SUPREME COURT OF THE UNITED STATES

RAYMOND B. YATES, M. D., P. C. PROFIT SHARING PLAN et al. v. HENDON, TRUSTEE

CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

Enacted “to protect … the interests of participants in employee benefit plans and their beneficiaries,” 29 U.S.C. § 1001(b), the Employee Retirement Income Security Act of 1974 (ERISA) comprises four titles. Relevant here, Title I, 29 U.S. C. §1001 et seq., mandates minimum participation, vesting, and funding schedules for covered pension plans, and establishes fiduciary conduct standards for plan administrators. Title II, codified in 26 U.S. C., amended various Internal Revenue Code (IRC) provisions pertaining to qualification of pension plans for special tax treatment, in order, inter alia, to conform to Title I’s standards. Title III, 29 U.S. C. §1201 et seq., contains provisions designed to coordinate enforcement efforts of different federal departments. Title IV, 29 U.S.C. § 1301 et seq., created the Pension Benefit Guaranty Corporation and an insurance program to protect employees against the loss of “nonforfeitable” benefits upon termination of pension plans lacking sufficient funds to pay benefits in full. This case concerns Title I’s definition and coverage provisions, though those provisions, indicating who may participate in an ERISA-sheltered plan, inform each of ERISA’s four titles. Title I defines “employee benefit plan” as “an employee welfare benefit plan or an employee pension benefit plan or … both,” §1002(3); “participant” to encompass “any employee … eligible to receive a benefit … from an employee benefit plan,” §1002(7); “employee” as “any individual employed by an employer,” §1002(6); and “employer” to include “any person acting … as an employer, or … in the interest of an employer,” §1002(5).

        Yates was sole shareholder and president of a professional corporation that maintained a profit sharing plan (Plan). From the Plan’s inception, at least one person other than Yates or his wife was a Plan participant. The Plan qualified for favorable tax treatment under IRC §401. As required by the IRC, 26 U.S.C. §401(a)(13), and ERISA, 29 U.S. C. §1056(d), the Plan contained an anti-alienation provision. Entitled “Spendthrift Clause,” the provision stated, in relevant part: “Except for … loans to Participants as [expressly provided for in the Plan], no benefit or interest available hereunder will be subject to assignment or alienation.” In December 1989, Yates borrowed $20,000 from another of his corporation’s pension plans (which later merged into the Plan), but failed to make any of the required monthly payments. In November 1996, however, Yates paid off the loan in full with the proceeds of the sale of his house. Three weeks later, Yates’s creditors filed an involuntary petition against him under Chapter 7 of the Bankruptcy Code. Respondent Hendon, the Bankruptcy Trustee, filed a complaint against petitioners (the Plan and Yates, as Plan trustee), asking the Bankruptcy Court to avoid the loan repayment. Granting Hendon summary judgment, the Bankruptcy Court first determined that the repayment qualified as a preferential transfer under 11 U.S.C. § 547(b). That finding was not challenged on appeal. The Bankruptcy Court then held that the Plan and Yates, as Plan trustee, could not rely on the Plan’s anti-alienation provision to prevent Hendon from recovering the loan repayment for the bankruptcy estate. That holding was dictated by Sixth Circuit precedent, under which a self-employed owner of a pension plan’s corporate sponsor could not “participate” as an “employee” under ERISA and therefore could not use ERISA’s provisions to enforce the restriction on transfer of his beneficial interest in the plan. The District Court and the Sixth Circuit affirmed on the same ground. The Sixth Circuit’s determination that Yates was not a “participant” in the Plan for ERISA purposes obviated the question whether, had Yates qualified as such a participant, his loan repayment would have been shielded from the Bankruptcy Trustee’s reach.

Held: The working owner of a business (here, the sole shareholder and president of a professional corporation) may qualify as a “participant” in a pension plan covered by ERISA. If the plan covers one or more employees other than the business owner and his or her spouse, the working owner may participate on equal terms with other plan participants. Such a working owner, in common with other employees, qualifies for the protections ERISA affords plan participants and is governed by the rights and remedies ERISA specifies. Pp. 8—20.

