DOJ Urges Partial Reversal of Tax Court in Tribune Media Case

TRIBUNE MEDIA COMPANY, formerly known as Tribune Company & Affiliates; CHICAGO BASEBALL HOLDINGS, LLC; NORTHSIDE ENTERTAINMENT HOLDINGS, LLC, formerly known as Ricketts Acquisition, LLC, Tax Matters Partner,
Petitioners-Appellees-Cross-Appellants
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant-Cross-Appellee

IN THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT

ON APPEAL FROM THE DECISIONS OF THE UNITED STATES TAX COURT

COMBINED ANSWERING AND REPLY BRIEF FOR THE COMMISSIONER OF INTERNAL REVENUE

DAVID A. HUBBERT
Deputy Assistant Attorney General

FRANCESCA UGOLINI (202) 514-3361
JENNIFER M. RUBIN (202) 307-0524
NORAH E. B RINGER (202) 307-6224
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

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TABLE OF CONTENTS

Table of contents

Table of authorities

Glossary

Introduction

Part I. Reply brief of the Commissioner as appellant

Argument:

Part II. Answering brief of the Commissioner as cross-appellee

Statement of the issue

Statement of the case

Summary of argument

Argument:

Conclusion

Certificate of compliance

TABLE OF AUTHORITIES

Cases:

ACM P'ship v. Commissioner, 157 F.3d 231 (3d Cir. 1998)

Ala. Tissue Ctr. of Univ. of Ala. Health Serv. Found., P.C. v. Sullivan, 975 F.2d 373 (7th Cir. 1992)

Anderson v. City of Bessemer City, 470 U.S. 564 (1985)

Arlington Park Jockey Club, Inc. v. Sauber, 262 F.2d 902 (7th Cir. 1959)

Arnett v. Commissioner, 473 F.3d 790 (7th Cir. 2007)

ASA Investerings P'ship v. Commissioner, 201 F.3d 505 (D.C. Cir. 2000)

Bob Jones Univ. v. United States, 461 U.S. 574 (1983)

Bogardus v. Commissioner, 302 U.S. 34 (1937)

Bonte v. U.S. Bank, N.A., 624 F.3d 461 (7th Cir. 2010)

Busch v. Commissioner, 728 F.2d 945 (7th Cir. 1984)

Canal v. Commissioner, 135 T.C. 199 (2010)

Charter Wire, Inc. v. United States, 309 F.2d 878 (7th Cir. 1962)

Coltec Indus., Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006)

Commissioner v. Duberstein, 363 U.S. 278 (1960)

Commissioner v. Meridian & Thirteenth Realty Co., 132 F.2d 182 (7th Cir. 1942)

Commissioner v. Transp. Trading & Terminal Corp., 176 F.2d 570 (2d Cir. 1949)

Cottage Sav. Ass'n v. Commissioner, 499 U.S. 554 (1991)

Cromeens, Holloman, Sibert, Inc. v. AB Volvo, 349 F.3d 376 (7th Cir. 2003)

Curry v. United States, 396 F.2d 630 (5th Cir. 1968)

Dixie Dairies Corp. v. Commissioner, 74 T.C. 476 (1980)

Feldman v. Commissioner, 779 F.3d 448 (7th Cir. 2015)

Fidelity Int'l Currency Advisor A Fund, LLC v. United States, 747 F. Supp. 2d 49 (D. Mass. 2010)

Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968)

Frank Lyon Co. v. United States, 435 U.S. 561 (1978)

Frierdich v. Commissioner, 925 F.2d 180 (7th Cir. 1991)

Gilbert v. Commissioner, 248 F.2d 399 (2d Cir. 1957)

Gregory v. Helvering, 293 U.S. 465 (1935)

GSS Holdings (Liberty) Inc. v. United States, 81 F.4th 1378 (Fed. Cir. 2023)

Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365 (1990)

John Kelley Co. v. Commissioner, 326 U.S. 521 (1946)

In re Larson, 862 F.2d 112 (7th Cir. 1988)

Milwaukee & Suburban Transp. Corp. v. Commissioner, 283 F.2d 279 (7th Cir. 1960)

Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972)

NA Gen. P'ship & Subs. v. Commissioner, T.C. Memo. 2012-172 (2012)

Ortmayer v. Commissioner, 265 F.2d 848 (7th Cir. 1959)

PepsiCo P.R., Inc. v. Commissioner, T.C. Memo 2012-269 (2012)

Pritired 1, LLC v. United States, 816 F. Supp. 2d 693 (S.D. Iowa 2011)

Pullman-Standard v. Swint, 456 U.S. 273 (1982)

Raphan v. United States, 3 Cl. Ct. 457 (1983)

Road Materials, Inc. v. Commissioner, 407 F.2d 1121 (4th Cir. 1969)

Roth Steel Tube Co. v. Commissioner, 800 F.2d 625 (6th Cir. 1986)

Sarkes Tarzian, Inc. v. United States, 240 F.2d 467 (7th Cir. 1957)

Saviano v. Commissioner, 765 F.2d 643 (7th Cir. 1985)

Sherwood Mem'l Gardens, Inc. v. Commissioner, 350 F.2d 225 (7th Cir. 1965)

Slappey Drive Indus. Park v. United States, 561 F.2d 572 (5th Cir. 1977)

Southgate Master Fund, L.L.C. v. United States, 659 F.3d 466 (5th Cir. 2011)

Stobie Creek Invs. LLC v. United States, 608 F.3d 1366 (Fed. Cir. 2010)

Tyler v. Tomlinson, 414 F.2d 844 (5th Cir. 1969)

United States v. S. Georgia Ry. Co., 107 F.2d 3 (5th Cir. 1939)

U.S. Bank Nat'l Ass'n v. Vill. at Lakeridge, LLC, 138 S. Ct. 960 (2018)

VHC, Inc. v. Commissioner, 968 F.3d 839 (7th Cir. 2020)

Whetsel v. Network Prop. Servs., LLC, 246 F.3d 897 (7th Cir. 2001)

Statutes:

Internal Revenue Code (26 U.S.C.):

Deficit Reduction Act of 1984, Pub. L. No. 98-369, 98 Stat. 494 (1984)

Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, 124 Stat. 1029 (2010)

Internal Revenue Code of 1954, Pub. L. No. 83-591, 68 Stat. 730, 68A Stat. 3 (1954)

Revenue Act of 1918, Pub. L. No. 65-254, 40 Stat. 1057 (1919)

Regulations:

Treasury Regulations (26 C.F.R.):

Subchapter K Anti-Abuse Rule, 60 Fed. Reg. 23 (Jan. 3, 1995)

Treatment of Partnership Liabilities, 56 Fed. Reg. 66348 (Dec. 23, 1991)

Miscellaneous:

GLOSSARY

Term	Definition
A.	Commissioner's appendix
Am.Br.	Amicus brief
B.	Petitioners' appendix
Br.	Commissioner's opening brief
CBH	Chicago Baseball Holdings, LLC; owner of the Cubs Assets after the Cubs Transaction
Cubs Assets	Assets, including the Chicago Cubs baseball team, that Tribune transferred to CBH as part of the Cubs Transaction
Cubs Transaction	Set of related transactions that closed on October 27, 2009, in which, inter alia, Tribune transferred the Cubs Assets to CBH through a disguised sale
I.R.C.	Internal Revenue Code (26 U.S.C.)
IRS	Internal Revenue Service
MLB	Major League Baseball
OSA	Operating Support Agreement
Petitioners	CBH and Tribune, collectively
Pet.Br.	Petitioners' combined answering and opening brief
RAC	Ricketts Acquisition, LLC, now known as Northside Entertainment Holdings, LLC; owner of 95% of CBH after the Cubs Transaction
RAC Finance	RAC Education Trust Finance, LLC; Subordinated Debt lender
Senior Debt	CBH's total $425 million in senior loans and senior notes, after the Cubs Transaction
Senior Guarantee	Tribune's collection guarantee for the Senior Debt
Subordinated Debt	CBH's $248.75 million in purported subordinated debt, funded by the Rickettses
Subordinated Guarantee	Tribune's collection guarantee for the purported Subordinated Debt
Treas. Reg.	Treasury Regulations (26 C.F.R.)
Tribune	Tribune Co., now known as Tribune Media Co.

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INTRODUCTION

Tribune Media Company wanted to avoid prodigious built-in gains tax from its disguised sale of the Cubs Assets to Chicago Baseball Holdings (“CBH”).¹ To do so, Tribune designed the Cubs Transaction in an attempt to meet the technical requirements for the debt-financed exception to the disguised-sale rules. To qualify for that exception, Tribune had to bear real economic risk for real debt that CBH borrowed to pay Tribune for the Cubs Assets. To meet Tribune's demands that the deal include maximum debt (to generate maximum tax benefits), CBH used debt to fund the lion's share of its $714 million payment to Tribune for the Cubs Assets: $425 million in Senior Debt from outside lenders, and $248.75 million in purported Subordinated Debt funded by the Ricketts family. To create the appearance that Tribune was at risk for that debt, the parties executed Tribune's collection guarantees for both tranches of debt.

Tribune's goal for the parties' complex arrangements was tax avoidance and not, as Tribune repeatedly asserts, tax deferral. (See Pet.Br.1, 11-12 & n.2, 57.) Even if deferral was the goal, unwarranted tax deferral also hurts the public fisc by delaying collection and enabling potential avoidance in future years. But the analysis here focuses on the 2009 timeframe of the Cubs Transaction,² when Tribune recently had changed from a C Corporation (which pays entity-level income taxes) to a pass-through S Corporation (which generally does not) owned by a tax-exempt entity. (Br.10.) That change in corporate status kicked off a ten-year recognition period for built-in gains tax. (Id.) To avoid built-in gains tax during that ten-year period, Tribune structured the Cubs Transaction to avoid recognizing its gain until 2018. (Br.9-13, 18-19.) Petitioners admit that Tribune avoided that tax during the several years that it maintained the corporate structure it had in 2009. (Pet.Br.11 n.2.) Tribune began paying that tax only because, in 2012, it unexpectedly converted back to a C Corporation — a fact that is irrelevant to determining petitioners' 2009 tax issues, which are at issue here. The IRS correctly rejected Tribune's attempt to avoid taxes by shoehorning the Senior Guarantee into the debt-financed distribution exception to the disguised-sale rules. That maneuver was abusive and counter to the purposes of the Internal Revenue Code's partnership provisions.

