Tax Court Misapplied Antiabuse Rules in Tribune Media, DOJ Argues

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

NORAH E. BRINGER
(202) 307-6224

Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

---

TABLE OF CONTENTS

Table of contents

Table of authorities

Statement regarding oral argument

Glossary

Introduction

Jurisdictional statement

Statement of the issues

Statement of the case

Summary of argument

Argument:

The Tax Court misinterpreted two anti-abuse tax regulations and erroneously ignored Tribune's remote risk from the Senior Guarantee in upholding its tax-free treatment of $425 million received in the Cubs Transaction

Standard of review

Conclusion

Certificate of compliance

Addendum of statutes and regulations

TABLE OF AUTHORITIES

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

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

Bank of N.Y. Mellon Corp. v. Commissioner, 801 F.3d 104 (2d Cir. 2015)

Baxter v. Commissioner, 910 F.3d 150 (4th Cir. 2018)

Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006)

Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013)

Bria Health Servs., LLC v. Eagleson, 950 F.3d 378 (7th Cir. 2020)

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

Chemtech Royalty Assocs., L.P. v. United States, 766 F.3d 453 (5th Cir. 2014)

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

Exelon Corp. v. Commissioner, 906 F.3d 513 (7th Cir. 2018)

Exelon Generation Co., LLC v. Loc. 15, Int'l Bhd. of

Elec. Workers, AFL-CIO, 676 F.3d 566 (7th Cir. 2012)

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

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

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

Gunther v. Commissioner, 909 F.2d 291 (7th Cir. 1990)

Hovde v. ISLA Dev. LLC, 51 F.4th 771 (7th Cir. 2022)

Johnson v. Guzman Chavez, 141 S. Ct. 2271 (2021)

Jones v. Liberty Glass Co., 332 U.S. 524 (1947)

Kearney Partners Fund, LLC v. United States, 803 F.3d 1280 (11th Cir. 2015)

Keeler v. Commissioner, 243 F.3d 1212 (10th Cir. 2001)

Kisor v. Wilkie, 139 S. Ct. 2400 (2019)

Knetsch v. United States, 364 U.S. 361 (1960)

Levin v. Commissioner, 832 F.2d 403 (7th Cir. 1987)

Nevada Partners Fund, LLC v. United States, 720 F.3d 594 (5th Cir. 2013)

Nicole Rose Corp. v. Commissioner, 320 F.3d 282 (2d Cir. 2003)

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

Reddam v. Commissioner, 755 F.3d 1051 (9th Cir. 2014)

Russian Recovery Fund Ltd. v. United States, 122 Fed. Cl. 600 (2015)

Sala v. United States, 613 F.3d 1249 (10th Cir. 2010)

Salem Fin., Inc. v. United States, 786 F.3d 932 (Fed. Cir. 2015)

Southgate Master Fund, L.L.C. ex rel. Montgomery Cap.

Advisors, LLC v. United States, 659 F.3d 466 (5th Cir. 2011)

TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006)

Statutes:

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

§ 401(a)

§ 501(a)

§ 707

§ 721

§ 731

§ 752

§ 1001

§ 1363(a)

§ 1374

§ 6212

§ 6213

§ 6214

§ 6223(a)(2)

§ 6226

§ 6662

§ 7442

§ 7482

§ 7483

Bipartisan Budget Act of 2015,

Pub. L. 114-74, Title XI, § 1101, 129 Stat. 584

Regulatory materials:

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

§ 1.701-2

§ 1.707-3

§ 1.707-5

§ 1.752-2

Subchapter K Anti-Abuse Rule, 60 Fed. Reg. 23

(Jan. 3, 1995) (codified at Treas. Reg. § 1.701-2)

Miscellaneous:

38 Am. Jur. 2d Guaranty (Feb. 2023 update)

Boris I. Bittker and James S. Eustice, Federal Income

Taxation of Corporations & Shareholders

(7th ed., Nov. 2020 update)

Fed. R. App. P. 13(a)(1)

H.R. Rep. No. 98-432, pt. 2 (1984)

H.R. Rep. No. 98-861 (1984) (Conf. Rep.)

Richard M. Lipton, Tribune Media: A Split Decision for the Chicago Cubs' Leveraged Partnership Transaction, 136 J. Tax'n 6 (Feb. 2022) 

STATEMENT REGARDING ORAL ARGUMENT

Under 7th Cir. R. 34(f) and Fed. R. App. P. 34(a), counsel for the Commissioner respectfully inform this Court that they believe holding oral argument would be appropriate because this case involves the application of highly technical tax rules to complex financial transactions.

GLOSSARY

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
RAC	Ricketts Acquisition, LLC, now known as Northside Entertainment Holdings, LLC; owner of 95% of CBH after the Cubs Transaction
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

---

INTRODUCTION

In 2009, Tribune Co., predecessor to Tribune Media Company, wanted to sell the Chicago Cubs baseball team, Wrigley Field, and other assets (“Cubs Assets”). The Ricketts family wanted to purchase the assets to hold as a multi-generational, treasured investment. But a simple sale would have resulted in a massive tax bill for Tribune, which it wanted to avoid, particularly as it was in bankruptcy at the time.

To avoid this outcome, Tribune designed the sale so that the lion's share of its proceeds — $673.75 million out of $714 million — was a nontaxable “debt-financed distribution,” thereby greatly reducing its taxable income under governing Treasury Regulations. Thus, Tribune dictated a complex transaction structure, using a leveraged partnership that paid Tribune for the Cubs Assets with (mostly) debts purportedly guaranteed by Tribune (“Cubs Transaction”). The linchpin of the structure was the guarantees: If Tribune did not bear genuine economic risk to pay back the loans, it would remain fully on the hook for the taxes it wished to avoid. Accordingly, Tribune guaranteed both “Senior Debt,” issued by outside parties, and purported “Subordinated Debt,” provided by a Ricketts family entity. The Tax Court correctly concluded that the Subordinated Debt was not debt at all — but equity, which Tribune could not use to characterize the proceeds it received as “debt-financed.”

Regarding the Senior Debt, the Tax Court recognized that the likelihood of Tribune ever being called on to repay the debt was “remote” (SA.3), but it nonetheless held that Tribune's guarantee of the Senior Debt (“Senior Guarantee”) should be respected for tax purposes. As we will show, this was legal error. On its face, it is nonsensical that Tribune would surrender its valuable Cubs Assets while maintaining a meaningful risk that it would have to pay off the loans that funded the very sales proceeds it received. And, indeed, the record establishes that Tribune did not view itself as having any meaningful risk from the Senior Guarantee — which was enforceable only after creditors had exhausted all other means to collect on the Senior Debt and failed to fully recover. Such a result was extremely unlikely. The collateral on the Senior Debt included a uniquely valuable Major League Baseball team, and senior creditors enjoyed numerous protections. At trial, expert witnesses for both sides assigned a near-zero value to the Senior Guarantee.

In concluding that Tribune's remote risk on the Senior Debt — at best, de minimis — sheltered $425 million of Tribune's payment from tax, the Tax Court misinterpreted two anti-abuse rules in the Treasury Regulations: Treas. Reg. §§ 1.752-2(j) and 1.701-2 (26 C.F.R.). Each rule independently bars Tribune from using its miniscule risk to gain such outsized tax benefits. The Tax Court's erroneous regulatory interpretation led to the wrong result here — and also created a roadmap for future tax abuse.

JURISDICTIONAL STATEMENT

A. Tax Court jurisdiction

This consolidated appeal concerns two Tax Court cases addressing the tax consequences of the Cubs Transaction. One case was filed by Tribune, and the other was filed by the partnership that owned the Cubs Assets after the transaction, Chicago Baseball Holdings, LLC (“CBH”). The IRS issued to Tribune a timely notice of deficiency, dated June 28, 2016. (SA.37-38; A.316-32; A.356.)¹ See I.R.C. § 6212 (26 U.S.C.). The IRS determined a $181.7 million deficiency in Tribune's income tax for 2009, largely driven by an increase in built-in gains tax from the Cubs Transaction, as well as accuracy-related penalties under I.R.C. § 6662. (SA.37-38; A.316-32; A.356.) On September 23, 2016, Tribune timely petitioned the Tax Court for redetermination. (SA.38; A.173-214; A.356.) See I.R.C. §6213. The Tax Court had jurisdiction over Tribune's case under I.R.C. §§ 6213, 6214, and 7442.