    (a) Congress intended working owners to qualify as plan participants. Because ERISA’s definitions of “employee” and, in turn, “participant” are uninformative, the Court looks to other ERISA provisions for instruction. See Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323. ERISA’s multiple textual indications that Congress intended working owners to qualify as plan participants provide, in combination, “specific guidance,” ibid., so there is no cause in this case to resort to common law. ERISA’s enactment in 1974 did not change the existing backdrop of IRC provisions permitting corporate shareholders, partners, and sole proprietors to participate in tax-qualified pension plans. Rather, Congress’ objective was to harmonize ERISA with these longstanding tax provisions. Title I of ERISA and related IRC provisions expressly contemplate the participation of working owners in covered benefit plans. Most notably, Title I frees certain plans in which working owners likely participate from all of ERISA’s fiduciary responsibility requirements. See 29 U.S.C. § 1101(a) and 26 U.S.C. § 414(q)(1)(A) and 416(i)(1)(B)(i). Title I also contains more limited exemptions from ERISA’s fiduciary responsibility requirements for plans that ordinarily include working owners as participants. See 29 U.S.C. § 1103(a) and (b)(3)(A) and 26 U.S.C. §401(c)(1) and (2)(A)(i), 1402(a) and (c). Further, Title I contains exemptions from ERISA’s prohibited transaction exemptions, which, like the fiduciary responsibility exemptions, indicate that working owners may participate in ERISA-qualified plans. See 29 U.S. C. §§1108(b)(1)(B) and (d)(1) and 26 U.S.C. §401(c)(3). Exemptions of this order would be unnecessary if working owners could not qualify as participants in ERISA-protected plans in the first place. Provisions of Title IV of ERISA are corroborative. For example, Title IV does not apply to plans “established and maintained exclusively for substantial owners,” §1321(b)(9) (emphasis added), a category that includes sole proprietors and shareholders and partners with a ten percent or greater ownership interest, §1322(b)(5)(A). But Title IV does cover plans in which substantial owners participate along with other employees. See §1322(b)(5)(B). Particularly instructive, Title IV and the IRC, as amended by Title II, clarify a key point missed by several lower courts: Under ERISA, a working owner may wear two hats, i.e., he can be an employee entitled to participate in a plan and, at the same time, the employer who established the plan. See §1301(b)(1) and 26 U.S. C. §401(c)(4). Congress’ aim to promote and facilitate employee benefit plans is advanced by the Court’s reading of ERISA’s text. The working employer’s opportunity personally to participate and gain ERISA coverage serves as an incentive to the creation of plans that will benefit employer and nonowner employees alike. Treating the working owner as a participant in an ERISA-sheltered plan also avoids the anomaly that the same plan will be controlled by discrete regimes: federal-law governance for the nonowner employees; state-law governance for the working owner. Excepting working owners from ERISA’s coverage is hardly consistent with the statutory goal of “uniform national treatment of pension benefits,” Patterson v. Shumate, 504 U.S. 753, 765, and would generate administrative difficulties. A 1999 Department of Labor advisory opinion (hereinafter Advisory Opinion 99—04A) accords with the Court’s comprehension of Title I’s definition and coverage provisions. Concluding that working owners may qualify as participants in ERISA-protected plans, the Department’s opinion reflects a “body of experience and informed judgment to which courts and litigants may properly resort for guidance.” Skidmore v. Swift & Co., 323 U.S. 134, 140. Pp. 8—14.

    (b) This Court rejects the lower courts’ position that a working owner may rank only as an “employer” and not also as an “employee” for purposes of ERISA-sheltered plan participation. The Sixth Circuit’s leading decision in point relied, in large part, on an incorrect reading of a portion of a Department of Labor regulation, 29 CFR § 2510.3—3, which states: “[T]he term ‘employee benefit plan’ [as used in Title I] shall not include any plan … under which no employees are participants”; “[f]or purposes of this section,” “an individual and his or her spouse shall not be deemed to be employees with respect to a … business” they own. (Emphasis added.) In common with other Courts of Appeals that have held working owners do not qualify as participants in ERISA-governed plans, the Sixth Circuit apparently understood the regulation to provide a generally applicable definition of “employee,” controlling for all Title I purposes. The Labor Department’s Advisory Opinion 99—04A, however, interprets the regulation to mean that the statutory term “employee benefit plan” does not include a plan whose only participants are the owner and his or her spouse, but does include a plan that covers as participants one or more common-law employees, in addition to the self-employed individuals. This agency view, overlooked by the Sixth Circuit, merits the Judiciary’s respectful consideration. Cf. Clackamas Gastroenterology Assoc., P. C., 538 U.S., at ___. Moreover, the Department’s regulation itself reveals the definitional prescription’s limited scope. The prescription describes “employees” only “[f]or purposes of this section,” i.e., the section defining “employee benefit plans.” Accordingly, the regulation addresses only what plans qualify as “employee benefit plans” under ERISA’s Title I. Plans that cover only sole owners or partners and their spouses, the regulation instructs, fall outside Title I’s domain, while plans that cover working owners and their nonowner employees fall entirely within ERISA’s compass. The Sixth Circuit’s leading decision also mistakenly relied on ERISA’s “anti-inurement” provision, 29 U.S. C. §1103(c)(1), which states that plan assets shall not inure to the benefit of employers. Correctly read, that provision does not preclude Title I coverage of working owners as plan participants. It demands only that plan assets be held to supply benefits to plan participants. Its purpose is to apply the law of trusts to discourage abuses such as self-dealing, imprudent investment, and misappropriation of plan assets, by employers and others. Those concerns are not implicated by paying benefits to working owners who participate on an equal basis with nonowner employees in ERISA-protected plans. This Court expresses no opinion as to whether Yates himself, in his handling of loan repayments, engaged in conduct inconsistent with the anti-inurement provision, an issue not yet reached by the courts below. Pp. 14—20.

