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Russian Recovery Fund Limited v. United States

United States Court of Appeals, Federal Circuit

March 14, 2017

RUSSIAN RECOVERY FUND LIMITED, Plaintiff-Appellant
v.
UNITED STATES, Defendant-Appellee

         Appeals from the United States Court of Federal Claims in Nos. 1:06-cv-00030-EGB, 1:06-cv-00035-EGB, Senior Judge Eric G. Bruggink.

          Douglas Hallward-Driemeier, Ropes & Gray LLP, Washington, DC, argued for plaintiff-appellant. Also represented by COURTNEY M. Cox, JUSTIN FLORENCE, Kathleen Saunders Gregor, Loretta R. Richard, Boston, MA; BRITTANY CVETANOVICH, Chicago, IL.

          ANDREW M. Weiner, Tax Division, United States Department of Justice, Washington, DC, argued for defendant-appellee. Also represented by RICHARD Farber, Gilbert Steven Rothenberg, Caroline D. Ciraolo, Diana L. Erbsen.

          Before O'MALLEY, Bryson, and WALLACH, Circuit Judges.

          WALLACH, Circuit Judge.

         Appellant Russian Recovery Fund Limited ("RRF"), acting through its tax matters partners Russian Recovery Advisers, L.L.C. ("RRA") and Bracebridge Capital, L.L.C. ("Bracebridge"), sued the United States ("the Government") in the U.S. Court of Federal Claims, seeking readjustment of partnership items pursuant to the Tax Equity and Fiscal Responsibility Act ("TEFRA"), I.R.C. §§6221-6233 (2000). RRF alleges that the Internal Revenue Service's ("the IRS") October 14, 2005 Notice of Final Partnership Administrative Adjustment ("2005 FPAA") improperly disallowed approximately $50 million of losses that RRF had claimed for fiscal year 2000 and imposed a 40% penalty on any underpayment. The parties filed cross-motions for summary judgment on timeliness grounds, and the Court of Federal Claims held that the limitations period for assessing taxes against RRF's indirect partners had expired as to some, but not all, indirect partners. See Russian Recovery Fund Ltd. v. United States (RRF I), 101 Fed. CI. 498, 510-11 (2011) (granting-in-part and denying-in-part the parties' motions for summary judgment). Following trial on the claims not resolved at summary judgment, the Court of Federal Claims entered judgment for the Government, sustaining the IRS's disallowance of the losses and imposition of penalties. See Russian Recovery Fund Ltd. v. United States (RRFII), 122 Fed. CI. 600, 601-02 (2015).

         RRF appeals. We have jurisdiction pursuant to 28 U.S.C. § 1295(a)(3) (2012). We affirm.

         Background

         The Court of Federal Claims's factual findings are extensive and clearly presented. See RRF II, 122 Fed. CI. at 602-14; RRF I, 101 Fed. CI. at 500-01. Because these factual findings are largely undisputed, we recite only those facts necessary to resolve this appeal.

         There are several players of interest. Nancy Zimmerman co-founded Bracebridge, a management company. RRF II, 122 Fed. CI. at 602. Bracebridge created RRF, a hedge fund. Id. Bracebridge also manages FFIP, L.P. ("FFIP"), another fund. Id. All three-Bracebridge, RRF, and FFIP-are partnerships. RRF I, 101 Fed. CI. at 500. Relevant to this appeal, Ms. Zimmerman is a direct partner of FFIP, and FFIP is a direct partner of RRF. Id. In this context, Ms. Zimmerman is an indirect partner of RRF and represents similarly situated indirect partners of RRF (direct partners of FFIP). Id.

         In 1998, Russian sovereign debt was traded exclusively on the Moscow Interbank Currency Exchange ("MICEX"). RRF II, 122 Fed. CI. at 603-04. Non-Russian investors could not invest directly in Russian sovereign debt on the MICEX; however, they could invest in derivative instruments known as credit-linked notes ("CLNs") sold by certain authorized banks. Id. at 603. When Russia defaulted on its sovereign debt in August 1998, the Russian ruble collapsed, and CLNs lost nearly all of their value. Id. These assets also became extremely illiquid: the Russian Central Bank imposed currency exchange limitations that prevented the ruble from being freely traded, and the Russian government only allowed the authorized banks to access the debt and trade in rubles. Id.