The IRS issued to Northside Entertainment Holdings, LLC — tax matters partner for CBH and known at the time of the Cubs Transaction as Ricketts Acquisition, LLC (“RAC”) — a timely notice of final partnership administrative adjustment dated June 28, 2016.² (SA.38; A.333-47; A.357.) See I.R.C. § 6223(a)(2). This notice made adjustments related to the Cubs Transaction and concluded that accuracy-related penalties applied. (SA.38; A.333-47; A.357.) On September 23, 2016, Northside Entertainment Holdings timely petitioned the Tax Court on behalf of CBH. (SA.38; A.215-55; A.358.) See I.R.C. § 6226(a). The Tax Court had jurisdiction over CBH's case under I.R.C. §§ 6226(a) and (f).

B. Appellate jurisdiction

On October 19, 2022, the Tax Court entered decisions in both cases, which were final and resolved all claims of all parties. (SA.128-29; SA.130-33.) On January 13, 2023, the Commissioner timely filed notices of appeal. (A.1575-78; A.1579-83.) See I.R.C. § 7483; Fed. R. App. P. 13(a)(1). On February 3, 2023, Tribune and CBH timely filed notices of cross-appeal. (A.1584-87; A.1588-91.) I.R.C. § 7483; Fed. R. App. P. 13(a)(1). This Court has jurisdiction under I.R.C. § 7482.

STATEMENT OF THE ISSUES

The Commissioner asserted that Tribune's guarantee of CBH's Senior Debt should be disregarded under either of two anti-abuse rules in the governing Treasury Regulations. The Tax Court rejected the application of both rules. The issues presented are:

STATEMENT OF THE CASE

A. Legal framework

A taxpayer who sells an asset normally pays tax on gain from the sale. See I.R.C. § 1001. The parties agree that this case involves a “disguised sale,” where Tribune contributed assets to a partnership (CBH), and received a distribution and partnership interest in return. (SA.14-20, SA.33, SA.47-49; A.373; A.1070.) Such a “disguised sale” is generally taxed the same as a simple sale. See I.R.C. § 707(a)(2)(B); Treas. Reg. § 1.707-3(a)(1), (b)(1). The disguised-sale rules prevent taxpayers from abusing the tax-free flow of contributions from partners to partnerships and (sometimes) tax-free distributions from partnerships to partners. See I.R.C. §§ 721, 731.

Tribune designed the Cubs Transaction to fit within an exception to the disguised-sale rules for debt-financed distributions. Under the debt-financed exception, where a partner contributes property to a partnership, which incurs an associated liability and within 90 days distributes the proceeds to the partner, the distribution is taxable only to the extent that it exceeds the partner's share of the liability. Treas. Reg. § 1.707-5(b)(1). This exception reflects that a partner's basis in its share of the partnership is increased by the partner's share of partnership liabilities. See I.R.C. § 752(a). In this context, as the partner's share of a liability grows, the taxable portion of the partner's distribution generally shrinks.

A partner's share of a partnership's recourse liability is determined under I.R.C. § 752 and associated regulations. Treas. Reg. §1.707-5(a)(2). Here, Tribune's share of the relevant liability (the Senior Debt) is the portion of that liability (if any) for which Tribune “bears the economic risk of loss” through the Senior Guarantee. Treas. Reg. § 1.752-2(a). “Except as otherwise provided in” Treas. Reg. §1.752-2, such risk is determined through the constructive-liquidation test in paragraph (b) of Section 1.752-2. That test posits the simultaneous occurrence of a hypothetical set of facts in which (1) the partnership's liabilities become payable in full, (2) its assets (“including cash”) “have a value of zero,” (3) the partnership disposes of “all of its property” for “no consideration,” (4) certain allocations are made among the partners, and (5) the partnership liquidates. See Treas. Reg. § 1.752-2(b).

Section 1.752-2 “otherwise provide[s]” an anti-abuse rule in paragraph (j). Under that rule, the Commissioner may disregard a partner's obligation, or treat it as someone else's obligation, “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 or related person bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.” Treas. Reg. § 1.752-2(j)(1).

All partnerships and their transactions also are subject to the subchapter K anti-abuse rule in Treas. Reg. § 1.701-2. Subchapter K of the Internal Revenue Code, which applies to partnerships, “is intended to permit taxpayers to conduct joint business . . . activities through a flexible economic arrangement without incurring an entity-level tax.” Treas. Reg. § 1.701-2(a). But to take advantage of the special subchapter K rules, which include the debt-financed exception, (1) “[t]he partnership must be bona fide and each partnership transaction or series of related transactions . . . must be entered into for a substantial business purpose,” (2) “[t]he form of each partnership transaction must be respected under substance over form principles,” and (3) “the tax consequences . . . must accurately reflect the partners' economic agreement and clearly reflect the partner's income.” Treas. Reg. §1.701-2(a).

B. Factual background

1. Tribune's ownership and ultimate sale of the Cubs Assets through a leveraged partnership structure

Tribune began publishing the Chicago Tribune newspaper in 1847, and more than 130 years later, in 1981, it bought two other iconic Chicago assets: the Chicago Cubs baseball team and Wrigley Field. (SA.7; A.359.) The Cubs are a “marquee baseball franchise” and “one of the crown jewels of Major League Baseball.” (A.395; A.1601.) In April 2007, Tribune announced that it would sell the Cubs Assets and use the proceeds toward Tribune's debt from a 2007 corporate restructuring. (SA.8-9.) The assets included the baseball team, Wrigley Field, Tribune's interest in Comcast SportsNet Chicago, LLC, real estate, and other related assets. (SA.9; see also, e.g., A.353; A.438-42.)

In 2007, Tribune also converted from a C Corporation (which pays entity-level income taxes) to an S Corporation (which generally does not) owned by an Employee Stock Ownership Plan (which also generally is exempt from income taxes). (SA.8.) See I.R.C. §§ 401(a), 501(a), 1363(a); see also Boris I. Bittker and James S. Eustice, Federal Income Taxation of Corporations & Shareholders ¶ 1.01 (7th ed., Nov. 2020 update). For ten years after the conversion, Tribune was required to pay tax on “built-in gains” realized from selling assets that it held while a C corporation, including the Cubs Assets. See I.R.C. § 1374(a) & (b)(1). Because Tribune had a relatively low basis in the assets (SA.34), it would have faced sizeable built-in gains tax on a straightforward sale.

To avoid that tax, Tribune required a transaction structure built around the debt-financed exception, as detailed in a descriptive memorandum provided to ten bidding groups cleared by Major League Baseball (“MLB”), including the Rickettses. (See SA.10-11; A.399 (June 2008 Tribune memo).) Thus, “Tribune intend[ed] to structure the transaction” as one or more partnerships, with Tribune retaining a 5% interest and a new partner controlling the remaining 95%. (A.399.) Tribune further provided that the partnership “will incur” debt “up to the maximum” MLB allowed, and Tribune “will guarantee” the debt. (A.399.) Tribune would receive a distribution of the debt, net of fees, plus a cash contribution from the new partner. (A.399.) “From the beginning of the bidding process, Tribune intended the sale of the Cubs to include as much debt as possible.” (SA.17.)

Tribune ultimately decided to pursue a transaction with the Rickettses, who have both “an enduring love of Cubs baseball” and “considerable wealth.” (SA.8, SA.12; see also A.363-69.) Their wealth stems primarily from TD Ameritrade, which Joe Ricketts founded. (SA.8; A.480.) His son, Thomas Ricketts, was the lead negotiator for his family in the Cubs Transaction, and after the transaction, he became the chairman and “control person” for the Cubs, which gave him “ultimate authority and responsibility” for all decisions regarding the baseball club. (SA.10; A.480; A.1623-25.)

In August 2009, Tribune and the Ricketts-controlled RAC signed the formation agreement, which was the principal document implementing the Cubs Transaction. (S.A.12; A.368, A.372; A.429-54 (formation agreement excerpt).) RAC was owned and funded by “an intergenerational Ricketts family trust.” (S.A.16-17; see also A.479.) The Rickettses used the trust to fund their investment in CBH because they “viewed the team as a long-term family investment” and because the trust was “outside the family's estate.” (SA.17, SA.19.)

The Rickettses agreed to Tribune's “required transaction structure,” which “was dictated by Tribune and nonnegotiable.” (SA.10-11.) The Cubs Transaction, which closed on October 27, 2009, proceeded through that structure: (1) Tribune contributed the Cubs Assets to CBH; (2) through RAC, the Rickettses contributed $150 million in equity to CBH; (3) CBH borrowed $425 million in Senior Debt, and the Rickettses funded $248.75 million in Subordinated Debt³; (4) Tribune executed collection guarantees for both tranches of CBH's debt; and (5) CBH transferred $714 million to Tribune (as adjusted), funded by $673.75 million in CBH debt plus some equity. (SA.14-20, SA.30, SA.33; A.373; A.1065-70; cf. A.399.) The parties agreed that $844.7 million was the enterprise value or headline value of the Cubs Transaction. (A.439; A.479; A.1086.) The assets Tribune contributed had a net fair-market value of $734.7 million (after accounting for liabilities CBH assumed). (SA.14.) After the transaction, Tribune held a 5% interest in CBH, and the remaining 95% of CBH was controlled by the Rickettses, through RAC. (SA.14-15; A.1069-70.)