    (c) Given the undisputed fact that Yates failed to honor his loan’s periodic repayment requirements, these questions should be addressed on remand: (1) Did the November 1996 close-to-bankruptcy repayments, despite the prior defaults, become a portion of Yates’s interest in the Plan that is excluded from his bankruptcy estate and (2) if so, were the repayments beyond the reach of the Bankruptcy Trustee’s power to avoid and recover preferential transfers? P. 20.

287 F.3d 521, reversed and remanded.

    Ginsburg, J., delivered the opinion of the Court, in which Rehnquist, C. J., and Stevens, O’Connor, Kennedy, Souter, and Breyer, JJ., joined. Scalia, J., and Thomas, J., each filed an opinion concurring in the judgment.

OPINION AND ORDER ON MOTION TO ALLOW TRUSTEE
TO TAKE ANY AND ALL NECESSARY ACTIONS TO LIQUIDATE PROPERTY
OWNED BY WESTERN BLUE SKY LLC

THIS MATTER is before the Court on the (1) Motion to Allow Trustee to Take Any and All Necessary Actions to Liquidate Property Owned by Western Blue Sky LLC ("Motion to Liquidate"); (2) Motion to Appoint and Compensate Bob Karls as Real Estate Broker to the Trustee; and (3) Debtor's Response to Trustee's Motion to Retain Realtor and Liquidate LLC Property. Following a hearing on February 4, 2003, the parties agreed to submit the matter on briefs.

Ashley Albright, the debtor in this Chapter 7 case ("Debtor"), is the sole member and manager of a Colorado limited liability company named Western Blue Sky LLC. n1 The LLC owns certain real property located in Saguache County, Colorado (the "Real Property"). The LLC is not a debtor in bankruptcy.

n1 The Debtor initiated this case on February 9, 2001, under Chapter 13. It was converted to Chapter 7 by the Debtor on July 19, 2001.

The Chapter 7 Trustee contends that because the Debtor was the sole member and manager of the LLC at the time she filed bankruptcy, he now controls the LLC and he may cause the LLC to sell the Real Property and distribute the net sales proceeds to his bankruptcy estate. n2 The Debtor maintains that, at best, the Trustee is entitled to a charging order n3 and cannot assume management of the LLC or cause the LLC to sell the Real Property.

n2 If the Trustee is entitled to control of the LLC, he could, presumably, as an alternative, dissolve the LLC, distribute its property to his bankruptcy estate, and then sell the property himself. The Trustee has not asserted any alter ego theory and has not attempted to pierce the veil of the LLC.

n3 The Debtor further asserts that because the LLC is "non-profit" pursuant to its operating agreement, no distribution of "profit" will ever be made and thus the value of this interest is zero. This argument erroneously assumes that a member of a Colorado limited liability company's distribution rights are limited only to "profits." They are not. Colo. Rev. Stat. § 7-80-102(10)("Membership interest means a member's share of the profits and losses of a limited liability company and the right to receive distributions of such company's assets.") See also Colo. Rev. Stat. § 7-80-702(1).

Pursuant to the Colorado limited liability company statute, the Debtor's membership interest constitutes the personal property of the member. Upon the Debtor's bankruptcy filing, she effectively transferred her membership interest to the estate. See 11 U.S.C. § 541(a). n4 Because there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate, and the Trustee has become a "substituted member." n5

n4 11 U.S.C. § 541(a)(1) provides, in relevant part: "The commencement of a case ... creates an estate. Such estate is comprised of ... all legal or equitable interests of the debtor in property as of the commencement of the case."

n5 Colo. Rev. Stat. § 7-80-702 provides (emphasis added):

(1) The interest of each member in a limited liability company constitutes the personal property of the member and may be transferred or assigned. However, if all of the other members of the limited liability company other than the member proposing to dispose of his or its interest do not approve of the proposed transfer or assignment by unanimous written consent, the transferee of the member's interest shall have no right to participate in the management of the business and affairs of the limited liability company or to become a member. The transferee shall only be entitled to receive the share of profits or other compensation by way of income and the return of contributions to which that member would otherwise be entitled.