The Tax Court, however, erroneously concluded that the Senior Guarantee supported petitioners' claims under the debt-financed distribution exception. In reaching that conclusion, the court misinterpreted and misapplied the plain text of two independent anti-abuse regulations: Treas. Reg. §§ 1.752-2(j) and 1.701-2. Regarding Section 1.752-2(j), the Tax Court erroneously ignored the real-world facts and circumstances surrounding the Cubs Transaction. Although the parties' complex arrangements made it appear as though Tribune had risk for the Senior Debt, the substance of the arrangements was otherwise because Tribune had — at most — de minimis risk under the Senior Guarantee. Petitioners' own expert calculated Tribune's risk from the Senior Guarantee as ranging from zero to a maximum 0.43% of the total Senior Debt.³ The substance of the parties' arrangements thus departed from the appearances those arrangements created, violating Section 1.752-2(j). Applying Section 1.701-2, the court failed to focus on whether the Senior Guarantee had a “business purpose.” Tribune guaranteed CBH's debt for one reason: minimizing taxes. That is not a “business purpose” under federal tax law. The Commissioner asks this Court to reverse the Tax Court's decision as to the Senior Debt or, at a minimum, to vacate and remand that portion of the decision to the Tax Court for application of the correct legal standards.

The Tax Court correctly found that the Subordinated Debt was equity, and not bona fide debt, for federal tax purposes — and that the related portion of CBH's payment to Tribune thus was not a debt-financed distribution. The Subordinated Debt was advanced from one Ricketts-controlled entity to another on terms that a third party would not accept. Thomas Ricketts singlehandedly determined those terms with no negotiation. These and other facts amply support the Tax Court's overall finding, reviewed for clear error, that the Subordinated Debt was equity. The Commissioner asks this Court to affirm the Tax Court's decision as to the Subordinated Debt.

PART I
REPLY BRIEF OF THE COMMISSIONER AS APPELLANT

ARGUMENT

In upholding petitioners' treatment of the Senior Debt, the Tax Court misinterpreted two anti-abuse regulations

A. The Tax Court failed to apply the plain text of Treas. Reg. § 1.752-2

1. The Section 1.752-2(j) anti-abuse rule analyzes real facts, circumstances, and substance

Tribune attempted to use the debt-financed exception to the disguised-sale rules to shelter, from built-in gains tax, the $425 million portion of CBH's payment to Tribune that CBH funded with Senior Debt. (Br.6-13.) But that ran afoul of the anti-abuse rule in Treas. Reg. § 1.752-2(j), and Tribune thus did not have risk on the Senior Debt “under the rules in paragraphs (b) through (k) of” the liability-allocation regulation, Section 1.752-2. Treas. Reg. § 1.752-2(a). (Br.44-61.)

Under paragraph (b), “[e]xcept as otherwise provided in [Section 1.752-2],” a partner's economic risk for a recourse partnership liability is determined through the lens of the highly improbable facts generated under the constructive-liquidation test. (Br.7-8, 45.) As petitioners acknowledge, such circumstances are so unlikely to occur that commentators have dubbed this the “atom bomb” test. (Pet.Br.30.) The analysis of economic risk under the liability-allocation regulation, however, does not begin and end with paragraph (b).

One of the exceptions to the constructive-liquidation test that Section 1.752-2 “otherwise provide[s]” is the anti-abuse rule in paragraph (j). The Tax Court misinterpreted Section 1.752-2 and constrained its analysis of paragraph (j)'s anti-abuse rule to the hypothetical facts generated under the constructive-liquidation test in paragraph (b). (Br.44-51.) Petitioners identify no support in the regulation's text for their view that paragraph (j) “builds on paragraph (b)” or applies after paragraph (b). (Pet.Br.38-40.) Paragraph (j) is one of the exceptions that Section 1.752-2 provides to the constructive-liquidation test in paragraph (b), and that exception is not subject to paragraph (b). (See Br.45-46.) Petitioners also rely on an example in Treas. Reg. § 1.752-2(j). (Pet.Br.42-43.) But an example in a regulation is “clearly not intended to be all inclusive.” Ala. Tissue Ctr. of Univ. of Ala. Health Serv. Found., P.C. v. Sullivan, 975 F.2d 373, 379 (7th Cir. 1992).

Fueled by interpretive mistakes, the Tax Court erroneously failed to consider whether the real-world “facts and circumstances” surrounding the Cubs Transaction “indicate that a principal purpose of the arrangement between the parties” was to “create the appearance of [Tribune] bearing the economic risk of loss” for the Senior Debt “when, in fact, the substance of the arrangement [was] otherwise.” See Treas. Reg. § 1.752-2(j).⁴ The Tax Court declined to consider important aspects of the parties' arrangements, such as the unlimited equity contributions that the Rickettses agreed the MLB Commissioner could demand under the OSA arrangements. (See SA.99-100; Br.24-26, 56-61; infra at 14-21.) With Tribune bearing an undisputed risk on the Senior Debt from zero to a maximum of 0.43% (see Br.35, 59; Pet.Br.57), the substance of the parties' arrangements here did not match the appearance that their arrangements created (see Br.52-61). The Tax Court further erred by believing that the Senior Debt “must be allocated to a partner,” and, viewing itself as under a false constraint to assign the Senior Debt to either RAC or Tribune, choosing Tribune. (SA.100.) But Section 1.752-2(j) allowed the court to disregard Tribune's purported obligation for the Senior Debt, and it did not have to be allocated to anyone. (Br.50-51.)

The Commissioner's interpretation allows paragraphs (b) and (j) to work together in determining economic risk, as Section 1.752-2(a) instructs (referencing “paragraphs (b) through (k)”). The constructive-liquidation test is efficient to administer and straightforwardly governs nearly all determinations regarding allocation of recourse partnership liabilities to partners.⁵ But when an obligation is disregarded under paragraph (j)'s anti-abuse rule, that obligation is disregarded — i.e., plays no role — in applying the constructive-liquidation test in paragraph (b). Here, Tribune's Senior Guarantee should be disregarded under paragraph (j), and it should play no role in applying the constructive-liquidation test in paragraph (b). The Commissioner thus is not, as petitioners and amicus principally contend, abandoning the constructive-liquidation test, seeking to displace that test, or rendering it superfluous. (E.g., Pet.Br.33-34, 38-40; Am.Br.8-11.) The Commissioner instead seeks to apply the plain text of Section 1.752-2 in its entirety, including the anti-abuse rule with its analysis of real-world “facts and circumstances.”

Petitioners emphasize that the constructive-liquidation test in Section 1.752-2(b) “has been on the books for more than thirty years.” (Pet.Br.34; see also Am.Br.8-11.) But so has the anti-abuse rule, which Treasury promulgated to protect against the possibility that sophisticated tax planners would engineer the appearance of risk — without any real-world substance — under the constructive-liquidation test. Since at least 1935, moreover, courts have held that literal compliance with technical requirements is not a basis for respecting transactions that lack economic substance. See Gregory v. Helvering, 293 U.S. 465, 468-70 (1935). Petitioners cannot claim to be surprised by this bedrock principle. (Cf. Pet.Br.34; Am.Br.1-2, 11-14.)

By limiting its anti-abuse analysis to the hypothetical facts generated by the constructive-liquidation test, the Tax Court failed to apply the plain text of Section 1.752-2. The record here supports a ruling by this Court that Section 1.752-2(j) bars Tribune from treating the $425 million corresponding to the Senior Debt as a non-taxable debt-financed distribution. (Br.56-61; infra at 14-21.) But at a minimum, the Tax Court's ruling under Section 1.752-2(j) is “infirm because of an erroneous view of the law” and should be vacated, with the case remanded for the Tax Court to apply the correct legal standard under Section 1.752-2(j). Pullman-Standard v. Swint, 456 U.S. 273, 292 (1982); see also Whetsel v. Network Prop. Servs., LLC, 246 F.3d 897, 904. (7th Cir. 2001).

2. The Commissioner's interpretation of Section 1.752-2(j) is consistent with congressional intent

The Tax Court failed to apply Section 1.752-2's plain text, and thus there is no need to examine the legislative history for related statutes. That history, however, is consistent with the Commissioner's interpretation of Section 1.752-2. (Br.51-52.) Petitioners argue that Congress generally intended that partnership debt could be allocated to a guaranteeing partner. (Pet.Br.33-34, 47.) They point to 1984 legislation directing that I.R.C. § 752 and related regulations “be applied without regard to the result reached” in Raphan v. United States, 3 Cl. Ct. 457 (1983), rev'd in part, 759 F.2d 879, 885-86 (Fed. Cir. 1985). See Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 79, 98 Stat. 494, 597 (1984). But in sharp contrast to Tribune's Senior Guarantee (see Br.18-19), the unconditional Raphan guarantee allowed creditors to proceed against the guarantor before exercising any creditor remedies, and that guarantee also “was a prerequisite to obtaining the loan which, in turn, was sine qua non of the deal.” 3 Cl. Ct. at 465; 759 F.2d at 886 n.3. The Claims Court in Raphan nonetheless disregarded the guarantee. See 3 Cl. Ct. at 465-66.

Concerned about that outcome, Congress directed Treasury to “prescribe regulations [under Section 752] relating to liabilities, including the treatment of guarantees. . . .” Deficit Reduction Act of 1984, 98 Stat. at 597. The regulations that Treasury promulgated provide that obligations that are generally “taken into account” under the constructive-liquidation test include “guarantees.” Treas. Reg. § 1.752-2(b)(3)(i). But additional rules otherwise provided in Section 1.752-2, including paragraph (j)'s anti-abuse rule, ensure that the allocation of liabilities among partners reflects the manner, if any, in which a guaranteeing partner “share[s] the economic risk of loss,” as Congress intended. H.R. Rep. No. 98-861, at 869 (1984) (Conf. Rep.).

Congress legislatively overruled Raphan in 1984 against a backdrop of nearly fifty years of judicial anti-abuse tax doctrines, see supra at 9-10, and there is no hint that Congress wanted to exempt a partner's guarantee from regulatory or judicial scrutiny for tax abuse. In more recent years, moreover, Congress has only increased legislative efforts to combat tax abuse, including by codifying the economic-substance doctrine. I.R.C. § 7701(o); Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, § 1409(a), 124 Stat. 1029, 1067-70 (2010).⁶

3. Judicial doctrines underlying Section 1.752-2(j) support the Commissioner's interpretation

The anti-abuse rule in Section 1.752-2(j) has its roots in judicial doctrines that long have protected the public fisc from tax abuse. (See Br.47-48, 52-55.) Petitioners contend that cases applying those doctrines are irrelevant and do not aid the Commissioner. (Pet.Br.47-50.) The Tax Court failed to apply the regulation's plain text, and this Court need not look further to reverse the Tax Court's decision as to the Senior Debt. But Section 1.752-2(j) was promulgated after many decades of judicial anti-abuse doctrines, and cases applying those doctrines help to provide context for the regulation.