2. Pre-closing approvals in Tribune's bankruptcy court proceedings and from Major League Baseball

In December 2008, during the bidding and negotiation process for the Cubs Assets, Tribune and some of its subsidiaries filed for Chapter 11 bankruptcy. (SA.12; A.358.) In September 2009, after the parties signed the formation agreement, the bankruptcy court authorized Tribune to enter into the Cubs Transaction. (SA.13; A.369-71.) The bankruptcy court determined that Tribune's guarantees were negotiated at arm's length and in good faith, and that they were “valid and enforceable pursuant to their terms and applicable law.” (A.370.) But “the Bankruptcy Court did not determine petitioners' federal income tax liability for any of the years or issues that are present” in the Tax Court cases on appeal here. (A.1302.) Tribune emerged from bankruptcy in December 2012, several years after the Cubs Transaction. (A.358.)

The Cubs Transaction also was subject to MLB approval, including sign-off by 75% of the MLB baseball clubs. (SA.13; A.371; A.1281-82 (Major League Constitution).) “A significant aspect of MLB approval” was compliance with MLB's debt-service rule, which “aims to ensure a team's debt does not impede its economic stability and ability to perform.” (SA.13-14; see A.468-76 (debt-service rule).) In a memorandum to the MLB clubs regarding the proposed Cubs Transaction, the Commissioner explained that “strict compliance” with the debt-service rule would be “difficult,” in part because of “the level of debt required by Tribune to structure the Transaction effectively.” (A.482.) But the Commissioner found that the rule's purpose would be satisfied, having “little doubt about the ability of the Ricketts Group to service the debt on the Club.” (A.482.) Both Tribune and the Rickettses understood that the relevant parties would be subject to the debt-service rule, “including all remedies imposed by the Commissioner pursuant thereto.” (A.482.) One “preferred” remedial measure was requiring a club to reduce its debt “by raising additional equity on whatever terms the Commissioner deems appropriate.” (A.471-73.) The memorandum to the clubs stated that “[i]n the event of non-compliance, the members of the Ricketts Group are aware that cash infusions may be necessary as a remedial matter. . . .” (A.482.) This memorandum was signed by Thomas and Joe Ricketts, the family trust, CBH, Tribune, and other parties. (A.484-490.)

In a letter to Thomas Ricketts, before the Cubs Transaction closed, the MLB Commissioner recognized that the structure “and, in particular, the level of debt were driven by the Tribune's considerations and required structuring.” (A.494.) The MLB Commissioner identified initial steps he would take if the Cubs did not comply with the debt-service rule but also reiterated his “broad array of remedial powers” under the rule. (A.494-95.) MLB ultimately approved the transaction (A.372) but had a variety of tools, beyond the debt-service rule, to keep the Cubs on the field. (See infra at 24-28.)

3. The Cubs Transaction's financing and Tribune's guarantees

a. The Senior Debt and so-called Subordinated Debt

CBH borrowed a total of $425 million in senior loans from a consortium of banks led by J.P. Morgan and senior notes (collectively, “Senior Debt”), and the Rickettses funded $248.75 million in so-called Subordinated Debt.⁴ (SA.17-19; A.375-77; A.540-706 (Credit Agreement for senior loans); A.707-822 (Note Purchase Agreement); A.829-37 (Subordinated Promissory Note); A.1065-69.) The banks also extended an undrawn $25 million senior revolving loan. (A.546; A.1065.) The Senior Debt was CBH's bona fide debt and was secured by virtually all CBH assets, including the Cubs baseball team.⁵ (A.626-28; A.716; A.922-23 (“Collateral”), A.929 (“Secured Parties”), A.932-33 (§ 3.01. Security Interest); A.1069.) CBH agreed to maintain a reserve account holding six months of Senior Debt payments, increased to nine months near the expiration of the MLB collective bargaining agreement. (A.558, A.587-88, A.647-48; A.758.)

Explaining the origins of the Subordinated Debt, Thomas Ricketts testified that there had been “stable financing” when Tribune announced the sale of the team. (A.1627-28.) But the financial crisis between the 2007 sale announcement and 2009 closing for the Cubs Transaction made it difficult to meet Tribune's demand that the transaction “include as much debt as possible.” (SA.17-19; see also A.1628.) RAC secured “as much debt funding as possible” through Senior Debt from outside sources. (SA.19.) But “with few options” remaining, the Rickettses funded the Subordinated Debt, almost entirely from the “private funds” of Thomas Ricketts's mother. (SA.19-20; A.1069; A.1628.) The Senior Debt had to be paid in full before payments could be made on the Subordinated Debt (other than limited interest payments). (SA.20.) Thomas Ricketts determined the interest rate for the Subordinated Debt and described the transaction to his mother, and “[s]he agreed to it.” (A.1628.) He also had authority to make decisions for the Subordinated Debt lender. (SA.19; see A.377; A.1069.)⁶

b. Tribune's Senior Guarantee of collection and CBH's minimum-debt commitment

Tribune executed the Senior Guarantee as part of the Cubs Transaction, while it was in bankruptcy and had no credit rating. (SA.30; A.379.) Tribune guaranteed collection, rather than payment, of CBH's Senior Debt. (SA.30-31; A.379; A.960 (Senior Guarantee).) Under a payment guarantee, a lender generally may pursue relief from the guarantor upon the borrower's failure to perform, without any requirement that the lender first exhaust other remedies. (See SA.30.) See also, e.g., Hovde v. ISLA Dev. LLC, 51 F.4th 771, 777 (7th Cir. 2022); 38 Am. Jur. 2d Guaranty § 14 (Feb. 2023 update). By contrast, Tribune's Senior Guarantee was a collection guarantee that could not be called upon until after (1) CBH failed to make a payment on the Senior Debt and the debt was accelerated; (2) the senior lenders had exhausted all remedies against CBH, including against the Cubs baseball team, Wrigley Field, and all other collateral; and (3) the senior lenders nonetheless failed to fully recover.⁷ (SA.31; A.960.) Tribune's guarantees “were at all times part of the proposed structure of the Cubs Transaction” and were not requested by the lenders. (A.379; A.1658 (testimony of attorney who represented CBH in Senior Debt negotiations).)

Explicitly for Tribune's benefit, CBH promised to maintain a minimum amount of debt ($673.75 million for the first three years and declining thereafter) through January 1, 2018, at the end of Tribune's ten-year recognition period for built-in gains under I.R.C. § 1374(a). (A.521, A.539; see supra at 10.) Tribune therefore ensured that the debt remained in place to continue sheltering its distribution from CBH. CBH and the Ricketts parties agreed to indemnify Tribune for certain tax-related consequences caused by breach of, inter alia, the minimum-debt requirements. (A.521-25.)

4. Factors making it highly improbable that the Senior Guarantee would be enforced against Tribune

The Cubs' strong revenue flow, as well as additional structural protections for the senior lenders, made default on the Senior Debt highly improbable. And even if default had occurred, the senior lenders had a security interest in nearly all of CBH's assets, including the Cubs baseball team, and were highly likely to fully recover the Senior Debt, without resort to Tribune's guarantee. Tribune and the Tax Court both concluded that Tribune's risk from its guarantees was “remote.” (SA.3, SA.32; A.1000; see infra at 31-32.) And experts for petitioners and the Commissioner agreed that the Senior Guarantee had minute value. (See infra at 34-36.)

a. The Cubs' strong revenue flow and structural protections built into the Cubs Transaction

i. The “cash waterfall” ensuring substantial revenue flowed to service the Senior Debt

As the Tax Court found, “CBH was expected to meet its financial obligations.” (SA.28.) * * * CBH memoranda regarding senior loans and notes projected total revenues to grow from $324.5 million in 2010 to $538.8 million in 2018. (A.1126; A.1274.) The Cubs had at least two major sources of consistent, substantial revenue: ticket sales and media revenue. Robert Dupuy, who was the MLB point person for the overall change in Cubs ownership, explained that “[t]he Cubs had always drawn well, even when they didn't perform well on the field,” because of “the iconic nature of Wrigley Field,” “the intensity and avidity of the Chicago sports fan, the size of the city and the management of the team.” (A.1602-03.) Tribune's descriptive memorandum similarly described a “growing stream of annual ticketing revenues” from the “loyal fan base,” with attendance at a “record high” in 2007. (A.391.) A 2009 CBH memorandum stated that, despite “difficult economic conditions” and an 11% increase in ticket prices, the Cubs renewed more than 98% of their season tickets, and the season-ticket waiting list increased from 87,000 to more than 100,000. (A.1128; see also A.1143 (chart titled “Attendance and Ticket Prices Increase Despite Team Performance”).) To be sure, as the Tax Court noted, “revenue is highly dependent on actual attendance at baseball games.” (SA.65.) But the record showed a fan base avid to attend Cubs baseball games.⁸

Both Tribune and CBH also emphasized in memoranda to potential investors or lenders the “stable and growing cash flow stream” from long-term media rights agreements. (A.392; A.1133; A.1238.) Between 2010 and 2018, local media revenue was projected to grow from $58.1 million to $99.7 million annually, and distributions from the Major League Central Fund (mostly from “extremely stable” national broadcasting revenue) were projected to be $23.9 million to $33.3 million annually. (A.1126, A.1133, A.1152; A.1239, A.1256, A.1274.)