(2) A substituted member is a person admitted to all the rights of a member who has died or has assigned his interest in a limited liability company with the approval of all the members of the limited liability company by unanimous written consent. The substituted member has all the rights and powers and is subject to all the restrictions and liabilities of his assignor; except that the substitution of the assignee does not release the assignor from liability to the limited liability company under section 7-80-502.

Section 7-80-702 of the Limited Liability Company Act requires the unanimous consent of "other members" in order to allow a transferee to participate in the management of the LLC. n6 Because there are no other members in the LLC, no written unanimous approval of the transfer was necessary. Consequently, the Debtor's bankruptcy filing effectively assigned her entire membership interest in the LLC to the bankruptcy estate, and the Trustee obtained all her rights, including the right to control the management of the LLC. n7

n6 This reading of § 7-80-702 is reinforced in Colo. Rev. Stat. § 7-80-108(3)(a). Section 108 sets forth the effect of an operating agreement and what provisions are non-waivable. Section 108(3) states that "unless contained in a written operating agreement or other writing approved in accordance with a written operating agreement, no operating agreement may [...] vary the requirement under section 7-80-702(1) that, if all of the other members of the limited liability company other than the member proposing to dispose of the member's interest do not approve of the proposed transfer or assignment by unanimous written consent, the transferee of the member's interest shall have no right to participate in the management of the business and affairs of the limited liability company or to become a member." Colo. Rev. Stat. § 7-80-108(3)(a). The clause "other than the member proposing to dispose of the member's interest" confirms that the "other members" identified in § 7-80-702 does not include the transferee..

n7 Under Colo. Rev. Stat. § 7-80-702, supra, the result would be different if there were other non-debtor members in the LLC. Where a single member files bankruptcy while the other members of a multi-member LLC do not, and where the non-debtor members do not consent to a substitute member status for a member interest transferee, the bankruptcy estate is only entitled to receive the share of profits or other compensation by way of income and the return of the contributions to which that member would otherwise be entitled. Thus, Mountain States Bank v. Irwin, 809 P.2d 1113 (Colo. App. 1991); Union Colony Bank v. United Bank of Greeley National Association, 832 P.2d 1112 (Colo. App. 1992) and Prefer v. Pharmnetrx LLC, 18 P.3d 844 (Colo.. App. 2000), cited by the parties, are distinguishable as they relate to multi-partner or member entities.

The Debtor argues that the Trustee acts merely for her creditors and is only entitled to a charging order against distributions made on account of her LLC member interest. n8 However, the charging order, as set forth in Section 703 of the Colorado Limited Liability Company Act, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties' interests affected. n9

n8 Colo. Rev. Stat. § 7-80-703 provides:
Rights of creditor against a member. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest thereon and may then or later appoint a receiver of the member's share of the profits and of any other money due or to become due to the member in respect of the limited liability company and make all other orders, directions, accounts, and inquiries which the debtor member might have made, or which the circumstances of the case may require. To the extent so charged, except as provided in this section, the judgment creditor has only the rights of an assignee of the membership interest. The membership interest charged may be redeemed at any time before foreclosure. If the sale is directed by the court, the membership may be purchased without causing a dissolution with separate property by any one or more of the members. With the consent of all members whose membership interests are not being charged or sold, the membership may be purchased without causing a dissolution with property of the limited liability company. This article shall not deprive any member of the benefit of any exemption laws applicable to the member's membership interest.

n9 The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to Colo. Rev. Stat. § 7-80-702, if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, 7-80-702 does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with "peppercorn" co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. 11 U.S.C. § § 544(b)(1) and 548(a).

The Colorado limited liability company statute provides that the members, including the sole member of a single member limited liability company, have the power to elect and change managers. n10 Because the Trustee became the sole member of Western Blue Sky LLC upon the Debtor's bankruptcy filing, the Trustee now controls, directly or indirectly, all governance of that entity, including decisions regarding liquidation of the entity's assets.

n10 See Colo. Rev. Stat. § 7-80-402 and § 7-80-405.