The cases also show that the Tax Court's refusal to even consider the real-world facts and circumstances in its anti-abuse analysis not only conflicts with the regulation's plain text but also is an aberration among judicial analyses of tax abuse. For example, where real economic effects are de minimis, courts ignore them in determining federal tax consequences. (Br.53-54.) But here, the Tax Court deemed Tribune's real-world de minimis risk on the Senior Debt — calculated by petitioners' expert as between zero and 0.43% of the Senior Debt — to be “irrelevant.” (SA.101.) The court failed to consider whether the appearance of the parties' arrangements matched their substance under Section 1.752-2(j), which is out of step with decades of case law applying economic-substance and substance-over-form principles (Br.47-48).

Tribune's zero (or near-zero) risk on the Senior Debt did not “meaningfully change [its] economic position” (see Pet.Br.48), and the appearance of risk generated by the form of the Senior Guarantee did not match the substance of Tribune's actual risk. Just as that would fail scrutiny under the judicial anti-abuse doctrines, it fails scrutiny under Section 1.752-2(j).

4. The parties' arrangements made it appear as though Tribune bore risk for the Senior Debt, but the substance of the arrangements was otherwise

Under Section 1.752-2(j), Tribune's purported “obligation . . . to make a payment” on the Senior Debt should be “disregarded” because “facts and circumstances indicate that a principal purpose” of the parties' arrangements surrounding the Cubs Transaction was to “create the appearance of [Tribune] bearing the economic risk of loss when, in fact, the substance of the arrangement” was “otherwise,” with Tribune bearing no more than de minimis risk (zero to 0.43%) on the Senior Debt. (Br.56-61.)

The Senior Guarantee gave the appearance that Tribune bore risk for the Senior Debt, and the guarantee was signed by Tribune, the senior lenders' agent, and Thomas Ricketts (for CBH). (A.972-74.) But Tribune would not have to pay a penny under the Senior Guarantee until after three high hurdles were cleared: (1) CBH defaulted on the Senior Debt and the debt was accelerated, (2) the senior lenders exercised all of their remedies against nearly all of CBH's assets (including the Chicago Cubs), and (3) such efforts still did not satisfy the outstanding Senior Debt. (Br.18-19.) It was nearly impossible for that series of events to occur, as reflected in the valuation of the Senior Guarantee by petitioners' expert, from zero to a maximum 0.43% of the Senior Debt. (Br.52-53.)

Petitioners nonetheless maintain that Tribune's “risk of loss on the guarantees was meaningful.” (Pet.Br.51-58.) Like the Tax Court, petitioners erroneously focus on Tribune's combined risk on the Senior Guarantee and the Subordinated Guarantee (e.g., Pet.Br.51-53, 56). But this case is about federal tax consequences, and for those purposes, the Tax Court correctly determined that the Subordinated Debt was not bona fide debt. (SA.56-90; see infra at 37-71.) Accordingly, whatever risk Tribune may have had on the Subordinated Debt, as a matter among private parties (see Pet.Br.56), cannot boost its nonexistent or miniscule risk on the Senior Debt, to support its claim to a debt-financed distribution of the Senior Debt. (Br.70-71; infra at 48 n.14.)⁷ See Gilbert v. Commissioner, 248 F.2d 399, 406 (2d Cir. 1957) (explaining that debt valid for other purposes is not necessarily bona fide debt for federal tax purposes). Petitioners also reference documents, dated more than a decade after the Cubs Transaction, regarding pricing of appeal bonds and life-insurance policies. (Pet.Br.57.) Those documents are not in the record and are irrelevant.

Petitioners focus on the likelihood of default, largely ignoring the other two steep hurdles to any liability for Tribune under the Senior Guarantee. (Pet.Br.51-56.) It was, moreover, highly unlikely that CBH would default on the Senior Debt and that even that initial hurdle would be crossed, due to the high levels of consistent revenue produced by the Cubs Assets and other aspects of the parties' arrangements. (Br.20-28, 57-58.) The agreement establishing the cash waterfall was signed by the senior lenders' agent and Thomas Ricketts (for CBH). (A.877-78.) Under the cash waterfall, it is undisputed that revenues projected to be seven to ten times the annual Senior Debt expense flowed first to the Senior Debt. (Br.20-24.) The kinds of risks petitioners identify on appeal (Pet.Br.51-52) were considered in preparing the underlying financial projections, which petitioners' expert concluded were reasonable and credible. (Br.23 n.9; A.1781-87 (testimony regarding preparation of the financial projections).) Other parts of the deal provided further protection against such risks. For example, CBH was required to hold in escrow six months of Senior Debt payments (increased to nine months around the expiration of the MLB collective bargaining agreement) (see Pet.Br.51-52), and it also had to maintain business interruption insurance (Br.16-17, 22 n.8). CBH concluded, moreover, that the Cubs' strong financial performance was not impacted by, e.g., the team's poor performance on the field or stress in the overall economy. (Br.20-22; cf. Pet.Br.51-52.) Petitioners also reference financial troubles faced by the Texas Rangers (Pet.Br.52), but that team was sold for significantly more than its outstanding debt (A.1541 & B.463-65 (expert reports relying on public news sources)).

The parties' arrangements regarding the Operating Support Agreement also reduced the likelihood that CBH would default on the Senior Debt, and by extension, that Tribune would face any liability under the Senior Guarantee. (Br.24-26.) CBH — not “[t]he government” (Pet.Br.54) — concluded that the OSA loan commitment would “indirectly benefit” the senior lenders (See Br.25; A.1113; A.1219). Petitioners claim that funds from the OSA could not be used for CBH's debt (Pet.Br.54), but as Thomas Ricketts confirmed, using OSA funds for CBH's operations “could free up cash for debt” (A.1794; see Br.25-26). The OSA Letter Agreement — signed by, e.g., Thomas Ricketts (individually and for CBH), RAC, and the family trust behind RAC — committed the Rickettses to transfer funds to the Cubs as equity or as a loan. (A.881, A.887-89; Br.24-25.) Petitioners contend that the OSA “safety net was capped at $35 million,” but they cite only an OSA loan document. (Pet.Br.54 (citing A.892).) In his opening brief, the Commissioner argued that, although OSA loans may be capped, equity contributions that the MLB Commissioner could require were not (Br.24-25, 50 n.12) — a fact that petitioners neither acknowledge nor dispute. If the OSA were drawn down, the Commissioner thus could require unlimited equity contributions under the OSA arrangements.

If CBH faced default despite these manifold strengths, it could access a $25 million revolving loan from the senior lenders, and MLB reserved the right to provide financial support. (Br.16, 26-28.) MLB also had broad tools to force additional equity contributions for teams in financial trouble and would use such tools to avoid foreclosure on the Cubs. (Br.26-28.) The parties to the arrangements here — including Thomas Ricketts (individually and for CBH), RAC, the family trust behind RAC, and Tribune — signed a memorandum to the other MLB clubs stating that the MLB Commissioner had “little doubt about the ability of the Ricketts Group to service the debt on the Club” and affirming that, if the Cubs became out of compliance with MLB's debt-service rule, the Ricketts Group knew that “cash infusions may be necessary.” (Br.14-15; A.478-92.) Like MLB, Tribune expected the Rickettses to stand behind CBH's debt before abandoning their investment, and that is one of many reasons Tribune concluded it faced only “remote” risk from its guarantees of CBH's debt.⁸ (Br.31-32; A.999-1000.)

In the extremely unlikely event that these various protections against default failed, CBH actually defaulted on the Senior Debt, and the Senior Debt was accelerated (clearing the first hurdle), the Senior Debt would only be triggered if the two remaining steep hurdles were cleared. The second hurdle required the senior lenders to exercise all of their remedies against nearly all of CBH's assets, including the Chicago Cubs baseball team. But the parties expected that the Rickettses and MLB would intervene before allowing creditors to foreclose on the Cubs.

Even if the senior lenders managed to seize and sell the Cubs, Wrigley Field, and the other assets securing the Senior Debt, the Senior Debt was overcollateralized, making it near-impossible that the third hurdle to Tribune's liability — failure to satisfy Senior Debt through creditor remedies — would be crossed. At the time of the Cubs Transaction, the fair-market value of CBH's assets was $844.7 million, as calculated by petitioners' expert, which was nearly double the $425 million in Senior Debt. (Br.58-59.) The value of MLB franchises was substantially increasing at that time, and by 2018, CBH's value was $2.7 billion. (Br.29, 33.) There was almost no chance that the value of the assets securing the Senior Debt would fall below the amount of that debt.

As described above and in the Commissioner's opening brief (at 56-61), the parties' arrangements made it appear that Tribune had risk for the Senior Debt. But an analysis of the facts and circumstances surrounding the Cubs Transaction reveals that the substance of those arrangements materially diverged from that appearance, as Tribune's risk was as low as zero and no more than de minimis. Tribune's purported obligation under the Senior Guarantee thus should be disregarded under the anti-abuse rule in Section 1.752-2(j).

B. The partnership anti-abuse rule in Treas. Reg. § 1.701-2 separately bars the tax benefits claimed from the Senior Guarantee

The Senior Guarantee also fails the general partnership (subchapter K) anti-abuse rule in Treas. Reg. § 1.701-2. (Br.61-73.) Petitioners contend that this regulation is invalid. (Pet.Br.58-62.) But I.R.C. § 7805(a) granted the Treasury Department authority to promulgate Section 1.701-2, which is consistent with congressional intent and case law.

In upholding petitioners' treatment of the Senior Debt under Section 1.701-2, the Tax Court misinterpreted the regulation and relied on irrelevant and unreliable evidence. (Br.61-73.) The record here supports a ruling in the Commissioner's favor under Section 1.701-2. But like Section 1.752-2, the Tax Court's legal errors regarding Section 1.701-2 require, at a minimum, vacatur and remand for application of the correct standard. Pullman-Standard, 456 U.S. at 292; Whetsel, 246 F.3d at 904.

1. I.R.C. § 7805(a) granted authority to promulgate Section 1.701-2

Building on decades of judicial anti-abuse tax doctrines, the Treasury Department promulgated Section 1.701-2 under the broad regulatory authority Congress granted in I.R.C. § 7805(a). Subchapter K Anti-Abuse Rule, 60 Fed. Reg. 23, 27 (Jan. 3, 1995). Section 7805(a) not only authorizes but directs the Secretary of the Treasury to “prescribe all needful rules and regulations for the enforcement of this title” i.e., the Internal Revenue Code (Title 26, U.S.C.). Congress has granted similarly broad regulatory authority since the Revenue Act of 1918. Revenue Act of 1918, Pub. L. No. 65-254, ch. 18, § 1309, 40 Stat. 1057, 1143 (1919); see Bob Jones Univ. v. United States, 461 U.S. 574, 596 (1983) (describing this history). Section 7805(a) is “essential to efficient and fair administration of the tax laws” because the tax system is “complex” and the Treasury Department “must be able to exercise its authority to meet changing conditions and new problems.” Bob Jones, 461 U.S. at 596.