To ensure debt service, the senior lenders required that significant cash streams would flow first to the Senior Debt through a “cash waterfall.” (SA.21-22; A.838-79 (cash collateral agreement).) The first $250 million annually in certain revenues, including net gate receipts, local media revenue, and MLB Central Fund distributions, was placed in the cash waterfall. (SA.22; A.508 (“TeamCo Assigned Revenues”); A.856.) Above an annual cap, typically $50 million, such revenues were used for operating expenses. (See A.851 (“TeamCo Obligation Cap”), A.858-59.) CBH also pledged to the cash waterfall distributions from Comcast SportsNet Chicago. (A.848 (“Pledged Revenues”), A.856.) Funds in the cash waterfall flowed first to service the Senior Debt, second to fund the Senior Debt reserve account, third to pay fees and other obligations, and fourth to a distribution account, which eventually flowed to the Subordinated Debt. (SA.22; A.859-60, A.865-68.)

Revenues committed to the cash waterfall were projected to substantially eclipse the total Senior Debt expense in every year from 2010 to 2018.⁹ Annual Senior Debt expense was projected between $31.9 million and $33.4 million. (A.1203 (“Total Senior Debt Expense”).) The amounts actually assigned to the cash waterfall and available for debt service were subject to the caps described above. But annual revenues assignable to the cash waterfall were projected between $235.4 million and $359.8 million, i.e., seven to ten times the maximum projected annual Senior Debt expense. (A.1126 & A.1274 (“Total Assignable TeamCo Revenues”).) Distributions from Comcast SportsNet Chicago, additionally pledged to the cash waterfall, were projected between $18.2 million and $26.8 million annually. (A.1126 & A.1274 (“CSN Distributions”).)

ii. Operating Support Agreement

“In order to obtain the approval” of the MLB Commissioner for the Cubs Transaction, CBH, Thomas Ricketts, and several Ricketts-related entities agreed to Operating Support Agreement (“OSA”) arrangements. (SA.15-16; A.880-90 (“OSA Letter Agreement”); A.891-901 (“OSA Loan Agreement”).) The OSA “provided a financial safety net for the Cubs” and assured MLB “that the team had operating revenue even amidst economic uncertainty.” (SA.16.)

The signatories to the OSA Letter Agreement promised that they would, “[a]t any time” and upon direction from the MLB Commissioner, “cause the transfer of funds” to the Cubs through an equity contribution or through an unsecured subordinated loan from an RAC-owned entity created for the OSA. (A.881.) OSA loans generally were limited to $35 million, but there was no stated limit on the equity contribution that the Commissioner could require. (See A.881; A.891-93.) If the OSA entity had less than the agreed $35 million balance, the Commissioner could direct the Ricketts parties to restore that balance. (SA.16; A.881-82; see also A.494-95 (letter from MLB Commissioner to Thomas Ricketts).) In the memorandum to MLB clubs regarding the proposed Cubs Transaction, the MLB Commissioner explained that this replenishment requirement ensured “that there would be at least $35 million available to address any situation where the Club is not in compliance with the [debt-service rule].” (A.481.)

OSA loans could be used only for operating expenses, but CBH memoranda stated that the Senior Debt nonetheless would “indirectly benefit” from the OSA loan commitment. (SA.16; A.1113; A.1219; see A.892.) The senior lenders were involved in OSA negotiations because, inter alia, they wanted to ensure that the Cubs “continued to operate so that cash flow would continue to reach their borrower.” (A.1641-42.) The OSA Loan Agreement explicitly made J.P. Morgan “an intended third party beneficiary” as collateral agent for the senior lenders. (A.896.) Under certain circumstances, the collateral agent could insist that OSA loans be made, including in unlimited amounts for “MLB Required Investments.” (A.891, A.896, A.899; A.904-06.) * * *

iii. Other MLB tools to ensure the Cubs played ball — and avoided seizure by creditors

“[U]nder all circumstances,” DuPuy testified, MLB would attempt to avoid having a baseball team seized as collateral. (A.1612.) In addition to the debt-service rule and the OSA arrangements, MLB had other tools to keep the Cubs on the field, keep the revenues flowing, and avoid seizure of the team by creditors. The Major League Constitution granted the MLB Commissioner broad authority to take specified “punitive action” and “other actions as the Commissioner may deem appropriate” where there was conduct by baseball clubs, owners, and others that the Commissioner deemed “not to be in the best interests of Baseball.” (A.1275-76.) If a baseball club got “in trouble” financially, DuPuy explained, the MLB Commissioner had remedies under the Major League Constitution and the debt-service rule, which were as “extreme” as “requiring additional equity be brought in” or “that teams be sold,” which “has happened.” (A.1611-12; ) The OSA Letter Agreement stated, moreover, that it was not intended to preclude the MLB Commissioner “from exercising any power . . . including, without limitation,” requiring CBH to transfer funds to the baseball club to support operations, “to be made out of equity contributions to [CBH].” (A.886.)

In the Senior Debt agreements, MLB also reserved the right to provide up to $35 million in a super-senior loan for operating expenses, as well as additional financial and other support, which could include curing loan defaults and helping to find a buyer for the team. (A.668, A.671-72; A.785, A.788-89.) Discussing these protections, DuPuy explained that all MLB teams can be affected when one team gets in financial trouble. (A.1611.) “[T]o ensure the game isn't disrupted,” MLB therefore tried to have “cooperation” and “a working relationship” with team lenders. (A.1611.) * * * And if CBH defaulted on the Senior Debt, the senior lenders generally agreed not to take enforcement actions during a 180-day standstill period.

(A.668-69; A.785-86.) The standstill period would allow MLB time “to step in and potentially help to cure” the circumstances surrounding any default. (A.1646-47 (testimony of lawyer representing CBH during the Cubs Transaction).)

b. Ultimate remedies against collateral securing Senior Debt, including the uniquely valuable Chicago Cubs

If a default on the Senior Debt extended beyond the 180-day standstill period, the senior lenders could exercise remedies against their collateral, i.e., against virtually all CBH assets, including the Chicago Cubs baseball team. (A.626-28; A.716; A.922-23, A.929, A.932-33.) Senior Debt totaled $425 million after the Cubs Transaction, and the parties agreed that the enterprise or headline value was $844.7 million. (A.377; A.439; A.479; A.1069; A.1086.) An August 2009 CBH memorandum about the senior notes reflected management's belief “that the Notes will benefit from significant overcollateralization.” (A.1135 (“implying an equity cushion (inclusive of subordinated debt) of approximately $475 million,” based on an estimated $900 million transaction valuation).)

And the collateral included a uniquely valuable asset: The Chicago Cubs, a “crown jewel” MLB franchise. (A.1601.) Notably, there are only 30 MLB clubs in the world, and the value of MLB franchises was substantially increasing in the years leading up to the Cubs Transaction. (A.371; A.394-95; A.1364-70; A.1417.) In short, as two CBH memoranda emphasized before the Cubs Transaction, CBH had a “strong collateral package and structural protections” because, inter alia, the Cubs were a “marquee franchise” that management believed would “continue to have a strong valuation as a result of the expected few transactions involving marquee franchises.” (A.1135 (regarding senior notes) & A.1241 (regarding senior loans) (capitalization altered).)

An S&P rating of CBH and the senior notes, dated on the Cubs Transaction closing date, reflected a “very high (90% to 100%) recovery” for senior noteholders in the event of a payment default. (A.823.) S&P contemplated a possible 40% reduction in value of the Cubs Assets, in an asset sale under distressed circumstances, against the purchase price of approximately $850 million. (A.827.) Among the risks that S&P considered were CBH's “substantial debt burden” and risks associated with the 2011 expiration of the MLB collective bargaining agreement. (A.824-25.) But such issues were “tempered by,” e.g., an “expectation for stable cash flow generation,” given MLB's success “through many difficult economic environments” and the Cubs' “strong track record of operational stability over many years”; liquidity from the OSA, Senior Debt reserve account, and the undrawn senior revolving loan; and the potential for MLB support. (A.825-27.) S&P did not mention Tribune's guarantees in its October 2009 rating. (A.823-28; see also A.425-26 (Fitch credit opinion regarding the senior notes, relying on similar factors and ignoring Tribune's guarantees).)