Because of the Court's ruling herein, the Debtor may be entitled to a claim for her contributions made to preserve an asset of this bankruptcy estate based on post-petition mortgage payments on the Real Property. The parties were asked to brief the issue, but the Debtor has not formally asserted such a claim. Therefore, the Court does not rule on the issue at this time.

Based on the foregoing, it is hereby:

ORDERED that the Trustee, as sole member, controls the Western Blue Sky LLC and may cause the LLC to sell its property and distribute net proceeds to his estate. Alternatively, the Trustee may elect to distribute the LLC's property to [*9] the bankruptcy estate, and, in turn, liquidate that property himself; and it is

FURTHER ORDERED that the Trustee's Motion to appoint Bob Karls as real estate broker for the Trustee is hereby granted; and it is

FURTHER ORDERED that the Debtor may file a claim, subject to objection in the regular course of this case, for her expenditures made to preserve an asset of this estate based on post-petition mortgage or other payments made by the Debtor.

DATED: 4-4-03

BY THE COURT:

A. Bruce Campbell
U.S. Bankruptcy Judge



 

OPINION DENYING DEFENDANT'S MOTION TO DISMISS
FIESTA INVESTMENTS, LLC

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ARIZONA
In re ) Chapter 7
GREGORY LEO EHMANN, ) CASE NO. 2-00-05708-RJH
Debtor. )

LOUIS A. MOVITZ, Trustee, ))

Plaintiff, ) ADVERSARY NO. 04-00956

OPINION DENYING DEFENDANT’S
FIESTA INVESTMENTS, LLC, ) MOTION TO DISMISS COUNT I

Defendant. )

The Court here concludes that because the operating agreement of a limited liability company imposes no obligations on its members, it is not an executory contract. Consequently when a member who is not the manager files a Chapter 7 case, his trustee acquires all of the member’s rights and interests pursuant to Bankruptcy Code1 §§ 541(a) and (c)(1), and the limitations of §§365(c) and (e) do not apply.

Procedural Background
Plaintiff Louis A. Movitz (“Trustee”) is the Chapter 7 Trustee for the estate of Debtor Gregory L. Ehmann (“Debtor”). The Trustee has sued Defendant Fiesta Investments, LLC (“Defendant” or “Fiesta”), an Arizona limited liability company of which the Debtor was a member when his bankruptcy case was filed. The Trustee’s suit seeks a declaration that the Trustee has the status of a member in Fiesta, a determination that the assets of Fiesta are being wasted, misapplied or diverted for improper purposes, and an order for dissolution and liquidation of Fiesta or the appointment of a receiver for Fiesta.

Fiesta has moved to dismiss the complaint. The Court understood Fiesta’s motion as directed to Count II of the complaint to be based solely on an argument that the Court lacks subject matter jurisdiction, which this Court has already denied. The motion to dismiss Count I rests more on substantive law, arguing essentially that the Trustee has no rights with respect to Fiesta other than the right to receive a distribution that might have been made to the Debtor if and when Fiesta decides to make such a distribution. Such a motion to dismiss should be granted only if the Court concludes that the Trustee could prove no set of facts that would entitle him to any remedy other than simply waiting to see if Fiesta should ever decide to make a distribution.

Background Facts
The Trustee’s complaint identifies Fiesta as an Arizona limited liability company that was formed in approximately 1998 by the Debtor’s parents, Anthony and Alice Ehmann. At the time it was formed, it had two assets, a 17% interest in City Leasing Co. Ltd. and 25% interest in Desert Farms LLC. Shortly after this bankruptcy case was filed, however, City Leasing was liquidated and as a result of that liquidation Fiesta received cash distributions in the amount of approximately $837,000 in the summer of 2000. Fiesta is still receiving regular quarterly distributions of cash from its other asset, Desert Farms.

The Trustee’s complaint stems from the fact that although no formal distributions have been declared or paid to members, and certainly not to the Debtor, substantial amounts of cash have flowed out of Fiesta to or for the benefit of other members, including $374,500 in loans to members or to corporations owned or controlled by members, a $42,500 payment to one member, and $124,000 paid to another member to redeem his interest. In response to the Trustee’s demand for information and distributions, the managing member of Fiesta, the Debtor’s father, responded that he had created “Fiesta a few years ago to remove assets from our estate for estate tax purposes, and to accumulate investments for the benefit of our children after our deaths .

[W]e see no reason to accede to the wishes of any member or assignee of any member which runs contrary to our original goals.” Yet the outflow of over half a million dollars does not seem to be consistent with the original goal “to accumulate investments for the benefit of our children after our deaths.”