The Internal Revenue Code of 1954 enacted subchapter K's partnership tax provisions and included the substantively unchanged text of Section 7805(a). Internal Revenue Code of 1954, Pub. L. No. 83-591, 68 Stat. 730, 68A Stat. 3, 239-54, 917 (1954). There is no reason to think — and petitioners have offered none — that Congress intended to exempt subchapter K from Section 7805(a) or otherwise narrow Treasury's authority to promulgate regulations preventing partnership tax abuse. Petitioners argue that Congress withheld specific authority to promulgate rules preventing tax abuse in partnership arrangements (Pet.Br.60), but Congress granted that authority in Section 7805(a). And the fact that Congress sometimes has specifically required Treasury to promulgate regulations (see Pet.Br.59-60) does not narrow Section 7805(a)'s sweep. Petitioners do not even attempt to show that Section 1.701-2 is outside of Congress's broad grant of authority in Section 7805(a), which they cite once (at 58) and then ignore.

Congress enacted subchapter K and Section 7805(a), moreover, against a backdrop of well-established judicial doctrines foreclosing abuse of the federal tax system. Nearly twenty years before the Internal Revenue Code of 1954, and sixty years before Treasury promulgated Section 1.701-2, the Supreme Court decided Gregory v. Helvering, 293 U.S. 465 (1935). Petitioners cite Gregory for the idea that a tax-reduction motive “'will not alter the result or make unlawful what the statute allows.'” (Pet.Br.60-61 (quoting 293 U.S. at 468-49).) But that significantly shortchanges Gregory's import. Gregory concerned the federal tax consequences of an arrangement (specifically, a corporate reorganization) that met relevant statutory requirements, which the Commissioner nonetheless concluded “was without substance and must be disregarded.” 293 U.S. at 467. The Court looked beyond the technical requirements to inquire “whether what was done, apart from the tax motive, was the thing which the statute intended.” Id. at 469. Gregory upheld the Commissioner's determination because the transaction was “outside the plain intent of the statute.” Id. at 470.

Petitioners complain (Pet.Br.59-62) that Section 1.701-2 allows the Commissioner to adjust or modify claimed tax treatment “to achieve tax results that are consistent with the intent of subchapter K” even where “the transaction may fall within the literal words of a particular statutory or regulatory provision.” Treas. Reg. 1.701-2(b). But that aspect of Section 1.701-2 is directly traceable to the reasoning in Gregory that petitioners ignore, which courts continue to apply today. (Br.63 & n.22.) E.g., Southgate Master Fund, L.L.C. v. United States, 659 F.3d 466, 479 (5th Cir. 2011); Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1352 (Fed. Cir. 2006); ACM P'ship v. Commissioner, 157 F.3d 231, 246-48 (3d Cir. 1998).

The Commissioner's appeal focuses on the business-purpose requirement in Section 1.701-2(a)(1) (Br.61-68), which also is directly traceable to longstanding caselaw. To apply “the doctrine of Gregory,” courts examine the motives behind a transaction and consider whether it was “entered upon for commercial or industrial purposes” and whether there was “no other motive but to escape taxation.” Commissioner v. Transp. Trading & Terminal Corp., 176 F.2d 570, 572 (2d Cir. 1949) (Hand, C.J.), quoted in Feldman v. Commissioner, 779 F.3d 448, 455 (7th Cir. 2015). The business-purpose requirement in Section 1.701-2 also is consistent with Congress's more recent codification of the judicial economic-substance doctrine, including the business-purpose requirement. I.R.C. § 7701(o)(1) & (o)(5)(A).

The business-purpose requirement is “essential” because “[e]ven the smartest drafters of legislation and regulation cannot be expected to anticipate every device” that “clever individuals in the private sector” may use in an attempt “to game the system.” ASA Investerings P'ship v. Commissioner, 201 F.3d 505, 513 (D.C. Cir. 2000) (discussing judicially created anti-abuse doctrines). It is neither surprising nor relevant, therefore, that some have “widely condemned” Section 1.701-2 “from the beginning,” as petitioners claim. (See Pet.Br.62.)

Section 1.701-2 is within the authority Congress granted the Treasury Department in Section 7805(a). The regulation is consistent with decades of caselaw, as well as with Congress's embrace of anti-abuse doctrines, and also gives taxpayers guidance regarding how the IRS will apply such concepts in the partnership context. District courts have enforced Section 1.701-2 without questioning its validity. Pritired 1, LLC v. United States, 816 F. Supp. 2d 693, 741-43 (S.D. Iowa 2011); Fidelity Int'l Currency Advisor A Fund, LLC v. United States, 747 F. Supp. 2d 49, 234-35, 244 (D. Mass. 2010), aff'd, 661 F.3d 667 (1st Cir. 2011). Congress may, moreover, legislatively overrule regulations it deems improper, but Section 1.701-2 was promulgated nearly thirty years ago and is “deemed to have received congressional approval and have the effect of law.” Cottage Sav. Ass'n v. Commissioner, 499 U.S. 554, 561 (1991) (internal quotations omitted), quoted in Arnett v. Commissioner, 473 F.3d 790, 795-96 (7th Cir. 2007).

2. The Commissioner may rely on both the Section 1.752-2(j) and Section 1.701-2 anti-abuse rules

The Commissioner relies on two independent anti-abuse regulations to disallow the benefits generated by the Senior Guarantee: Section 1.752-2(j) and Section 1.701-2. Consistent with Gregory, a transaction that passes muster under “the literal words” of Section 1.752-2 nevertheless could be abusive under Section 1.701-2. See Treas. Reg. § 1.701-2(b). The regulations thus complement each other and are not, as petitioners suggest, in conflict. (See Pet.Br.64.) Petitioners also assert that applying Section 1.701-2 here “violates the 'elementary tenet' that 'a specific [provision] will not be controlled or nullified by a general one.'” (Pet.Br.63 (quoting Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365, 375 (1990); see also Am.Br.11-12).) But from their Guidry quote, petitioners omit that this tenet of textual interpretation applies only “[w]here there is no clear intention otherwise.” Guidry, 493 U.S. at 375 (internal quotations omitted). This omitted language is important here, for Section 1.701-2(b) does state a “clear intention” that Section 1.701-2 still applies where tax claims meet other “particular statutory or regulatory provision[s].”

In any event, the Commissioner may argue that both anti-abuse regulations apply here. Like Federal Rule of Civil Procedure 8(d)(3), Tax Court Rule 31(c) allows parties to make alternative claims, “regardless of consistency.” E.g., Cromeens, Holloman, Sibert, Inc. v. AB Volvo, 349 F.3d 376, 397 (7th Cir. 2003) (discussing the “doctrine of pleading in the alternative”).

3. The Tax Court erroneously interpreted and applied Section 1.701-2

a. The business-purpose requirement applies to each transaction, not “to the function of the partnership as a whole”

Under Section 1.701-2(a)(1), a “partnership must be bona fide and each partnership transaction or series of related transactions (individually or collectively, the transaction) must be entered into for a substantial business purpose.” (Emphasis added.) As indicated by the word “and,” the bona fide partnership requirement and business-purpose requirement are separate mandates. In conflict with that plain text, the Tax Court erroneously held that the regulation's business-purpose requirement broadly applies “to the function of the partnership as a whole” and not “to every agreement.” (SA.109; Br.61-65.)

If left undisturbed, the Tax Court's interpretation could eviscerate Section 1.701-2 because a partnership with an overall bona fide “function” could, without running afoul of Section 1.701-2, freely engage in tax abuse through transactions with no business purpose. (Br.64-65.) Petitioners do not even attempt to defend this aspect of the Tax Court's ruling and have forfeited the opportunity to do so. (See Pet.Br.64-68 (focusing on the scope of the transaction subject to the business-purpose inquiry).) Bonte v. U.S. Bank, N.A., 624 F.3d 461, 466 (7th Cir. 2010) (“Failure to respond to an argument . . . results in waiver.”). The Tax Court's erroneous interpretation of Section 1.701-2(a)(1) should be reversed.

b. The Tax Court failed to focus the business-purpose inquiry on the Senior Guarantee

The Tax Court also erroneously failed to analyze whether the Senior Guarantee was “entered into for a substantial business purpose,” as Section 1.701-2(a)(1) requires. (Br.65-68.) The court instead briefly discussed whether the Cubs Transaction, as a whole, was a sham. (See SA.110-14.) Under that approach, as long as Tribune actually carried out the disguised sale of the Cubs Assets to CBH, the parties could avoid scrutiny under Section 1.701-2 while engaging in utter chicanery to avoid tax for Tribune on hundreds of millions of dollars in gains on the Cubs Assets. That is not, and cannot be, the law.

The text of the regulation, moreover, confirms that its business-purpose analysis focuses on the Senior Guarantee. (Br.65-68.) For example, the facts-and-circumstances test requires identifying “the transaction” that generated “the claimed tax benefits” and then comparing such benefits with the purported business purpose for that transaction. Treas. Reg. § 1.701-2(c). (Br.66-68.) Petitioners argue that the business-purpose analysis could focus on either a single “transaction” or a “series of related transactions,” relying on the parenthetical in Section 1.701-2(a)(1). (Pet.Br.64-65.)⁹ To be sure, in other circumstances, tax benefits could be generated by a series of transactions. But the claimed tax benefits at issue here — i.e., Tribune's tax-free claim to the $425 million funded by the Senior Debt — resulted from the Senior Guarantee, and that transaction is the correct focus for the business-purpose inquiry under Section 1.701-2. (Br.65-68.)

Petitioners contend that the business-purpose analysis considers “the entire Cubs transaction” because all parts of the transaction were necessary to generate the tax benefits, including “forming the partnership, taking out the loans, and distributing the proceeds to Tribune.” (Pet.Br.66.) But if the parties had taken those steps without the Senior Guarantee, that would have been a straightforward disguised sale in which CBH borrowed money to pay Tribune for the Cubs Assets, and Tribune would have been subject to built-in gains tax on the $425 million funded by the Senior Debt. That portion of CBH's payment to Tribune could escape tax under the debt-financed exception only if Tribune had economic risk for the Senior Debt under Treas. Reg. § 1.752-2, and the only source of that purported economic risk was the Senior Guarantee. Section 1.701-2 thus requires a comparison of the claimed tax benefits — tax-free treatment of $425 million — with the purported business purpose for the Senior Guarantee.