         These events had serious consequences for Tiger Management, LLC ("Tiger"), one of the world's largest managers of hedge funds. Id. at 604. Two of Tiger's funds, foreign partnerships that do not pay U.S. taxes, had purchased CLNs through Deutsche Bank for more than $230 million. Id. After the collapse, those CLNs were worth less than 10% of their original value. Id. And Tiger overall was in bad straits: in 1998, Tiger managed $22 billion; but by 2000, that amount had dropped to $6 billion as a result of heavy losses in Russian debt, Asian debt, and an investment in U.S. Airways. Id. at 613. During that period, Tiger needed cash to redeem the shares of investors who wanted out, but the capital controls on Russian debt hampered Tiger's ability to sell its devalued CLNs. Id.; see id. at 604 & n.9.

         Ms. Zimmerman "believed that she could make money for herself and investors by obtaining devalued Russian debt at pennies on the dollar in anticipation of a recovery of the ruble and hence something approaching face value of debt instruments." Id. at 603. As a result, Bracebridge established RRF and sought holders of Russian securities to contribute CLNs or cash in exchange for shares of RRF. Id. at 603-04; see J.A. 1758. Bracebridge also established RRA, a separate management company to advise RRF and collect management fees. RRFII, 122 Fed. CI. at 602.

         Despite earnest marketing efforts by Bracebridge during the first several months, RRF largely failed to obtain investors and still had no assets in March 1999. Id. at 605. An internal Bracebridge email on March 9, 1999 discussed a potential contribution of CLNs from an entity through Deutsche Bank. Id. Given concern that RRF needed partners to attract the potential investor, the email proposed having Bracebridge-controlled entities become RRF partners. Id. A telephone list circulated the next day contained the contact information of players from Bracebridge, Deutsche Bank, and Tiger. Id.

         In April 1999, FFIP "contribute[d] the first assets to RRF." Id.; see id. at 602. Then, on April 30, 1999, Brace-bridge's James DiBiase emailed Ms. Zimmerman about the "need[]" to represent that a "high" percentage "of RRF (i.e., FFIP) is owned by individuals" to attract Deutsche Bank's investors. Id. at 606 (internal quotation marks and citation omitted). In a second email on May 14, 1999, he advised Ms. Zimmerman that RRF should not allow corporations to join because "it could possibly impair one of our most valuable assets, " i.e., "the built-in losses in Russian depreciated assets that might end up in RRF." Id. (internal quotation marks and citation omitted). As explained in a later email by Mr. DiBiase, the presence of corporations could preclude later resale "since people interested in buying tax losses don't want to transact with corporations." Id. (internal quotation marks and citation omitted).

         A series of transactions followed, each of which was orchestrated by Deutsche Bank. Id. at 604, 620. First, in late May 1999, RRF's first two substantial outside investors-both funds operated by Tiger-transferred CLNs to RRF in exchange for an ownership interest in RRF. Id. at 607. Prior to investing, however, Tiger requested certain changes to the "standard RRF offering memorandum" and refused to execute the standard subscription agreement representing that "the Shares subscribed for hereby are being acquired by the undersigned for investment purposes only, for the account of the undersigned[, ] and not with a view to any sale or distribution thereof." Id. (paraphrasing J.A. 8178); see J.A. 5898-99. In response, RRF reduced the three-year lock-up period to "allow[] Tiger to redeem its shares on or after July 1, 1999, in exchange for cash or assets 'in kind, '" and excluded the representation that Tiger was purchasing the shares "for investment purposes only" from the subscription agreement. RRF II, 122 Fed. CI. at 607; see J.A. 8853, 8900, 8945-48. Second, on June 3, 1999 (i.e., approximately two weeks after the first transaction between RRF and Tiger), "Tiger sold all of its RRF partnership shares to FFIP" for approximately $14.1 million, a discount of $800, 000. RRF II, 122 Fed. CI. at 609; see J.A. 9069. Notably, during the two weeks between Tiger's acquisition of its ownership interest in RRF and its sale of that interest to FFIP, the value of the shares had in fact increased. RRF II, 122 Fed. CI. at 609. And a fax from Deutsche Bank to Mr. DiBiase during this period makes clear that "it was RRF, not Tiger, that would have had an interest in an entity like FFIP purchasing [Tiger's] shares" and acquiring the built-in losses. Id. at 608. Third, on June 22, 1999, RRF sold 77.18% of the Tiger CLNs to General Cigar Corporation ("General Cigar") for cash and shares. Id. at 609; see J.A. 4992-95. Finally, in 2000, RRF sold the remaining 22.82% of the Tiger CLNs on the open market. RRF II, 122 Fed. CI. at 609-10.