The Parties’ Arguments
While the parties disagree on several relevant legal principles, a dispute that is absolutely central to the motion to dismiss is whether the Trustee’s rights are governed by Bankruptcy Code § 541(c)(1) or by § 365(e)(2). In a very general sense, the latter provision, if applicable, permits the enforcement of state and contract law restrictions on the Trustee’s rights and powers, whereas the former provision, if applicable, would render such restrictions and conditions unenforceable as against the Trustee. Because § 541 applies generally to all property and rights that the Trustee acquires, whereas § 365 applies more specifically to executory contract rights, the answer to this question hinges on whether the Trustee is asserting a property right or an executory contract right.

The Trustee’s complaint does not expressly seek to exercise any rights under an executory contract, nor does it identify the Fiesta Operating Agreement as being an executory contract, but merely attaches it as an exhibit. Indeed, as Fiesta notes, the deadline for the Trustee to have assumed or rejected an executory contract has long since passed.2 In its motion to dismiss, Fiesta relies heavily on various provisions of the Fiesta Operating Agreement which provide that in the event a trustee acquires a member’s interests, such action shall not dissolve the company or entitle “any such assignee to participate in the management of the business and affairs of the company or to exercise the right of a Member unless such assignee is admitted as a Member . . . .” Operating Agreement ¶7.2. “Such an assignee that has not become a Member is only entitled to receive to the extent assigned the share of distributions . . . to which such Member would otherwise be entitled with respect to the assigned interest.” Id. Fiesta further notes that such limitations on the rights of assignees of members’ interests in LLCs are specifically authorized by state law, Arizona Revised Statutes (“A.R.S.”) § 29-732(A). Fiesta also argues that the Trustee is akin to a judgment creditor, and that A.R.S. § 29-655(c) provides that a charging order is the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the member’s interest in an LLC. Nowhere in its motion to dismiss, however, does Fiesta argue that the Operating Agreement creates an executory contract between Members and the LLC, that § 365(e)(2) renders such provisions on which Fiesta relies enforceable against the Trustee, or that § 541(c)(1) is for some other reason inapplicable.

In response, the Trustee argues that he is not a mere assignee of the Debtor’s membership interest, but rather acquired all of the Debtor’s right, title and interest pursuant to §541(a). He argues, further, that the Trustee took the Debtor’s rights free of certain conditions and restrictions that would otherwise devalue the asset in the hands of any other assignee, pursuant to § 541(c)(1).

In reply, Fiesta relies on § 365(e) to maintain that the state and contract law restrictions are enforceable against the Trustee notwithstanding § 541(c)(1). Nowhere, however, does Fiesta ever establish, much less even attempt to demonstrate, that the Trustee’s complaint seeks to enforce rights under an executory contract. To the contrary, Fiesta simply assumes or flatly asserts that the Trustee’s rights hinge entirely on an executory contract: “In the case at bar, there is no dispute that if the Operating Agreement is considered as a partnership agreement it is an executory contract.” Fiesta Reply at 6. And yet the very case that Fiesta cites after making that assertion itself concluded that a partnership relationship may include both an executory contract and a nonexecutory property interest in the profits and surplus. Cutler v. Cutler (In re Cutler), 165 B.R. 275, 280 (Bankr. D. Ariz. 1994)(Case, B.J.).

If a partnership relation entails both executory contract rights and nonexecutory property rights, then it would seem to necessitate a threshold determination of which kind of rights are at issue for the particular kind of relief a Trustee seeks with respect to a partnership or LLC. Before reaching that issue, however, it may be fruitful first to examine whether the Fiesta Operating Agreement even includes any executory contract rights.




Legal Analysis
Although the Bankruptcy Code contains no definition of an executory contract, the Ninth Circuit has adopted the “Countryman Test”: “[A] contract is executory if ‘the obligations of both parties are so far unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.’”3

While Fiesta undoubtedly owes many obligations to its members pursuant to the Operating Agreement, for the contract to be executory there would also have to be some material obligation owing to the company by the member. Moreover, such member’s obligation must be so material that if the member did not perform it, Fiesta would owe no further obligations to that member.

As noted above, in its briefing on the motion to dismiss Fiesta has not attempted to demonstrate that the Operating Agreement is in fact an executory contract, much less to demonstrate exactly what material obligation is owed to the company by its members. Moreover, the founding member’s statement of the purposes for which the company was formed suggests that it is very likely there are no such obligations. The purpose was twofold: to remove assets from the parents’ estates for estate tax purposes, and to accumulate investments for the benefit of their children after their deaths. One would certainly not expect the children-members to have any obligations with respect to satisfaction of that first goal, which was a unilateral act by the parents, and it is highly unlikely the children-members undertook any obligations with respect to the second goal, any more than would an ordinary prospective heir.