* * * ¹⁰

5. Tribune's contemporaneous determination that it had “remote” risk on the guarantees and that the guarantees were “insignificant to the overall transaction”

Tribune concluded that the possibility that its guarantees would be called upon was “remote.” (SA.32; A.1000.) A memorandum documenting Tribune's accounting conclusions for the Cubs Transaction explained that the guarantees were “of collection and not of payment” and that Tribune would not have to perform on its collection guarantees until CBH failed to pay and the lenders had exhausted “all legal remedies (including liquidation)” against “all collateral,” without recovering the full amount.¹¹ (A.999; A.1672-73.) The memorandum observed that the value of the Cubs businesses was approximately $850 million, and the “first to absorb losses” would be CBH's equity. (A.999-1000.) Tribune also looked to CBH's additional liquidity from the OSA and $25 million senior revolving loan. (A.999.) Tribune reasoned that, if there were shortfalls and the Rickettses (with a reported net worth of more than $1 billion) refused to contribute additional funds, they would effectively abandon[ their] substantial previous investment.” (A.999-1000.) Tribune concluded that “the likelihood of performance” on the guarantees “is remote.” (A.1000.)

Tribune also concluded that the Rickettses received “no perceived benefit” from the Senior Guarantee, and that it was “unlikely” that the guarantee resulted in either more debt or better conditions for the Senior Debt. (A.1000; see also SA.32.) Tribune determined that its guarantees were “insignificant to the overall transaction” and “not a continued necessity” for CBH. (A.1003.)

On its financial statements, Tribune disclosed the guarantees in notes but did not book any liability, create any reserve, or report any value for them. (SA.32-33; A.380; A.992-94 (excerpted financial statements); see A.1000.)

6. Tribune's sale of its CBH interest to RAC

The Cubs Transaction included options for Tribune to sell, and for RAC to buy, Tribune's 5% interest in CBH, at certain points after the end of Tribune's ten-year recognition period for built-in gains tax under I.R.C. § 1374. (SA.34-35; * * *see supra at 10.) RAC exercised its option in 2018 and, * * * it paid $107 million for Tribune's 5% interest in CBH. (SA.34-35; )

C. Tax reporting and IRS determinations

On its partnership return, CBH reported a distribution of just under $714 million to Tribune and allocated to Tribune $673.75 million in recourse liabilities. (SA.33 n.22, SA.36-37; A.1071.) Accordingly, on its 2009 tax return, Tribune reported the Cubs Transaction as a disguised sale with net built-in gains of (after other adjustments) only $33.8 million. (SA.36-37; A.1071; A.1097 (Tribune's “Disguised Sale Calculation”).)

After examination, the IRS determined that the Cubs Transaction did not qualify for the debt-financed exception. (SA.37; A.330-32; A.356.) Based on that conclusion, as well as other matters not relevant to the Commissioner's appeal, the IRS determined a $181.7 million tax deficiency for Tribune. (SA.37; A.318, A.330; A.356.) The IRS made related adjustments for CBH, including reclassifying the Subordinated Debt as equity and the Senior Debt as nonrecourse, as well as adjusting the parties' capital contribution amounts. (SA.38; A.333-47; A.357.) Both notices reflected the Commissioner's determination of accuracy-related penalties under I.R.C. § 6662. (SA.37-38; A.326; A.347; A.356-57.)

D. Tax Court trial and expert witness testimony

Tribune and CBH both filed petitions with the Tax Court, which consolidated the cases. (SA.38; A.173-214; A.215-55.) The parties submitted eight stipulations of fact with exhibits, and the court held a trial in October and November 2019.

Both sides presented expert testimony regarding Tribune's risk from the guarantees and the value of the guarantees. Dr. Douglas Skinner, testifying for the Commissioner, explained that it was “very, very unlikely” that Tribune would have to pay out on its collection guarantees because it would have to do so only after “a bunch of steps,” including the Cubs being sold for less than the face value of the debt. (A.1686.) Dr. Skinner valued the combination of Tribune's guarantees of the Senior Debt and Subordinated Debt between $6.12 to $18.86 million in his “base case analysis.” (A.1497-99 (explaining that this was likely an overstatement).) But, if the Subordinated Debt was recast as equity, Tribune's remaining financial exposure “was effectively non-existent” because “there was almost no chance (0.00% to 0.08%)” that the value of the Cubs Assets would fall below $450 million (the Senior Debt plus the undrawn $25 million revolving loan). (A.1501-02.) If the Subordinated Debt was recast as equity, leaving Tribune at risk only from the Senior Guarantee, Dr. Skinner found that the guarantees were “effectively worthless (between at most [$30,000] and $1.07 million . . .).” (A.1501-02.)

Petitioners' experts reached similar conclusions. Dr. Israel Shaked concluded that CBH would generate sufficient cash, “with a significant margin of safety,” to pay its debts. (A.1411.) Dr. Anil Shivdasani calculated that the present value of expected payments for the Senior Guarantee ranged from $0 to $1.95 million (at most) and for the Subordinated Guarantee, from $7.53 million to $10.76 million. (A.1318.) Dr. William Chambers testified that the senior lenders would fully recover under S&P's standard distress scenario (a 40% haircut) and that they would recover 88% or 89% under a “more severe distress scenario” (a 50% haircut). (A.1384-87.) Dr. Chambers also testified, however, that the value of the Cubs, “ha[d] been both higher and rising more rapidly than the average.” (A.1693.) After the Cubs Transaction, Dr. Chambers explained, “CBH had a strong business position” based on its “stable and increasing revenue” and on the Cubs “outperform[ing] the league average in every major performance metric.” (A.1370.)

E. Tax Court opinion and decisions

The Tax Court issued an opinion finding that the likelihood Tribune would have to fulfill its guarantee was “remote,” but the court held that fact was “not sufficient to disregard it.” (SA.3.) For tax purposes, however, the court found that the Subordinated Debt was equity, not genuine debt, and that the corresponding portion of Tribune's distribution was taxable. (SA.3, SA.56-90.) Weighing in favor of an equity finding were, e.g., the “significantly intertwined” interests of CBH and the subordinated lender, both controlled by the Rickettses (SA.80); use of the Subordinated Debt for “a significant change in the ownership of assets” (SA.87); the effective absence of a fixed maturity date (SA.62-63); and the parties' intent (SA.78). The court found that it was “beyond unlikely” that the Rickettses would liquidate CBH, which they owned, to enforce any subordinated-lender rights. (SA.89-90.)

Regarding the Senior Guarantee, the Tax Court first applied the constructive-liquidation test of Treas. Reg. § 1.752-2(b), which initially determines a partner's allocable share of the partnership's recourse liability. (See supra at 7-8.) Applying the five hypothetical circumstances that are deemed to occur under that test, see Treas. Reg. §1.752-2(b)(1)(i)-(v), the Tax Court allocated the Senior Debt to Tribune as a recourse liability. (SA.94-98.)

The court next rejected the Commissioner's reliance on the anti-abuse rule in Treas. Reg. § 1.752-2(j)(1), which calls for disregarding a partner's obligation “if facts and circumstances indicate that a principal purpose of the arrangement between the parties is,” contrary to the arrangement's substance, to make it appear the partner bears economic risk of loss. The Commissioner argued that Tribune's risk of loss was meaningless in light of the many side agreements and other features of the Cubs Transaction that ensured the Senior Guarantee would never be triggered. (See supra at 14-31.) In applying the anti-abuse test, the Tax Court thought it appropriate to import the hypothetical facts from its constructive-liquidation analysis. (See SA.98-101.) Thus, the court assumed that “CBH could pay neither its debts nor its operating expenses,” “the Cubs would be deemed worthless,” and the Rickettses would have no incentive to preserve their investment. (SA.99-100.) The court stated that, because the constructive-liquidation test “tests the worst-case scenario” in which “even cash is rendered worthless,” it was “irrelevant,” under the anti-abuse rule, whether Tribune was likely to be called upon to fulfill the Senior Guarantee. (SA.101.) The court further believed that the Treasury Regulation required some partner of CBH to be allocated the Senior Debt and stated that “there is no evidence that RAC was that partner.” (SA.100.)