         Following these transactions, Mr. DiBiase began working with Ernst & Young to "provide[] the documents and facts that would collectively lay the foundation upon which the accountants would prepare RRF's [tax] returns." Id. at 622. On August 14, 2001, RRF filed its 2000 tax return, allocating a loss to FFIP, which included a loss of $49, 786, 826 from the sale of the 22.82% of the Tiger CLNs. Id. at 609-10; RRF I, 101 Fed. CI. at 500; see J.A. 1621-23, 9496.[1] FFIP then reported losses for the 2000 and 2001 tax years, much of which were attributable to the loss claimed by RRF in 2000. RRF I, 101 Fed. CI. at 500. FFIP's 2001 losses flowed through FFIP to Ms. Zimmerman, who filed her 2001 individual tax return on October 15, 2002. Id. On her 2001 individual tax return, Ms. Zimmerman reported a "substantial amount" of RRF's loss. Id. "In other words, the bulk of the losses RRF allocated to FFIP in 2000 were not passed through in 2000, but were retained by FFIP until 2001, at which point the losses impacted Ms. Zimmerman's 2001 return." Id.

         In 2005, the IRS performed an audit of FFIP's 2001 partnership return, which ultimately resulted in the issuance of a "no adjustments letter" to FFIP. Id. at 501; see J.A. 201. However, in October 2005, the IRS issued the 2005 FPAA to RRF for its 2000 tax year, which disallowed the loss RRF claimed for the sale of the Tiger CLNs and imposed a 40% penalty. RRF I, 101 Fed. CI. at 501; RRF II, 122 Fed. CI. at 621.

         Discussion

         RRF argues that the Court of Federal Claims erred by (1) denying its cross-motion for summary judgment in RRF I because "the proposed assessments were time-barred, " Appellant's Br. 22 (capitalization omitted); (2)"holding that Tiger's contributions to RRF were not valid partnership contributions, " id. at 33 (capitalization modified); and (3) "upholding a massive penalty based on its new partnership requirements, " id. at 55 (capitalization omitted). After articulating the relevant standard of review, we address these arguments in turn.

         I. Standard of Review

         The present appeal involves factual findings and legal conclusions reached on summary judgment and following trial. "We review the Court of Federal Claims'[s] grant of summary judgment under a de novo standard of review, with justifiable factual inferences being drawn in favor of the party opposing summary judgment." Winstar Corp. v. United States, 64 F.3d 1531, 1539 (Fed. Cir. 1995) (en banc) (citation omitted), aff'd, 518 U.S. 839 (1996). In appeals following a trial, we review the Court of Federal Claims's legal conclusions de novo and its factual findings for clear error. See John R. Sand & Gravel Co. v. United States, 457 F.3d 1345, 1353 (Fed. Cir. 2006).

         The present appeal also raises issues of statutory and regulatory construction, the characterization of transactions for tax purposes, and the reasonable cause exception to tax penalties. "We . . . review questions of statutory and regulatory construction without deference." SRA Int'l, Inc. v. United States,766 F.3d 1409, 1412 (Fed. Cir. 2014). "We review the characterization of transactions for tax purposes de novo, based on underlying findings of fact, which we review for clear error." Wells Fargo & Co. v. United States, 641 F.3d 1319, 1325 (Fed. Cir. 2011) (citation omitted). Finally, as to the reasonable cause exception to tax penalties, "[w]hether the elements that constitute reasonable cause are present in a given situation is a question of fact, but what ...


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