This suspicion is borne out by a close reading of the Operating Agreement itself. It imposes many obligations on the managers, but as noted above the manager is the Debtor’s father, not the Debtor. Article V is entitled “Rights and Obligations of Members,” but in fact it identifies only rights and no obligations. It (1) limits members’ liability for company debts, (2) grants members the right to obtain a list of other members, grants members the right to approve by majority vote the sale, exchange or other disposition of all or substantially all of the company’s assets, (4) grants the members rights to inspect and copy any documents, (5) grants members the same priority as to return of capital contributions or to profits and losses, and (6) grants the permissible transferee of a member’s interests the right to require the company to adjust the basis of the company’s property and the capital account of the affected member. In short, the Article of the Operating Agreement that is partially titled “Obligations of Members” reveals that members have no obligations to the company.

In the entire Agreement, the only provision where members, who are not managers, agree to do anything is Article 7.4, which provides in part that “Each member agrees not to voluntarily withdraw from the company as a member . . . .” It is now questionable in the Ninth Circuit whether such an agreement merely to refrain from acting is sufficient, standing alone, to create an executory contract.4 But we need not go that far to resolve this issue, because the sentence in which each member agrees not to voluntarily withdraw goes on to say: “[A]nd each Member further agrees that if he attempts to withdraw from the Company in violation of the provisions of this paragraph, he shall receive One Dollar ($1.00) in payment of his interest in the Company and the remaining portion of such Member’s interest shall be retained by the Company as liquidated damages.” This reveals that what at first may have appeared as a mandatory obligation is in fact merely an option, which gives each member the option of withdrawing if he is willing to accept $1.00 for his interest. But under Helms, such an unexercised option is not an executory contract.5

As demonstrated by the excellent analysis in Smith,6 it is facile to assume that all partnership agreements are executory contracts. Closer analysis reveals that if there are no material obligations that must be performed by the members of a limited liability company or the limited partners in a limited partnership, then the contract is not executory and is not governed by Code § 365.7 This case is therefore unlike others that have expressly found “an obligation to contribute capital” and other “continuing fiduciary obligations among the partners that make this [Partnership] Agreement an executory contract.”8

In the absence of any obligation on the part of the member, it is difficult to see where an executory contract lies. This is consistent with the whole purpose of Fiesta. It was created simply as a way to reduce the estate tax liabilities that might otherwise have been incurred upon the death of the parents and the distribution of their estate to their heirs. Indeed, as King Lear suggests, the irrevocable transfer of the parents’ assets to Fiesta and the irrevocable gift of membership interests in Fiesta to their children probably creates even less obligations on the children than the ordinary filial obligations morally felt by most expectant heirs.

Moreover, not only do there not appear to be any obligations imposed upon members by the Fiesta Operating Agreement, but there are certainly none with respect to either receipt of a distribution or proper management of the company by its managers. Members do not have to do anything to be entitled to proper management of the company by the managers. The Trustee’s complaint does not involve the Debtor’s lone arguable obligation not to voluntarily withdraw.

Because there are no obligations imposed on members that bear on the rights the Trustee seeks to assert here, the Trustee’s rights are not controlled by the law of executory contracts and Bankruptcy Code § 365. Consequently the Trustee’s rights are controlled by the more general provision governing property of the estate, which is Bankruptcy Code § 541.

Code § 541(c)(1) expressly provides that an interest of the debtor becomes property of the estate notwithstanding any agreement or applicable law that would otherwise restrict or condition transfer of such interest by the debtor. All of the limitations in the Operating Agreement, and all of the provisions of Arizona law on which Fiesta relies, constitute conditions

and restrictions upon the member’s transfer of his interest. Code § 541(c)(1) renders those restrictions inapplicable. This necessarily implies the Trustee has all of the rights and powers with respect to Fiesta that the Debtor held as of the commencement of the case.

It therefore appears that the Trustee may be able to prove a set of facts that would entitle the Trustee to some remedy. The appropriate remedy might include a declaration of the Trustee’s rights, redemption of the Debtor’s interest,9 appointment of a receiver to operate the partnership in accordance with its purposes and the members’ rights,10 or dissolution, wind up and liquidation. Consequently Fiesta’s motion to dismiss must be denied.



FOOTNOTES:
1 Unless otherwise indicated, all chapter, section, and rule references are to the Bankruptcy
Code, 11 U.S.C. §§ 101-1330, and to the Federal Rules of Bankruptcy Procedure, Rules 1001-9036.