The Tax Court also rejected the Commissioner's arguments under the subchapter K anti-abuse rule in Treas. Reg. § 1.701-2. (SA.106-14.) To pass muster under that rule, among other things, a “partnership must be bona fide and each partnership transaction . . . must be entered into for a substantial business purpose.” Treas. Reg. § 1.701-2(a)(1) (emphasis added). The Tax Court interpreted the business-purpose requirement to apply not “to every agreement” of partners or partnerships but rather “to the function of the partnership as a whole.” (SA.109.) The court stated that “CBH, without a doubt, had a bona fide business purpose,” as it was created “to hold and operate the Cubs,” and the “transaction was not a sham and resulted in significant economic outcomes to Tribune and RAC.” (SA.110.) The court also found “unpersuasive” the contention that the Senior Guarantee lacked business purpose, stating that “a remote possibility that a guaranty will be called is still a possibility and does not invalidate a guaranty.” (SA.110-14.)

Citing Dr. Skinner's testimony regarding the maximum combined value of the Senior Guarantee and Subordinated Guarantee, the Tax Court concluded that “the guaranties had economic value” and that “the senior debt guaranty is not a sham or an illusory agreement created solely for tax purposes.” (SA.112-13.) It stated that the Senior Guarantee had genuine nontax consequences for Tribune because “[t]he guaranties affected Tribune's credit rating” in a 2016 S&P analysis. (SA.113.) Observing that “[c]ollection guaranties are valid guaranties,” the court also rejected the argument that Tribune had minimal risk from the Senior Guarantee. (SA.114.) Ultimately, the Tax Court held that the portion of Tribune's distribution attributable to the Senior Guarantee was a nontaxable debt-financed distribution. (SA.118-19, SA.127.)

The Tax Court entered decisions in both cases consistent with its opinion. (SA.128-29; SA.130-33.) Of note, although the Tax Court's findings regarding the Subordinated Debt increased Tribune's gain from the Cubs Transaction, the Tribune decision reflected no tax deficiency or overpayment because Tribune's net operating loss offset the gain increase. (See SA.128-29; T.C. No. 20940-16 Doc. 363.)

SUMMARY OF ARGUMENT

The fundamental question in this case is whether Tribune bore meaningful risk of loss from the Senior Guarantee, such that $425 million of the $714 million distribution it received from CBH was a “debt-financed” distribution. If Tribune did not genuinely assume risk for such debt, then the distribution it received would not qualify for the “debt-financed” exception to the disguised-sale rules and would be fully taxable. The Treasury Regulations set forth two anti-abuse tests for determining whether Tribune's purported obligation should be disregarded, and the Tax Court misapplied both tests.

1. First, the Tax Court incorrectly constrained the anti-abuse rule of Treas. Reg. § 1.752-2(j) to the hypothetical facts generated under the constructive-liquidation test in paragraph (b) of that regulation. But paragraph (j) is an exception to — and is not controlled by — the mechanical test in paragraph (b). The anti-abuse rule requires consideration of actual “facts and circumstances” and the “substance of the arrangement” at issue. Treas. Reg. § 1.752-2(j)(1). By limiting the anti-abuse analysis to hypothetical facts generated under the constructive-liquidation test in paragraph (b) — which are extremely unlikely to occur — the Tax Court eviscerated the anti-abuse rule.

Under a proper analysis of the anti-abuse rule, it is plain that Tribune's Senior Guarantee should be disregarded. The Tax Court and Tribune itself concluded that Tribune had no more than a “remote” risk under the Senior Guarantee. There were myriad protections in place that all but assured Tribune would never be called upon to repay any portion of the Senior Debt. The Cubs' strong revenue was expected to far outstrip the Senior Debt service, and much of that revenue flowed first to the Senior Debt. Major League Baseball also insisted on tools to keep the Cubs on the field — and keep the cash flowing. No one expected CBH to default, but if it did, the Senior Debt was overcollateralized with the Chicago Cubs baseball team and other CBH assets. According to petitioners' expert, the maximum present value for payments on the Senior Guarantee was only 0.43% of the value of the Senior Debt (plus an undrawn revolving loan). Tribune's miniscule risk on the Senior Guarantee, especially compared to its outsized claimed tax benefits, should have been central to the Tax Court's anti-abuse analysis, but the court concluded that Tribune's actual risk was “irrelevant” under Section 1.752-2(j).

2. The Tax Court also erroneously refused to consider the subchapter K anti-abuse rule in Treas. Reg. § 1.701-2. That rule provides that a “partnership must be bona fide and each partnership transaction . . . must be entered into for a substantial business purpose.” Treas. Reg. § 1.701-2(a)(1) (emphasis added). The Commissioner here argued that there was no non-tax business purpose for Tribune's Senior Guarantee, but the Tax Court construed the anti-abuse rule as applying only to partnership formation and not to individual partnership transactions. The regulation plainly says otherwise.

The court thus failed to apply Section 1.701-2's plain text to the Senior Guarantee, which sheltered $425 million from built-in gains tax. The Senior Guarantee — which no lender asked for, and which Tribune insisted on providing from the outset — was designed solely to provide a hook for invoking the debt-financed exception to the disguised-sale rules. Indeed, Tribune has never plausibly explained the business purpose for its gratuitous guarantee of $425 million in debt, and there was none.

Under either anti-abuse test, Tribune's guarantee of the Senior Debt should have been disregarded, making the debt-financed exception unavailable to shelter Tribune's built-in gains from the sale of its Cubs Assets. The Tax Court erred in holding otherwise.

ARGUMENT

The Tax Court misinterpreted two anti-abuse tax regulations and erroneously ignored Tribune's remote risk from the Senior Guarantee in upholding its tax-free treatment of $425 million received in the Cubs Transaction

Standard of review

This Court reviews the Tax Court's legal conclusions de novo and reviews for clear error factual findings and application of the law to the facts. Feldman v. Commissioner, 779 F.3d 448, 453-54 (7th Cir. 2015). This Court thus reviews de novo the Tax Court's legal interpretations of the anti-abuse rules in Treas. Reg. § 1.752-2(j) and § 1.701-2.

A. The Tax Court erroneously held that Tribune's actual (and remote) risk was irrelevant to the anti-abuse rule in Treas. Reg. § 1.752-2(j)

1. Section 1.752-2(j) analyzes “facts and circumstances” and “the substance of the arrangement”

Regulatory interpretation proceeds under “[t]he same basic rules that apply to statutory interpretation,” considering first “whether the language at issue has a plain and unambiguous meaning with regard to the particular dispute in the case.” Bria Health Servs., LLC v. Eagleson, 950 F.3d 378, 382-83 (7th Cir. 2020 (internal quotations omitted; citing, e.g., Kisor v. Wilkie, 139 S. Ct. 2400, 2414-18 (2019)). This inquiry concerns “the entire text of the regulation, its purpose and context, and precedents or authorities that can inform the analysis.” Id. at 383. “If the meaning of the regulatory text is clear,” however, “the task is complete.” Exelon Generation Co., LLC v. Loc. 15, Int'l Bhd. of Elec. Workers, AFL-CIO, 676 F.3d 566, 570 (7th Cir. 2012), as amended (May 9, 2012).

As relevant here, a distribution to a partner is a nontaxable debt-financed distribution only to the extent the partner bears the economic risk of loss for the corresponding partnership debt. Treas. Reg. § 1.707-5(a)(2)(i) & (b)(1); Treas. Reg. 1.752-2(a). “Except as otherwise provided in [Section 1.752-2],” a partner's economic risk of loss is determined under the constructive-liquidation test in paragraph (b). Treas. Reg. §1.752-2(b). The constructive-liquidation test is easy to apply but divorced from reality. It poses an artificial and disastrous set of circumstances in which, inter alia, a partnership's assets (“including cash”) are worth “zero,” the partnership disposes of all its property for “no consideration,” and its liabilities are payable in full. See Treas. Reg. §1.752-2(b). The Tax Court held that, under the “worst-case scenario” posited by the constructive-liquidation test, Tribune bore the economic risk of loss for the Senior Debt. (SA.96.)

But that is not the end of the inquiry. Paragraph (a) of Section 1.752-2 instructs that “the rules in paragraphs (b) through (k)” determine the extent (if any) to which a partner bears the economic risk of loss for a partnership liability — not just paragraph (b). And paragraph (b) itself begins with the phrase “[e]xcept as otherwise provided in this section. . . .” Treas. Reg. § 1.752-2(b)(1). Thus, the plain regulatory text emphasizes that the constructive-liquidation test in paragraph (b) does not control — but rather is subject to — the other provisions in Section 1.752-2. “[T]he most natural reading of the 'except as otherwise provided' clause” is that paragraph (b) is a default rule that determines economic risk “unless” another provision of Section 1.752-2 applies. Johnson v. Guzman Chavez, 141 S. Ct. 2271, 2288 (2021) (interpreting an immigration statute); Jones v. Liberty Glass Co., 332 U.S. 524, 530-31 (1947) (similar interpretation of tax statutes); Gunther v. Commissioner, 909 F.2d 291, 295 (7th Cir. 1990) (same).

