged buyouts, and recapitalizations. Mr. Kahn prepared a rebuttal report.

In his rebuttal report, Mr. Kahn determines that the conclusions of Respondent's expert Mr. Gellis were incorrect. First, Mr. Kahn concludes that the Guarantees were well disclosed, served a business purpose, and had value. Second, he concludes that the Subordinated Debt's terms were commercially reasonable and a market participant would have expected such terms from an unrelated borrower and guarantor in a transaction comparable to the Cubs Transaction.

David Moes. Mr. Moes is a senior managing director with Ankura Consulting Group, LLC, a global litigation and management consulting firm. He is a Certified Public Accountant and has business degrees in accounting and finance. He is an active member of many business and civic organizations, including the American Institute of Certified Public Accountants, the Illinois CPA Society, and the American Bar Association. Mr. Moes prepared two opening expert reports.

Payment Performance Report. Mr. Moes analyzed CBH's payment performance with respect to the Senior Debt and the Subordinated Debt, as well as CBH's compliance with the related financing agreements. Mr. Moes determined that CBH made the required interest and principal payments on the debt and that CBH complied with the debt's terms. Additionally, Mr. Moes concluded that CBH had available cash flows to pay the full amount of accrued interest that was due on the Subordinated Debt each year from 2010 to 2016.

Gain Accounting Report. Mr. Moes evaluated Tribune's calculation of its gain from the Cubs Transaction for both federal income tax and GAAP financial reporting purposes. He determined that Tribune's calculations for both purposes were supported by Tribune's books and records. He further explained that adjustments in both calculations (i) were appropriately supported by accounting records and other contemporaneous documentation prepared by Tribune, (ii) were reasonably reflected in the respective gain calculations, and (iii) are common in transactions where control of assets and related liabilities is exchanged.

Israel Shaked. Prof. Shaked is a Professor of Finance and Economics at Boston University's Questrom School of Business and the Managing Director of The Michel-Shaked Group, a firm that provides corporate finance and business consulting services to law firms, governmental agencies, and corporations worldwide. For the last 41 years, he has taught courses at the doctoral, graduate, and undergraduate levels on various topics, including business valuation, corporate finance, financial institutions and markets, financial economics, and general management. Prof. Shaked prepared an opening expert report and a rebuttal report.

Opening Report. Prof. Shaked analyzed the creditworthiness of CBH from the perspective of a third-party lender as of the closing of the Cubs Transaction. He concluded that CBH was expected to generate sufficient cash to pay its debts, including both the Senior Debt and Subordinated Debt. He also concluded that, at closing, the fair market value of CBH's assets exceeded its debts by at least $171 million, and that CBH was therefore adequately capitalized. Additionally, he concluded that a third-party lender would have lent to CBH on terms and at an interest rate both substantially similar to those of the Subordinated Debt.

Rebuttal Report. In his rebuttal report, Prof. Shaked analyzes the reports of Howard Gellis and Prof. Hart and concludes both reports are flawed and reach unsubstantiated and incorrect conclusions. Prof. Shaked finds that the Mr. Gellis's report failed to conduct key financial analyses necessary to determine whether a third-party lender would be willing to loan money to CBH on terms substantially similar to those of the Subordinated Debt. Prof. Shaked concludes that Prof. Hart's report begins from a flawed premise of the definition of “a true partnership” and errs in its determinations regarding Tribune's partnership interest in CBH based on control rights and residual income rights.

Anil Shivdasani. Prof. Shivdasani is the Wells Fargo Distinguished Professor and the Director of the Wells Fargo Center for Corporate Finance at the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill. He has published, taught, and consulted on various topics in financial economics. He has significant experience in corporate valuation, mergers and acquisitions, capital structure, corporate restructurings, financing strategies, and corporate governance. Prof. Shivdasani prepared an opening expert report and a rebuttal report.