Focusing on the transaction (or portion thereof) that generated the tax benefits is consistent with cases applying the economic-substance doctrine, as Treasury intended when it promulgated Section 1.701-2. (Br.66-68; cf. Pet.Br.66 (arguing that such cases are irrelevant).) For example, in GSS Holdings (Liberty) Inc. v. United States — the subject of petitioners' October 9, 2023 letter to this Court — the Federal Circuit explained that the economic-substance doctrine “focus[es] solely on 'the transaction . . . that gave rise to the alleged tax benefit.'” 81 F.4th 1378, 1382 (Fed. Cir. 2023) (quoting Coltec, 454 F.3d at 1356). The Federal Circuit held that this approach should not be applied under the step-transaction doctrine, id. at 1381-83, but that does not affect this case, which does not involve the step-transaction doctrine.

Petitioners also posit that, to show business purpose, they need only describe what the Senior Guarantee did, and that there is no need to probe why Tribune executed the Senior Guarantee. (Pet.Br.70-71.) But that is exactly what the business-purpose inquiry involves — examining the reasons behind a transaction to determine the presence (or absence) of objective, non-tax reasons for it. In Gregory, for example, the Supreme Court considered the reasons motivating the corporate reorganization at issue and found a lack of “business or corporate purpose.” 293 U.S. at 469. In Frank Lyon Co. v. United States, the Court also examined why the parties engaged in the transaction under scrutiny and found, inter alia, that it was “imbued with tax-independent considerations.” 435 U.S. 561, 583-84 (1978). See also Transp. Trading, 176 F.2d at 572; Feldman, 779 F.3d at 455. The business-purpose analysis, whether under Section 1.701-2 or judicial doctrines, necessarily examines why parties entered a transaction.¹⁰

c. Tribune had no business purpose for the Senior Guarantee

Petitioners have never identified a plausible non-tax business purpose for the Senior Guarantee. They assert that Tribune sought “to ensure the ultimate repayment of CBH's loans” by bearing the ultimate burden of those debts. (Pet.Br.69 (internal quotations omitted).) But except for avoiding taxes, it made no sense for Tribune to relinquish 95% of its ownership over the Cubs Assets, while guaranteeing the Senior Debt funding CBH's payment to Tribune for the Cubs Assets. For very good reasons, everyone involved was confident that CBH would pay its debts. And given the parties' arrangements and the Senior Debt's overcollateralization, Tribune had no more than a de minimis (zero to 0.43%) risk on the Senior Debt.

There is no evidence, moreover, that the Senior Guarantee had any effect on the terms or amount of the Senior Debt, and petitioners do not claim otherwise. (See Pet.Br.71.) There was, for example, no evidence that a lender offered CBH a lower interest rate, a larger loan, or any more favorable terms than it would have without the Senior Guarantee. Tribune itself concluded that it was “unlikely” that the Senior Guarantee “enhanced” the Senior Debt's amount or terms. (Br.32, 69; A.1000.) If the Senior Guarantee caused any such enhancement, moreover, that would have benefited CBH and the Rickettses, as CBH's 95% owners — not only the senior lenders, as petitioners claim (Pet.Br.72). Tribune determined, however, that “the Rickettses received “no perceived benefit” from the Senior Guarantee. (A.1000.) Tribune viewed its guarantees as “insignificant to the overall transaction” and “not a continued necessity” for CBH's successful operations. (A.1003.) Petitioners also point out that the senior lenders negotiated the terms of Tribune's guarantees. (Pet.Br.71-72.) This does nothing to show a business purpose for Tribune to guarantee the funds CBH used to pay Tribune for the Cubs Assets, and it is hardly surprising that sophisticated banks and institutions loaning $425 million would take an interest in the terms of guarantees Tribune insisted on providing.

The evidence shows that Tribune had no business purpose for the Senior Guarantee, which existed only to support outsized tax benefits. The Tax Court thus erred in concluding that petitioners' treatment of the Senior Debt passed muster under Section 1.701-2.

d. The Tax Court also erroneously relied on irrelevant and unreliable evidence

The Tax Court's alternative rejection of the Commissioner's view of the Senior Guarantee (SA.110-14) proceeded through multiple legal errors and relied on irrelevant and unreliable evidence (Br.68-73). Petitioners assert that the court properly relied on the total valuation of both guarantees (for the Senior Debt and Subordinated Debt). (Pet.Br.72.) But that was inconsistent with the Tax Court's correct conclusion that the Subordinated Debt was not debt, for federal tax purposes. The court should not have used Tribune's risk on that separate non-debt to boost petitioners' claim that Tribune had risk for the Senior Debt. (Br.70-71; see supra at 15-16.) Petitioners also defend the Tax Court's reliance on S&P estimates, prepared from 2012 to 2016, of Tribune's risk under both guarantees. (Pet.Br.73.) The Tax Court should not have placed any weight on those documents, which were prepared years after the Cubs Transaction by an analyst who lumped together the purported risk on both guarantees and lacked basic knowledge about the elements of the deal. (Br.71-73; see infra at 57-58.)

As with Section 1.752-2(j), the Tax Court committed multiple legal errors in its analysis of Section 1.701-2, and it compounded those errors by relying on irrelevant and unreliable evidence. (Br. 61-73.) The Tax Court's decision, at a minimum, should be vacated as to its analysis of the Senior Guarantee under Section 1.701-2, and the case remanded for application of the correct legal framework to relevant facts.

PART II
ANSWERING BRIEF OF THE COMMISSIONER AS CROSS-APPELLEE

STATEMENT OF THE ISSUE

Whether the Tax Court clearly erred in finding that the Subordinated Debt was equity and not bona fide debt, for federal tax purposes.

STATEMENT OF THE CASE

In addition to the Senior Debt, which is the subject of the Commissioner's appeal, CBH funded the payment to Tribune for the Cubs Assets with $248.75 million in so-called Subordinated Debt provided by the Ricketts family. Following a lengthy and comprehensive analysis, the Tax Court correctly found that the Subordinated Debt was equity, rather than genuine debt, for federal tax purposes. (SA.56-90.) As a result, the portion of the payment to Tribune that CBH funded with Subordinated Debt ($248.75 million) did not qualify for the debt-financed exception to taxation.

A. Supplemental facts regarding the Subordinated Debt¹¹

To put its “nonnegotiable” tax-avoidance plan into action, Tribune demanded that the Cubs Transaction “include as much debt as possible.” (S.A.17; Br.6-13.) The parties secured $425 million in Senior Debt from banks and institutional lenders, but due to difficulties in the financial markets at the time, the Rickettses had to consider other ways to meet Tribune's debt demands. (Br.17; SA.17-19; A.1627-28.) The Rickettses ultimately used the “private funds” of Thomas Ricketts's mother, Marlene Ricketts, to fund nearly all of CBH's $248.75 million in purported Subordinated Debt. (SA.17, SA.19-20; A.829-37; A.1628.) When asked to describe the negotiation over the Subordinated Debt, Thomas Ricketts explained that he “figured out what [he] thought would be a . . . pretty fair interest rate” and described the transaction to his mother, and “[s]he agreed to it.” (A.1628.) Ricketts confirmed that he was “responsible for all the primary terms of the subordinated debt” and that there was “[n]o negotiation” over those terms. (A.1795-97.) An S&P analysis from July 2009 assumed the Ricketts-related parties holding the Subordinated Debt would act “very much like equity holders.” (A.1740.)

To lend the Subordinated Debt to CBH, a separate entity — RAC Education Trust Finance, LLC (“RAC Finance”) — was created by the entity holding Marlene Ricketts's “private funds” and the Ricketts-controlled RAC (95% owner of CBH). (SA.19.) By virtue of Thomas Ricketts's role with RAC (owner of 95% of the borrower, CBH), he also had the authority to make decisions for RAC Finance (the Subordinated Debt lender). (SA.19; A.1069.)

Thomas Ricketts signed the Subordinated Debt promissory note on behalf of CBH, as the borrower. (A.837.) The note stated a maturity date in fifteen years and provided for annual interest payments at a rate of 6.5%. (A.829-30.) But CBH could pay interest only if there was enough money at the bottom of the cash waterfall, which flowed first to the Senior Debt and then to other obligations before reaching the Subordinated Debt. (SA.20-22, SA.25; A.830; A.859-60, A.865-68; Br.22-24.) On the Cubs Transaction closing date, Thomas Ricketts also signed (for lender RAC Finance) an election of the “PIK Interest” option, which allowed CBH to pay less than half of the interest in cash, with most of the interest added to the Subordinated Debt principal, to be paid at maturity. (SA.26; A.377; A.830-31.)

A Subordination Agreement controlled the Subordinated Debt terms. (SA.20-21; A.829; A.1176-92 (Subordination Agreement).) Other than “permitted payments” of interest, no payments were allowed toward the Subordinated Debt until the Senior Debt was fully paid. (SA.20; A.1177-79.) The senior lenders could extend the payment timeline for, or increase the amount of, the Senior Debt — without any limitation or notice to RAC Finance. (SA.23-24; A.1184.) Because the Subordinated Debt could not be paid before the Senior Debt, the senior lenders “could, in effect, extend the maturity date of the sub debt indefinitely.” (SA.24.)

Until the Senior Debt was paid in full, the Subordinated Debt lender (RAC Finance) could not enforce “any rights or remedies.” (SA.27; see SA.20-21; A.1181.) RAC Finance agreed to transfer all claims to the senior lenders in the event of, e.g., dissolution, liquidation, or bankruptcy. (SA.20-21; A.1179.) And during any default, RAC Finance granted power of attorney to the senior lenders. (SA.21; A.1180.) While the Senior Debt was outstanding, the Tax Court observed, there was “a 'complete and utter standstill' of RAC Finance's ability to pursue remedies” for the Subordinated Debt. (SA.27 (quoting expert witness).)

As with the Senior Debt, Tribune executed a collection guarantee for the Subordinated Debt (“Subordinated Guarantee”), which was necessary to support Tribune's claim that the portion of CBH's payment to Tribune funded by the $248.75 million in Subordinated Debt was a non-taxable debt-financed distribution. (See Br.6-13, 33.)

After the Cubs Transaction, RAC owned 95% of CBH, and Tribune owned the remaining 5%. (SA.14-15; A.1069-70.) When the Ricketts-funded Subordinated Debt was combined with the Ricketts-funded capital contributions of RAC to CBH, the proportion of capital they contributed (95%) aligned with their ownership interests (95%). (SA.14-15, 76-77.)

The Rickettses contemplated paying off some of the Subordinated Debt by selling subordinated notes, and they created marketing materials for that effort. (SA.28-30; B.162-63 (presentation excerpt); B.164-242 (private placement memorandum excerpt).) Those materials stated that potential subordinated noteholders would receive the right of first refusal for CBH equity offerings and other privileges, such as private use of Wrigley Field, premium seats, preferred parking, and the opportunity to travel with the Cubs. (SA.30; B.187.) Ultimately, no subordinated notes were sold, and the Tax Court found that no one “was genuinely interested in acquiring any of the sub debt.” (SA.30.)