Section 1.752-2 “otherwise provide[s]” the anti-abuse rule in paragraph (j). Under its plain text, the anti-abuse rule does not concern the hypothetical facts generated under the constructive-liquidation test in paragraph (b). Paragraph (j) instead considers whether “facts and circumstances indicate that a principal purpose of the arrangement between the parties is to” either “[1] eliminate the partner's economic risk of loss with respect to that obligation or [2] create the appearance of the partner or related person bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.” Treas. Reg. §1.752-2(j)(1) (emphases added). A “payment obligation may be disregarded” where “the facts and circumstances evidence a plan to circumvent or avoid the obligation.” Treas. Reg. § 1.752-2(j)(1), (3) (emphasis added). This plain language mandates looking at economic reality, not artifice.

Put another way, the artificial facts used in the constructive-liquidation test may create the appearance of economic risk when there is none in substance. To guard against that possibility, the anti-abuse rule analyzes the actual “facts and circumstances . . . of the arrangement between the parties” and “the substance of [that] arrangement.” Treas. Reg. § 1.752-2(j)(1). In this regard, paragraph (j) incorporates doctrines from decades of case law, including the economic-substance and substance-over-form principles, which focus on practical realities — not hypothetical possibilities. The “animating principle” behind such doctrines “is that the law looks beyond the form of a transaction to discern its substance.” Feldman, 779 F.3d at 454. The Supreme Court “has never regarded the simple expedient of drawing up papers as controlling for tax purposes when the objective economic realities are to the contrary.” Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978) (internal quotations and citation omitted); see also Exelon Corp. v. Commissioner, 906 F.3d 513, 523 (7th Cir. 2018) (describing judicial anti-abuse doctrines).

Under facts analogous to Tribune's Senior Guarantee, the Fifth Circuit disregarded an “essentially gratuitous” loan guarantee that inflated a partner's tax basis but lacked economic substance. Nevada Partners Fund, LLC v. United States, 720 F.3d 594, 612 (5th Cir. 2013), vacated on other grounds, 571 U.S. 1119 (2014). That gratuitous guarantee “was not required by the bank as a condition of the loan and did not further any non-tax related business objective.” Id.; see also Kearney Partners Fund, LLC v. United States, 803 F.3d 1280, 1292, 1296 (11th Cir. 2015) (per curiam) (disregarding a similar guarantee).

Consistent with these underlying judicial doctrines, which apply in every tax case, the plain text of the Section 1.752-2(j) anti-abuse rule demands a focus on Tribune's real-world risk, considering the actual facts and circumstances surrounding the Cubs Transaction.

2. In conflict with Section 1.752-2(j)'s plain text, the Tax Court limited its analysis to hypothetical facts in the “worst-case scenario” under the constructive-liquidation test in Section 1.752-2(b)

Against the regulation's plain text, the Tax Court held that the remoteness of Tribune's economic risk was “irrelevant” under the Section 1.752-2(j) anti-abuse rule. (SA.101.) The Tax Court erroneously constrained its analysis of the anti-abuse rule in paragraph (j) to the hypothetical facts under paragraph (b). (See SA.99-101.) The court viewed “the probability of Tribune's fulfillment of its promise in the [Senior Guarantee as] irrelevant” under the anti-abuse rule in paragraph (j) because the constructive-liquidation test in paragraph (b) “does not posit an expected occurrence” but rather “tests the worst-case scenario.” (SA.101.)

The court similarly and erroneously rejected the Commissioner's contention that the Rickettses would protect their intergenerational investment because, the court stated, “in a constructive liquidation, the Cubs would be deemed worthless and the Ricketts family would lack an incentive to preserve its investment.” (SA.99 (emphasis added).) The court similarly stated that, “[i]n a constructive liquidation where CBH could pay neither its debts nor its operating expenses, CBH's creditors would not look to the Ricketts family for payment under the [OSA], they would look to Tribune for payment of the debt.”¹² (SA.100 (emphasis added).) But the hypothetical facts under the constructive-liquidation test are irrelevant under the anti-abuse rule, which concerns actual facts, circumstances, and economic substance.

The Tax Court further misread Section 1.752-2(j) when it stated that “[a] recourse debt must be allocated to a partner.” (SA.100 (finding “no evidence that RAC was that partner”).) The regulation instead provides that an obligation “may be disregarded or treated as an obligation of another person” where a partner has only an illusory obligation to pay a purportedly recourse liability. Treas. Reg. § 1.752-2(j)(1) (emphasis added). And where “the facts and circumstances evidence a plan to circumvent or avoid” a partner's payment obligation, the obligation “is not recognized.” Treas. Reg. § 1.752-2(j)(3). This rule does not require an asserted payment obligation to be allocated to anyone. Rather, an obligation may be disregarded, which also is the usual result under the economic-substance doctrine. The plain text of Section 1.752-2 “just means what it means,” and the Tax Court erred by failing to give effect to that text, “as the court would any law.” Kisor, 139 S. Ct. at 2415.

3. Legislative history supports the Commissioner's interpretation of Section 1.752-2(j)

The text of Section 1.752-2 is clear, and this Court need not consider legislative history. But congressional intent for the disguised-sale rules in I.R.C. § 707 is consistent with the Commissioner's interpretation of Section 1.752-2(j). The Committee on Ways and Means explained that disguised sales “should be treated for tax purposes in a manner consistent with their underlying economic substance” and that tax consequences under anticipated Treasury regulations should “depend[ ] upon the underlying economic substance of the transaction.” H.R. Rep. No. 98-432, pt. 2, at 1218, 1221 (1984). And the relevant conference report anticipated that a payment would not be taxable “to the extent the contributing partner, in substance, retains liability for repayment of the borrowed amounts.” H.R. Rep. No. 98-861, at 862 (1984) (Conf. Rep.) (emphasis added).

Consistent with congressional focus on economic substance for disguised sales and the debt-financed exception, Section 1.752-2(j)'s anti-abuse rule applies to actual facts, circumstances, and substance. The Tax Court undermined congressional intent by limiting its Section 1.752-2(j) analysis to artificial facts used in the constructive-liquidation test and holding to be irrelevant critical facts, including whether Tribune, “in substance, retain[ed] liability for repayment of” CBH's Senior Debt. H.R. Rep. No. 98-861, at 862.

4. Tax law disregards de minimis risks

The Tax Court also overlooked fundamental cornerstones of federal tax law that apply in every tax case and should have shaped analysis of the “substance of the arrangement” under Section 1.752-2(j). Despite stating that Tribune's risk was irrelevant under Section 1.752-2(j), the Tax Court appears to have placed some weight on the Commissioner “conced[ing] the possibility” that the Senior Guarantee could be called. (SA.101.) Any such “possibility” was infinitesimal, however, as illustrated by the present value that Dr. Shivdasani, petitioners' expert, determined for expected payments under the Senior Guarantee: a maximum of $1.95 million — or only 0.43% of the $450 million the guarantee claimed to potentially cover. (A.1318, A.1341-42.)

In determining federal tax consequences, courts ignore such de minimis risks or effects. In Exelon, for example, this Court rejected arguments based on theoretical risk in favor of a “reasonable expectation or likelihood standard.” 906 F.3d at 524-25 (internal quotations omitted). Similarly, the D.C. Circuit held that the Tax Court “did not err by carving out an exception for de minimis risks, as no investment is entirely without risk.” ASA Investerings P'ship v. Commissioner, 201 F.3d 505, 514 (D.C. Cir. 2000). See also, e.g., Knetsch v. United States, 364 U.S. 361, 366 (1960) (disregarding transaction that did “not appreciably affect [a taxpayer's] beneficial interest except to reduce his tax”) (internal quotations omitted); TIFD III-E, Inc. v. United States, 459 F.3d 220, 228 & n.5 (2d Cir. 2006) (disregarding risk of loss that was not “meaningful” and “so remote as to be irrelevant”); Chemtech Royalty Assocs., L.P. v. United States, 766 F.3d 453, 464-65 (5th Cir. 2014) (finding a sham partnership where, e.g., some parties “faced effectively no risk” and also “did not meaningfully share in any potential upside”).