Opening Report. Prof. Shivdasani analyzed the Guarantees to assess whether they had economic value as of the closing of the Cubs Transaction. He concluded that they did. He also estimated the present value of expected payments under the Guarantees.

Rebuttal Report. Prof. Shivdasani notes that both he and Prof. Skinner conclude that the Guarantees had economic value. However, Prof. Shivdasani's rebuttal concludes that Prof. Skinner's report made inappropriate assumptions and contains flawed sensitivity analyses. These led to Prof. Skinner's erroneous suggestion that the Guarantees' value might be lower than the one he calculated. Prof. Shivdasani also points out that Prof. Skinner's unsupported assumption that a CBH default would not occur in the partnership's first three years leads him to understate the Guarantees' value.

Toby Stuart. Prof. Stuart is the Helzel Chair in Entrepreneurship, Strategy and Innovation, and the Faculty Director of the Berkeley Haas Entrepreneurship Program at the Haas School of Business, University of California, Berkeley. He has received numerous awards for teaching and research, including the 2007 Kauffman Prize Medal for Distinguished Research in Entrepreneurship. His research has focused on, among other things, social networks and inter-firm strategic transactions. Prof. Stuart prepared a rebuttal report.

Prof. Stuart concludes that Prof. Hart's opinions are inappropriately based on an analysis of the narrow issue of control rights. Prof. Stuart also points out that Prof. Hart failed to recognize that Tribune's consent and veto rights gave Tribune a measure of control. As a result, Prof. Hart erroneously concluded that Tribune's interest in CBH was not economically meaningful.

VII. EVIDENTIARY ISSUES AND OTHER SIGNIFICANT DISPUTES

Petitioners anticipate certain evidentiary issues, including potentially filing a motion in limine. Respondent has filed three interrelated motions in limine and identified additional potential motions. Petitioners will only discuss Respondent's motions actually filed as of the time this memorandum is filed.⁶⁰

A. Respondent Reserves Hearsay and “Improper Summary” Objections to Petitioners' Business Records

During the stipulation process, Respondent reserved hearsay and “improper summary”⁶¹ objections to a wide range of documents that the parties stipulated were authentic. These include Tribune's tax and accounting workpapers and email negotiations of the Guarantees and other key documents.

Petitioners have provided to Respondent affidavits certifying that each of these documents is a record of regularly conducted business activity under FRE 803(6) and 902(11). And Respondent's “improper summary” objections are based on a misunderstanding of FRE 1006. Depending on Respondent's position, Petitioner may move in limine for admission of these documents.

B. Respondent's Experts Rely on Witness Interviews They Did Not Attend

Portions of the expert reports of Mr. Gellis and Prof. Skinner rely on summaries of witness interviews that neither expert attended. FRE 703 delineates the facts or data on which an expert may base his or her opinion.⁶² Petitioner believes, based on the case law,⁶³ that these experts cannot “reasonably rely” — within the meaning of FRE 703 — solely on these summaries of interviews they did not attend. Additionally, such a summary constitutes inadmissible hearsay. Petitioners anticipate conducting voir dire with respect to this issue at trial, and may move to exclude portions of one or both expert reports on this basis.

C. Respondent Moved to Exclude S&P Credit Rating Reports Showing S&P Viewed the Guarantees as “Significant Financial Risks”

S&P published multiple credit rating reports of Tribune that show S&P (i) took the Guarantees into account when rating Tribune's credit, (ii) viewed the Guarantees as a “significant financial risk,” and (iii) consolidated a portion of CBH's partnership debt onto Tribune's balance sheet in rating Tribune's credit. Respondent has moved to exclude these reports and portions of Petitioners' expert reports based thereon. The Court directed Petitioners to respond by October 2. Petitioners will demonstrate that the reports are admissible. Petitioners will also move in limine for admission of the reports pursuant to FRE 803(6) and 902(11).

Dated: September 27, 2019

Respectfully submitted,⁶⁴