In the Tax Court, the parties presented competing expert testimony regarding the Subordinated Debt, including whether its terms were commercially reasonable. (SA.39-40, SA.83-85.) As the court described, experts testifying for the Commissioner concluded, inter alia, that the interest rate on the Subordinated Debt was too low and that a third-party lender would not have agreed to the terms that Thomas Ricketts — controlling the borrower and the lender — singlehandedly determined. (SA.84-85.)

B. The Tax Court found that the Subordinated Debt was equity

The Tax Court found that the Subordinated Debt was equity, for federal tax purposes. (SA.56-90.) The court organized its analysis of the Subordinated Debt through the factors in Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980). (SA.56-57 (observing that this Court has “cited with approval” many of the cases underlying Dixie Dairies).) Factors that “weigh[ed] significantly toward equity” included “intent of the parties, right to enforce payment, risk, identity of the interest, and use of the advance.” (SA.90.) The court found that several factors were neutral: the source of payments (SA.66-67), lender participation rights (SA.70-72), and the status of the Subordinated Debt compared to other claims (SA.72-73). The Tax Court also found that some factors supported a debt finding: labels by the parties that carried little weight (SA.58-59), adequate capitalization of CBH (SA.80-82), and CBH making required payments on the Subordinated Debt (SA.88).

Following a thorough analysis spanning thirty-four pages, the Tax Court found that the Subordinated Debt was equity and not bona fide debt. (SA.90.) As a result, the $248.75 million portion of CBH's payment to Tribune that was funded by the Subordinated Debt did not qualify for the debt-financed exception to the disguised-sale rules, and thus was subject to built-in gains tax. (SA.90, SA.127.)

SUMMARY OF ARGUMENT

The Tax Court correctly found that the so-called Subordinated Debt was actually equity, for federal tax purposes. That overall finding is amply supported by the record here, and petitioners have not shown any error, much less clear error, in the Tax Court's thorough analysis.

To meet Tribune's tax goals, CBH's payment to Tribune for the Cubs Assets had to be funded with as much debt as possible. Through the Senior Debt of $425 million, the parties maximized the debt CBH could secure from third parties, and the Rickettses turned to their own coffers to advance additional “debt.” Ultimately, the Rickettses used the private funds of Marlene Ricketts (Thomas Ricketts's mother) to fund nearly all of the $248.75 million in Subordinated Debt.

Numerous facts support the Tax Court's overall finding that the Subordinated Debt more closely resembled equity and lacked key markers of genuine debt. For example, Thomas Ricketts singlehandedly decided the loan terms, and his mother accepted them — with no negotiation over the terms of a loan for nearly a quarter-billion dollars. That absence of bargaining at arm's length indicates equity. Given the extent of the subordination to the senior lenders, moreover, lender RAC Finance had no real enforcement rights, and the record supports the Tax Court's finding that an outside lender would not have accepted the Subordinated Debt terms. With the Ricketts family controlling both lender and borrower, there was no chance that the lender (owned by the Rickettses) would take any enforcement actions against the borrower (CBH, also owned by the Rickettses).

These and other facts support the Tax Court's finding that the Subordinated Debt was equity. Looking at the overall picture, facts indicating equity outweigh other facts that are neutral or indicate debt. The Tax Court, for example, correctly placed little weight on the parties' labeling and treatment of the Subordinated Debt as “debt.” The parties had to give the impression of debt to support petitioners' claimed tax treatment. But those appearances did not match the objective facts, which support the Tax Court's finding that the Subordinated Debt was equity. Accordingly, the portion of CBH's payment to Tribune for the Cubs Assets that was funded by the Subordinated Debt does not qualify for the debt-financed distribution exception, as the Tax Court correctly held.

ARGUMENT

The Tax Court correctly held that the Subordinated Debt was equity for federal tax purposes

Standard of review

The Tax Court's overall finding that the Subordinated Debt was equity, as well as the court's underlying factual findings, are reviewed for clear error. Charter Wire, Inc. v. United States, 309 F.2d 878, 880 (7th Cir. 1962)¹²; see also Frierdich v. Commissioner, 925 F.2d 180, 182-83 (7th Cir. 1991) (reviewing for clear error Tax Court finding that payment was not a loan); Busch v. Commissioner, 728 F.2d 945, 949-50 (7th Cir. 1984) (same in analyzing shareholder withdrawals).

Petitioners observe (Pet.Br.74) that this Court has stated that “the question whether a debtor-creditor relationship existed 'has been variously described as one of fact and one of law.'” VHC, Inc. v. Commissioner, 968 F.3d 839, 842 (7th Cir. 2020) (quoting In re Larson, 862 F.2d 112, 116 (7th Cir. 1988)). The historical cases categorizing the debt-equity issue as a legal question trace back to this Court's reliance, in Ortmayer v. Commissioner, 265 F.2d 848, 854 (7th Cir. 1959), on the Supreme Court's opinion in Bogardus v. Commissioner, 302 U.S. 34, 39 (1937).¹³ But the year after Ortmayer, the Supreme Court rejected the relevant reasoning in Bogardus. Commissioner v. Duberstein, 363 U.S. 278, 289 n.11 (1960). Duberstein applied clear-error review to a tax issue that, like the debt-equity analysis, rests “on the application of the fact-finding tribunal's experience with the mainsprings of human conduct to the totality of the facts of each case.” 363 U.S. at 289-91. Moreover, the Supreme Court has clarified more recently that “the standard of review for a mixed question depends on whether answering it entails primarily legal or factual work.” U.S. Bank Nat'l Ass'n v. Vill. at Lakeridge, LLC, 138 S. Ct. 960, 968 (2018) (reviewing for clear error a “mixed question” where “[t]he court takes a raft of case-specific historical facts, considers them as a whole, [and] balances them one against another” to make an overall determination (footnote omitted)).

The inquiry here is overwhelmingly factual, and therefore the clear-error standard applies to the Tax Court's finding that the Subordinated Debt was equity. So long as the Tax Court's “account of the evidence is plausible in light of the record viewed in its entirety,” including any “inferences that may be drawn from the facts in the record,” this Court must affirm. Anderson v. City of Bessemer City, 470 U.S. 564, 573-74, 577 (1985).

A. Legal framework

Tribune claimed that the portion of the payment it received from CBH that was funded by the Subordinated Debt ($248.75 million) was a non-taxable debt-financed distribution. (See Br.6-11, Br.16-17.) To qualify for such tax treatment, the Subordinated Debt must at least have been bona fide debt for federal tax purposes.¹⁴ “The 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.” Gilbert, 248 F.2d at 402. But there is no single test to draw a line between debt and equity. E.g., John Kelley Co. v. Commissioner, 326 U.S. 521, 530 (1946); Sherwood Mem'l Gardens, Inc. v. Commissioner, 350 F.2d 225, 228 (7th Cir. 1965); Arlington Park Jockey Club, Inc. v. Sauber, 262 F.2d 902, 905 (7th Cir. 1959).

As the Tax Court observed was the case here (SA.90), arrangements can include elements that suggest both equity and debt. See John Kelley, 326 U.S. at 530; Commissioner v. Meridian & Thirteenth Realty Co., 132 F.2d 182, 185 (7th Cir. 1942). Whether parties truly intended to create debt “often is not free from doubt,” and courts decide that issue “based on analysis of the entire record.” Road Materials, Inc. v. Commissioner, 407 F.2d 1121, 1124 (4th Cir. 1969). Each case “turns on its own particular facts.” Busch, 728 F.2d at 951; see also VHC, 968 F.3d at 842. This Court determines “actual” intent to create debt based on “the objective facts of each case,” which helps “to detect those persons who attempt to evade taxes” by “distinguish[ing] the true loan and the false one.” Frierdich, 925 F.2d at 183, 185 (emphasis added). See also, e.g., Busch, 728 F.2d at 948 (treating “objective factors as indications of intent”); Estate of Mixon v. United States, 464 F.2d 394, 407 (5th Cir. 1972).

The Tax Court here organized its analysis through thirteen factors identified in Dixie Dairies, 74 T.C. at 493. (SA.56-58.) This Court has relied on the same or similar factors in other tax cases, as the Tax Court observed (SA.57-58), and as petitioners acknowledge (Pet.Br.75). See, e.g., Larson, 862 F.2d at 117; Busch, 728 F.2d at 948; Sherwood, 350 F.2d at 228-29. The factors “are not equally significant,” and “differing circumstances may bring different factors to the fore.” Slappey Drive Indus. Park v. United States, 561 F.2d 572, 581 (5th Cir. 1977).

B. The Subordinated Debt was equity, and not bona fide debt, for federal tax purposes

The record amply supports the Tax Court's conclusion that the Subordinated Debt — a $248.75 million advance from one Ricketts-controlled entity to another, with no negotiation over its terms — was equity and not bona fide debt. Petitioners have failed to show any error, much less clear error, in that overall finding or in the underlying factual findings. This Court should affirm the Tax Court's decision regarding the Subordinated Debt.¹⁵

1. The Rickettses funded the Subordinated Debt and controlled both lender and borrower

The Tax Court correctly found that the interests of the borrower (CBH) and lender (RAC Finance), both controlled by the Rickettses, were “significantly intertwined” and that this weighed in favor of equity. (SA.80.) The Rickettses' control over both lender and borrower “provides especially strong support” for the equity finding. See Busch, 728 F.2d at 951. Under such circumstances, “the arm's length dealing that characterizes the money market is lacking.” Road Materials, 407 F.2d at 1124. Unlike the wrangling one might expect at arm's length over a loan of nearly $250 million, Thomas Ricketts alone decided the Subordinated Debt terms, and his mother accepted them with “[n]o negotiation.” (A.1795-97.) This Court has found that such absence of bargaining at arm's length is “uncharacteristic of a bona fide loan.” Frierdich, 925 F.2d at 183.

Petitioners make no attempt to undermine the Tax Court's finding that the Subordinated Debt parties are closely related and controlled by close family members. (See Pet.Br.91-92.) Petitioners assert that “RAC would have had a fiduciary obligation to RAC Finance to seek to enforce the subordinated debt” against CBH (Pet.Br.95), but that makes no sense because RAC both controlled RAC Finance and owned 95% of CBH. As the Tax Court found, the Subordinated Debt “was issued by an entity held entirely by the Ricketts family to an entity held entirely by the Ricketts family.” (SA.79.) The record supports the Tax Court's finding that, even if there were meaningful enforcement rights for the Subordinated Debt (and there were not, see infra at 60-64), it was “beyond unlikely” that the Rickettses would enforce those rights “by causing the liquidation of CBH, the company they owned.” (SA.90.)