Tribune's minimal risk on the Senior Guarantee also is grossly disproportionate to the tax benefits it claimed from that risk. When courts apply anti-abuse doctrines in tax cases, they consider whether the claimed tax benefits are disproportionate to, e.g., expected risk or gain from the arrangement generating the tax benefits. In Reddam v. Commissioner, for example, the court found that a transaction was a sham given that “the magnitude of even the most optimistic gain is dwarfed by the magnitude of the tax loss it was designed to generate.” 755 F.3d 1051, 1061 (9th Cir. 2014). “[S]ome prospect of profit” does not give economic substance to a transaction “if the prospect of a non-tax return is grossly disproportionate to the [expected] tax benefits.” Salem Fin., Inc. v. United States, 786 F.3d 932, 949 (Fed. Cir. 2015). See also, e.g., Bank of N.Y. Mellon Corp. v. Commissioner, 801 F.3d 104, 120 (2d Cir. 2015); Blum v. Commissioner, 737 F.3d 1303, 1312 (10th Cir. 2013); Keeler v. Commissioner, 243 F.3d 1212, 1217 (10th Cir. 2001); Sala v. United States, 613 F.3d 1249, 1254 (10th Cir. 2010). Here, the magnitude by which Tribune's tax-free treatment of $425 million dwarfs its miniscule risk from the Senior Guarantee demonstrates that, under “the substance of [this] arrangement,” Tribune did not truly bear the economic risk of loss for CBH's Senior Debt, as Section 1.752-2(j)(1) requires.

5. The Tax Court's interpretation of Section 1.752-2 conflicted with its own precedent

The Tax Court's interpretation of Section 1.752-2(j) also conflicted with that court's legal analysis in the only other opinion addressing this rule. Canal Corp. v. Commissioner invalidated an indemnification that was part of a transaction structured to fit within the rules for debt-financed distributions. 135 T.C. 199, 207-10 (2010). In applying Section 1.752-2(j), Canal explained that “[t]he anti-abuse rule mandates that we consider the facts and circumstances” and did not rely on the hypothetical facts under the constructive-liquidation test in Section 1.752-2(b). Id. at 213-16. Canal focused on the indemnity that generated the claim to the tax benefits, and disregarded it “because it created no more than a remote possibility” of actual liability. 135 T.C. at 216. Here, the Tax Court similarly found that Tribune's risk was “remote” but then held that fact was “irrelevant” under Section 1.752-2(j). (SA.3, SA.101.)

The Tax Court highlighted other aspects of the Canal transaction that it found factually distinguishable from the Cubs Transaction (see SA.104-05), but it did not acknowledge or explain the stark contrast in its legal analysis between the two cases. If the Tax Court had applied its precedent in Canal, it at least would have considered — if not found dispositive — that Tribune “should not be allocated any part of” the Senior Debt due to the “remote possibility that [Tribune] would actually be liable for payment.” Canal, 135 T.C. at 216-17.

6. The Senior Guarantee should be disregarded under the Section 1.752-2(j) anti-abuse rule

The record shows that the Senior Guarantee was a contrived window dressing, designed 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.” Treas. Reg. § 1.752-2(j)(1). By misreading Section 1.752-2(j) and upholding Tribune's tax-free treatment of the $425 million of its distribution, corresponding to the Senior Guarantee, the Tax Court reached the wrong result here and paved the way for other taxpayers to claim huge tax benefits with essentially zero risk.¹³

Tribune's low risk on the Senior Guarantee was baked into the Cubs Transaction from the beginning, and other aspects of the transaction made that risk a near-nullity, as experts for both sides concluded. First, no one expected CBH to default on any of its debt, and that was even less likely for the Senior Debt. Projected revenues committed to the cash waterfall were seven to ten times the maximum annual Senior Debt expense and flowed first to the Senior Debt. (See supra at 20-24.)¹⁴ If catastrophic circumstances brought that powerful waterfall to a trickle, such that default loomed on the Senior Debt, CBH had six (or nine) months of payments in the Senior Debt reserve account, as well as access to additional liquidity through the OSA arrangements and the undrawn $25 million senior revolving loan. (See supra at 16-17, 24-26.)¹⁵ The 180-day standstill period gave CBH and MLB even more time to resolve any default, and MLB had a variety of tools to support the team and to require additional investment under, e.g., the Major League Constitution, debt-service rule, and OSA Letter Agreement. (See supra at 14-15, 24-28.¹⁶) MLB reserved the right to make a super-senior loan of up to $35 million, as well as to provide the team other support, including additional financial support — all to keep the Cubs on the field and to try, under all circumstances, to avoid seizure of the team by its creditors. (See id.¹⁷)

But even if it came to that, Tribune would not have to pay a penny on the Senior Guarantee until after the senior lenders had exhausted all remedies against all collateral — including the Chicago Cubs baseball team — and still failed to satisfy the Senior Debt. (See supra at 18-19.¹⁸) Compared to $425 million in Senior Debt, the enterprise value was $844.7 million, which Dr. Shaked (testifying for petitioners) concluded was the fair-market value of CBH's assets.¹⁹ Dr. Skinner (testifying for the Commissioner) concluded “there was almost no chance” that the value of the Cubs Assets would decline below $450 million and, with the Subordinated Debt recast as equity, found the guarantees to be “effectively worthless,” valued between $30,000 and $1.07 million. (A.1501-02.) Experts testifying for petitioners reached consistent conclusions. Dr. Chambers found that the senior lenders would fully recover under S&P's standard distress scenario (a 40% haircut). (A.1384-87 (finding an 88-89% recovery under a more severe distress scenario with a 50% haircut).) And Dr. Shivdasani calculated the present value of expected payments under the Senior Guarantee from $0 to a maximum of $1.95 million, or 0.43% of the $450 million potentially subject to the guarantee.²⁰

Looking to the actual “facts and circumstances” and the “substance of the arrangement,” as Section 1.752-2(j) requires, Tribune's miniscule risk from the Senior Guarantee does not support sheltering $425 million from tax, and the Tax Court erred in concluding otherwise. On this record — even solely on petitioners' own evidence — this Court could not only reverse and vacate the Tax Court's decision as to the Senior Guarantee but also affirmatively hold that Section 1.752-2(j) bars Tribune from treating the $425 million corresponding to the Senior Debt as a nontaxable debt-financed distribution.²¹

The Commissioner recognizes, however, that this Court may find it appropriate to remand these cases for the Tax Court to apply the correct legal analysis. See, e.g., Pullman-Standard v. Swint, 456 U.S. 273, 291-92 (1982). In any remand, the Tax Court should apply the Section 1.752-2(j) anti-abuse rule to the substance of the Senior Guarantee, considering the actual facts and circumstances surrounding the Cubs Transaction, and without considering the artificial conditions of the constructive-liquidation test in Section 1.752-2(b). The Tax Court also should disregard de minimis risk and consider the extent by which Tribune's claimed and deliberately designed tax benefits overshadow its vanishingly small risk from the Senior Guarantee.

B. The business-purpose requirement in the subchapter K anti-abuse rule, Treas. Reg. § 1.701-2, applies to “each partnership transaction,” not only to “the partnership as a whole”

1. The Tax Court's interpretation of Section 1.701-2 conflicted with the regulation's plain text

The Tax Court also failed to follow the plain text of the Section 1.701-2 anti-abuse rule. Section 1.701-2(a) explains that subchapter K was intended to allow taxpayers to jointly conduct business activities “through a flexible economic arrangement without incurring an entity-level tax.” However, to participate in that flexible arrangement, among other things, “[t]he partnership must be bona fide and each partnership transaction or series of related transactions . . . must be entered into for a substantial business purpose.” Treas. Reg. § 1.701-2(a)(1) (emphasis added). See also Russian Recovery Fund Ltd. v. United States, 122 Fed. Cl. 600, 616 (2015), aff'd on other grounds, 851 F.3d 1253 (Fed. Cir. 2017). In conflict with Section 1.701-2's plain text, the Tax Court held that the business-purpose requirement is “a broad provision applying to the function of the partnership as a whole” and not “to every agreement into which the partnership or its partners enter.” (SA.109.)

The Tax Court's understanding that the Section 1.701-2 anti-abuse rule applies only “to the function of the partnership as a whole” clashes with several aspects of the regulation that concern individual transactions. Section 1.701-2(a)(2) requires that “[t]he form of each partnership transaction must be respected under substance over form principles.” (Emphasis added.) Treas. Reg. § 1.701-2(a)(3) states that each partner's tax consequences “of partnership operations and of transactions between the partner and the partnership must accurately reflect the partners' economic agreement and clearly reflect the partner's income.” (Emphasis added.) And Treas. Reg. § 1.701-2(b) provides that “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, the Commissioner can recast the transaction for federal tax purposes. . . .” (Emphases added.)

“[E]ven though the transaction may fall within the literal words” of a statute or regulation, moreover, the Commissioner may examine the “particular facts and circumstances” and adjust or modify the claimed tax treatment “to achieve tax results that are consistent with the intent of subchapter K.”²² Treas. Reg. § 1.701-2(b). Treas. Reg. §1.701-2(c) provides a facts-and-circumstances test for determining “[w]hether a partnership was formed or availed of” to reduce tax in a manner inconsistent with the purposes of subchapter K, “including a comparison of the purported business purpose for a transaction and the claimed tax benefits resulting from the transaction.”²³ (Emphases added.) The text and structure of Section 1.701-2 make clear that this