Petitioners acknowledge that equity is favored when owners are also creditors and “advance funds in amounts that align with their ownership interests.” (Pet.Br.91.) That kind of proportional alignment often is considered when analyzing the identity of interests between a shareholder and putative creditor. Slappey Drive, 561 F.2d at 583; Mixon, 464 F.2d at 409. Where advances are made “in direct proportion to shareholder ownership,” that “gives rise to a strong inference that the advances represent additional capital investment and not loans.” Arlington Park, 262 F.2d at 906; see also Charter Wire, 309 F.2d at 880; Tyler v. Tomlinson, 414 F.2d 844, 849 (5th Cir. 1969) (recognizing that “a loan proportionate to stock ownership becomes a form of pari passu equity”).

The Tax Court correctly found that analogous proportionality is present here and favors equity. (SA.76-77 (discussing the parties' intent).) Petitioners posit that “Tribune was not a creditor, so the interests of the owners and creditors did not align.” (Pet.Br.91.) But they fail to acknowledge that the Rickettses' advance of the Subordinated Debt created proportionality between their capital contributions to CBH (including the Subordinated Debt) and their CBH ownership interest. As the Tax Court explained, if the Subordinated Debt advanced by RAC Finance is added to RAC's capital contributions to CBH, that totals 95% of the capital contributions to CBH, which perfectly aligns with RAC's 95% ownership interest of CBH. (SA.76-77.)

The Tax Court recognized that partners may negotiate an ownership interest different from their economic contributions (see Pet.Br.82-84), but the court found that under the circumstances here, “[t]his alignment is not a coincidence” but rather “reflects the parties' mutual intent to create equity.” (SA.77-78.)

The record amply supports the Tax Court's finding that “[t]he interrelatedness of the lender and borrower is clear,” and this factor favors equity. (SA.80.)

2. CBH used the Subordinated Debt to acquire capital assets

Equity is indicated where funds are used to acquire assets because that is a traditional use of capital contributions. E.g., Charter Wire, 309 F.2d at 880; Slappey Drive, 561 F.2d at 583. Petitioners assert that CBH used the Subordinated Debt for neither equity nor operating expenses, as “it was used to fund the special distribution to Tribune.” (Pet.Br.88-89.) This attempt at obfuscation fails. CBH's “special distribution” to Tribune was payment to acquire capital assets — the Cubs Assets — through a disguised sale. (See Br.6-13.) The Tax Court correctly found that this “was a significant change in the ownership of assets,” which “strongly favors equity.” (SA.87.)

3. Especially given Tribune's tax-avoidance aims, it matters little how the parties labeled or categorized the Subordinated Debt

The Tax Court correctly placed “low probative value” on the parties' labeling and categorization of the Subordinated Debt as “debt.” (SA.59; SA.74-75.) Labels can be misleading and cannot “transform substantive equity into debt.” Mixon, 464 F.2d at 404. With the same interests on both sides of purported debt and “no countervailing pull,” a transaction's form may readily depart from its “intrinsic economic nature,” and labels “lose their meaningfulness.” Fin Hay Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968).

That is one reason why the debt-equity analysis focuses on objective facts (see supra at 49-50), and petitioners miss the mark in suggesting that the Tax Court should have focused more on the subjective intent of “the parties to the transaction.” (Pet. Br.75-76.) Statements of interested parties regarding intent “are not necessarily conclusive, even when they are uncontradicted,” and parties to a lawsuit “cannot expect the Tax Court to accept [their] personal testimony as the absolute fact.” Frierdich, 925 F.2d at 185. The Rickettses chose how to divide their advances to CBH between capital and purported debt, and the parties labeled them accordingly, but “they were not free to decide for themselves what tax consequences would attach to their conduct.” Slappey Drive, 561 F.2d at 585.

It also was proper for the Tax Court to consider that, for “Tribune to achieve its desired tax outcome,” the Subordinated Debt “needed to give the impression of debt.” (SA.75.) In Saviano v. Commissioner, this Court rejected an “attempt to superimpose a loan upon [a] transaction through the use of misleading terminology,” where that was a “transparent attempt” to allow the taxpayer to “enjoy the desired tax deduction.” 765 F.2d 643, 650 (7th Cir. 1985). Saviano thus focused “not on the labels which the parties chose to utilize” but rather “on the economic substance of the transaction.” Id. See also, e.g., Sherwood, 350 F.2d at 229.

Petitioners protest that “third parties that cared about the nature of the subordinated debt” — specifically, MLB, the senior lenders, and S&P — “all viewed it as debt.”¹⁶ (Pet.Br.78-80.) Given MLB's involvement in the Cubs Transaction, it can hardly be considered an outsider to the transaction, and MLB knew that Tribune required a high level of debt “to structure the Transaction effectively.” (See Br.14-15; A.482.) MLB was not concerned about the high level of purported debt (see Pet.Br.79) because it was confident that the Rickettses could service CBH's debt, and MLB had tools to force additional equity contributions. (Br.14-15, 24-28.) As to the senior lenders, both Subordinated Debt and equity were relegated below the Senior Debt. Ensuring such relegation and limiting CBH's exposure to Subordinated Debt would reasonably motivate interest of the senior lenders in the treatment and amount of the Subordinated Debt (see Pet.Br.78-79), as a state-law matter between private parties. But that does not govern the federal tax consequences at issue here, as explained supra at 48 n.14.

Petitioners cite a 2009 S&P document (Pet.Br.79) that considered the Subordinated Debt as among CBH's private-party obligations (see A.823-28). But that analysis also emphasized “the flexibility that the subordinated debt provides” because it was held by the Rickettses, “whom [S&P] expect[ed] would be supportive of the company in a distressed scenario.” (A.825.) As reflected in a different S&P analysis from 2009, S&P assumed the Ricketts-related entities advancing the Subordinated Debt would act “very much like equity holders.” (A.1740.) No weight should be placed on S&P ratings of Tribune from 2012 to 2016. (See Pet.Br.79-80.) Those later ratings were prepared years after the Cubs Transaction by an analyst who was not aware of even basic elements of that transaction. (See Br.72-73.) In their earlier discussion of Section 1.701-2, Petitioners state that this analyst relied on Tribune's financial disclosure, but there are no details about the Subordinated Debt in the portion of the disclosure on which she allegedly relied for information about the Cubs Transaction. (Pet.Br.73 (citing B.385).) Even if the S&P analyst followed standard practices (Pet.Br.73), she did so in an information vacuum, as confirmed by her trial testimony. (Br.71-73; A.1712-31.)

The Cubs Transaction structure — and in particular, the high levels of CBH debt combined with Tribune's collection guarantees — was built to accomplish Tribune's tax-avoidance aims. The Rickettses helped to accommodate those aims by funding the Subordinated Debt. Especially under such circumstances, the Tax Court correctly placed little weight on the parties' labeling and treatment of the Subordinated Debt as “debt,” which helped them create “the appearance of debt for tax purposes.” (SA.58-59, SA.75.) Despite those outward appearances, the parties intended the Subordinated Debt “to function economically as equity.” (SA.75.)

The Tax Court correctly gave little weight to the parties' labeling the Subordinated Debt as debt.

4. The Subordinated Debt effectively lacked a fixed maturity date

A fixed maturity date is “a characteristic of a debt obligation.” Mixon, 464 F.2d at 404; see also, e.g., Frierdich, 925 F.2d at 183. A flexible maturity date, however, can support an equity finding. Milwaukee & Suburban Transp. Corp. v. Commissioner, 283 F.2d 279, 282-83 (7th Cir. 1960), vacated in unrelated part, 293 F.2d 628 (7th Cir. 1961) (vacating earlier opinion as to “the accounting method issue”); see also PepsiCo P.R., Inc. v. Commissioner, T.C. Memo 2012-269, at *58-*66 (2012).

The record amply supports the Tax Court's conclusion here that “the maturity date was subject to reservations and conditions that render it not fixed,” which weighed in favor of equity. (SA.63.) Petitioners do not contest the Tax Court's finding that the fifteen-year maturity on the face of the Subordinated Debt note could be indefinitely extended if CBH failed to pay the Senior Debt or if the senior lenders chose to extend the payment schedule for that debt. (SA.60-63.) They posit that this “is common” and claim that the Tax Court's reasoning “would turn all subordinated debt into equity.” (Pet.Br.86-87.) But subordination also generally weighs in favor of an equity finding, as discussed infra at 62-63.

5. With no meaningful enforcement rights, and no chance any rights would actually be enforced, the risk in advancing the Subordinated Debt resembled equity, not debt

The Tax Court correctly found that RAC Finance's risk in advancing the Subordinated Debt more closely resembled that of an equity holder, not that of a lender. (SA.68, SA.89-90.) See Saviano, 765 F.2d at 648 (considering whether the risk of advancing funds was that of a lender or an investor). A capital investor and a creditor both expect repayment of funds advanced to a business, but “the creditor expects repayment regardless of the [debtor's] success or failure, while the investor expects to make a profit” if the business is successful. Larson, 862 F.2d at 117. Among the indicia of a loan, therefore, is “a definite obligation to repay the advance.” Mixon, 464 F.2d at 405 (discussing enforcement rights).

The record supports the Tax Court's finding that RAC Finance lacked meaningful enforcement rights, which “strongly” favored equity. (SA.68.) When combined with the effective absence of a fixed maturity date, the Subordinated Debt lacked “the most significant, if not the essential feature of a debtor and creditor as opposed to a stockholder relationship.” United States v. S. Georgia Ry. Co., 107 F.2d 3, 5 (5th Cir. 1939).

CBH was allowed to make annual interest payments on the Subordinated Debt only if sufficient CBH earnings flowed to the bottom of the cash waterfall. (Br.20-23; supra at 39-40.) If that did not occur, RAC Finance had no means to enforce the payment of current interest, in tension with a creditor's right to receive interest “in any event.” Meridian, 132 F.2d at 187. CBH was required to pay the Subordinated Debt principal only after fifteen years, but the senior lenders could unilaterally extend that timeline. That placed the Subordinated Debt principal — and most of the interest, which RAC Finance elected to defer — at the risk of CBH's business for a prolonged period, which also weighs in favor of equity. See Slappey Drive, 561 F.2d at 583 & n.18. Any rights that RAC Finance had to enforce payment of principal, moreover, came into play only after the Senior Debt was paid in full, on whatever timeline the senior lenders allowed. (SA.20-21, SA.68; see A.1179-83.) The record amply supports the Tax Court's findings that the Subordinated Debt “was so relegated that it was the obligation of last priority” for CBH and that RAC Finance “had no real tool to enforce payment” in the event of default. (SA.90; see also SA.68.)

Petitioners contend that the terms of the Subordinated Debt are common, that subordinated debt can be recognized as valid debt for federal tax purposes, and that subordination to the Senior Debt “cannot support a showing of equity.” (See Pet.Br.89-90, 94-96.) The Tax Court recognized that “not every subordinated instrument is equity” but explained that subordination nonetheless “generally favors equity,” and “the more repayment is subordinated, the more it looks like equity.” (SA.69-70.) In Charter Wire, this Court confirmed that subordination “bear[s] on the true nature” of shareholder advances. 309 F.2d at 880. In another case, this Court rebuffed a party's protest that subordination “is a common practice,” explaining that “subordination necessarily destroys one of the essential rights of the creditor, and the willingness to subordinate is indicative of equity investment.” Sarkes Tarzian, Inc. v. United States, 240 F.2d 467, 470-71 (7th Cir. 1957); see also Meridian, 132 F.2d at 188 (explaining that subordination is “not decisive” but “bears real weight”).

The record also supports the Tax Court's finding that it was “beyond unlikely” that the Ricketts-controlled RAC Finance would enforce any rights it had “by causing the liquidation of CBH, the company they [the Rickettses] owned.” (SA.90.) Petitioners do not suggest the presence of any intra-family strife that could affect that finding, and this is consistent with Tribune's own view that the Rickettses would cover CBH shortfalls before abandoning their investment. (A.999-1000.) In Tyler, the Fifth Circuit explained that a demand for payment of shareholder advances “would have completely havocked the corporation with bankruptcy as a possibility,” which may have been acceptable to a creditor but not to shareholders. 414 F.2d at 849. The shareholders' interests “so undermined the traditional dichotomy between debtor and creditor” that it was “extremely unlikely” that they would demand repayment of the advances. Id. The same reasoning applies here. The lack of meaningful enforcement rights for the Subordinated Debt, combined with no realistic possibility that RAC Finance would exercise any such rights, strongly supports the Tax Court's conclusion that the Subordinated Debt was equity risk, not debt. (SA.68, SA.89-90.)

6. A third party would not have accepted the Subordinated Debt terms

Because “it was doubtful that [CBH] could have obtained a similar loan from an independent lending institution,” that pointed “in the direction of capital contributions rather than loans.” Larson, 862 F.2d at 117; see also Arlington Park, 262 F.2d at 905. (SA.83-86.) The Tax Court recognized that a related party reasonably may offer more flexible terms than an unrelated party and thus analyzed whether the Subordinated Debt terms were a “'patent distortion of what would normally have been available.'” (SA.83 (quoting NA Gen. P'ship & Subs. v. Commissioner, T.C. Memo. 2012-172, at *13 (2012).)

The Tax Court described competing expert testimony regarding the commercial reasonableness of the Subordinated Debt terms. (SA.84-85.) An expert testifying for the Commissioner concluded that the Subordinated Debt terms “'would not have been available from unaffiliated third parties.'” (SA.85 (quoting expert report).) He explained that the interest rate was too low, and “the subordination terms made the sub debt so toothless as to 'render[ ] them no threat to the priority interests of the senior lenders.'” (SA.84-85 (quoting expert report).) This supports the Tax Court's finding that CBH could not have obtained debt from a third party on terms similar to the Subordinated Debt, and that petitioners failed to show that those terms “were not patently unreasonable.” (SA.86)

The Tax Court found confirmation of that view in the Rickettses' efforts, ultimately abandoned, to market subordinated notes to third parties. (SA.85-86.) Petitioners challenge the Tax Court's finding that they failed to show that any third party “expressed genuine interest” in the subordinated notes. (SA.86; Pet.Br.93-94.) In support, they cite vague and unattributed statements, contained in at least a double layer of hearsay in an expert report. (Pet.Br.94 (citing B.448 (e.g., “'believes his client will be interested in participating in the deal'”).) That does not show clear error in the Tax Court's finding that no one “expressed genuine interest” in subordinated notes. (SA.86 (emphasis added).)

In marketing the subordinated notes to outsiders, moreover, the Tax Court observed that the Rickettses “felt the need to sweeten the deal in various ways” and that they “marketed the opportunity as an equity investment.” (SA.75-76, SA.86.) The court stated that some perks offered were “typically afforded to team owners” (SA.76), and petitioners claim this is unsupported in the record (Pet.Br.85). The only perks petitioners mention are “priority parking and box suites,” and they assert that “similar privileges are available to corporate sponsors and season ticketholders in sports stadiums across the country.” (Pet.Br.84-85.) Petitioners offer no evidence that even the Cubs' corporate sponsors and season ticketholders — who held 21,000 seats in 2009 (A.1148) — have the same perks offered to “a maximum of 8-10” potential subordinated noteholders (B.163), such as “Private use of Wrigley Field” and “Annual team travel” (B.187). It would be surprising if the holders of 21,000 season-ticket seats had access to such perks. And petitioners ignore that potential subordinated noteholders also were offered “a right of first refusal on any future sales of Cubs equity.” (T.C.Op.76; see B.187.) As trumpeted in the first line of the descriptive memorandum about the Cubs sale, “[o]pportunities to own major league professional sports clubs are rare.” (A.390.) It is unimaginable that sponsors and season ticketholders “across the country” have the right of first refusal to buy equity in professional sports teams (see Pet.Br.85), and the inclusion of this perk supports the Tax Court's finding that the Rickettses marketed the subordinated notes “as an equity investment” (SA.76).

In any event, the Tax Court's findings that (1) a third party would not have accepted the Subordinated Debt terms, and (2) petitioners failed to show that the terms were not patently unreasonable, are well supported by the record, including by the Commissioner's expert testimony. (SA.84-86.) There is no clear error here.

7. The record supports the Tax Court's findings that several factors were neutral

a. Where an obligation will be repaid only out of earnings, that indicates equity, but where an obligation must be paid “in any event” — regardless of the borrower's success — that indicates debt. Meridian, 132 F.2d at 186-87; see also Mixon, 464 F.2d at 405. CBH was expected to have sufficient funds to pay its debt obligations (SA.64-65), but “[a]n expectation of repayment solely from corporate earnings is not indicative of bona fide debt regardless of its reasonableness.” Roth Steel Tube Co. v. Commissioner, 800 F.2d 625, 631 (6th Cir. 1986). (SA.64-65.)

Annual interest on the Subordinated Debt could be paid only out of CBH earnings at the bottom of the cash waterfall, which supports the Tax Court's conclusion that the source of interest payments weighed in favor of equity. (SA.63-65.) Payment of Subordinated Debt principal, on the other hand, was not limited to funds flowing through the cash waterfall. (SA.66.) Given the bifurcation of the sources of payment, the Tax Court reasonably found this element to be neutral. (SA.66-67.)

Petitioners contend that the Tax Court failed to consider the fact that unpaid interest would be added to the principal and ultimately would have to be paid. (Pet.Br.87.) That was certainly the case for the majority of the Subordinated Debt interest, which RAC Finance voluntarily deferred until the payment of principal (in fifteen years or on whatever timeline resulted from the senior lenders' actions). The “very little concern” that RAC Finance showed regarding interest was out of step with the general rule that “a true lender is concerned with interest.” Curry v. United States, 396 F.2d 630, 634 (5th Cir. 1968). A “failure to insist on regular interest payments” weighs against a debt finding. Tyler, 414 F.2d at 849. And the only source of regular interest payments was CBH's earnings at the bottom of the cash waterfall. Accordingly, there was no error in the Tax Court's finding that the source of payments was neutral.

b. A lender's participation in management weighs in favor of an equity interest. Saviano, 765 F.2d at 649; Mixon, 464 F.2d at 406. The record supports the Tax Court's finding that this factor was neutral here. (SA.70-72.) Although the Subordinated Debt did not increase the Rickettses' control over CBH, they already controlled 95% of CBH. (SA.71.) Considering analogous circumstances in Slappey Drive, the Fifth Circuit concluded that the lack of additional control gained through the purported loans “[did] not cut against the equity classification.” 561 F.2d at 585 n.23.

Petitioners have not undermined the Tax Court's conclusion that this factor was neutral. (Pet.Br.90-91.) The Rickettses already controlled CBH through RAC, and it is irrelevant that RAC Finance (also controlled by RAC) did not, itself, have “a seat at [CBH's] table.” (See Pet.Br.91.)

c. The Tax Court also considered the status of the Subordinated Debt, compared to other creditors. (SA.72.) The court recognized petitioners' view that the Subordinated Debt was technically on equal footing with CBH's other unsecured creditors and was superior to equity. (SA.73.) The Commissioner countered that, in a real-world competition between creditors, the insider-provided Subordinated Debt could be relegated below third-party creditor claims and pushed closer to equity. (SA.73.) The Tax Court was unpersuaded by either position and found that the Subordinated Debt was “positioned so closely between debt and equity that its position is not illuminating.” (SA.73.)

Petitioners contend that “this factor should have favored debt, because the subordinated debt would have been repaid ahead of equity.” (Pet.Br.92-93.) But they neither mention nor attempt to challenge the Commissioner's real-world argument. The record supports both views on this issue, and thus supports the Tax Court's conclusion that this factor was neutral.

C. The Tax Court correctly found that the Subordinated Debt was equity, and not bona fide debt

The record overwhelmingly supports the Tax Court's overall finding that the Subordinated Debt was equity. The Rickettses funded the Subordinated Debt and controlled both lender and borrower, and their ownership interest in CBH aligned with their capital contributions when the Subordinated Debt was included. Thomas Ricketts alone determined the Subordinated Debt terms, with no negotiation, and evidence supports the Tax Court's finding that third parties would not have accepted those terms. The Subordinated Debt lacked a fixed maturity date or meaningful enforcement rights, and it was “beyond unlikely” that one Ricketts-owned entity (RAC Finance) would enforce any such rights against another (CBH). These and other facts indicating equity outweighed those that were neutral or indicated debt.

Through a comprehensive and lengthy analysis, which did far more than “mechanically” count factors (see Pet.Br.24), the Tax Court correctly concluded that the totality of the facts weighed in favor of finding that the Subordinated Debt was equity. Petitioners have not shown any error, much less clear error, in that overall finding.

CONCLUSION

The Commissioner asks this Court to reverse the Tax Court's decision as to the Senior Guarantee, which should be disregarded for federal tax purposes, or to vacate the Tax Court's decision as to the Senior Guarantee and remand this case for the Tax Court to apply the correct legal analysis. The Tax Court correctly found that the Subordinated Debt was not bona fide debt, and the Commissioner asks this Court to affirm the Tax Court's decision as to the Subordinated Debt. If the Court were to vacate the decision as to the Subordinated Debt, it should remand for resolution of outstanding issues.

Respectfully submitted,

DAVID A. HUBBERT
Deputy Assistant Attorney General

Norah E. Bringer

FRANCESCA UGOLINI (202) 514-3361
JENNIFER M. RUBIN (202) 307-0524
NORAH E. BRINGER (202) 307-6224
Attorneys
Tax Division
Department of Justice
Post Office Box 502

NOVEMBER 6, 2023