2 The bankruptcy case was filed as a voluntary Chapter 7 on May 26, 2000. Bankruptcy Code § 365(d)(1) provides that in a Chapter 7 case, an executory contract is deemed rejected unless assumed or rejected by the Trustee within 60 days after the filing of the case.

3 Unsecured Creditors’ Comm. v. Southmark Corp. (In re Robert L. Helms Constr. and Dev. Co., Inc.), 139 F.3d 702, 705 (9th Cir. 1998), quoting Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir. 1988), and citing Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 MINN. L. REV. 439, 460 (1973).

4 In the case where the Ninth Circuit first expressly adopted the Countryman test, it held that such an agreement to refrain from acting may be sufficient to make a contract executory: “ Because of the exclusive nature of the license which Fenix received, Select-A-Seat was under a continuing obligation not to sell its software packages to other parties. Violation of this obligation would be a material breach of the licensing agreement.” Fenix Cattle Co. v. Silver (In re Select-A-Seat Corp.), 625 F.2d 290, 292 (9th Cir. 1980)(decided under the prior Bankruptcy Act). That decision was legislatively repealed in 1984 by the adoption of § 365(n). More recently, the en banc decision in Helms, supra note 3, reformulated the test in a way that focuses only on affirmative performance: “The question thus becomes: At the time of filing, does each party have something it must do to avoid materially breaching the contract?” 139 F.3d at 706. And the Andrews/Westbrook analysis, as thoroughly explained in In re Bergt, 241 B.R. 17, 21-36 (Bankr. D. Alaska 1999), demonstrates that it makes no sense to determine the “executoriness” of a contract if its assumption would impose no administrative liability on the estate, because the avoidance of such administrative liability when it exceeds the contractual benefits is the sole reason for executory contract law.

5 Helms, supra note 3, at 705.

6 Samson v. Prokopf (In re Smith), 185 B.R. 285, 292-93 (Bankr. S.D. Ill. 1995) (a majority of courts that have found limited partnership agreements to be executory contracts “have either accepted the executory contract characterization summarily or have dealt with limited partnership agreements under which the limited partner has continuing financial obligations to the partnership.”).

7 See, e.g., In re Garrison-Ashburn, L.C., 253 B.R. 700, 708-09 (Bankr. E.D. Va. 2000)(there is no executory contract and § 365 does not apply to an operating agreement that imposes no duties or responsibilities on its members, but merely provides for the structure of the management of the entity); Smith, supra note 6, at 291-95 (limited partnership agreement was not executory as to a limited partner/debtor who had no material obligations to perform; the Chapter 7 trustee steps into the shoes of the debtor and may exercise debtor’s right to dissolve the partnership).

8 Calvin v. Siegal (In re Siegal), 190 B.R. 639, 643 (Bankr. D. Ariz. 1996)(Case, J.), citing In re Sunset Developers, 69 B.R. 710, 712 (Bankr. D. Idaho 1987). See also Summit Invest. and Dev. Corp. v. Leroux, 69 F.3d 608 (1st Cir. 1995)(§ 365 applies to general partner debtors who have duties and obligations to limited partnership); Broyhill v. DeLuca (In re DeLuca), 194 B.R. 65 (Bankr. E.D. Va. 1996)(§ 365 applies to debtors who were managers of limited liability companywith ongoing duties and responsibilities; because debtors’ personal identity and participation were material to the development project, the § 365(e)(2) exception to assumption applies); In re Daugherty Constr., Inc., 188 B.R. 607, 612 (Bankr. D. Neb. 1995)(operating agreements are executory contracts because there are material unperformed and continuing obligations among the members, including participation in management and contributions of capital).

9 As noted above, Fiesta has already redeemed one member’s interest for $124,000. That suggests that it has the power to do so, that redemption of a member’s interest is not contrary to Fiesta’s interests or purposes, and that $124,000 might be an appropriate value for the Debtor’s interest. Because the schedules filed in this case reflect priority and unsecured debts of less than $70,000, such a remedy might entirely satisfy the Trustee while simultaneously avoiding any disruption of the partnership or any conflict with the purposes for which it was created.

10 Although § 105(b) provides that “a court may not appoint a receiver in a case under this title,” the precise language of that provision and case law make clear that it applies only to the administrative bankruptcy “case,” not to an adversary proceeding. A “case” is what is commenced by the filing of a petition, e.g., § 301, whereas a “proceeding” is commenced by a summons and complaint, Bankruptcy Rules 7001 & 7004. The provision was added simply because the Code “has ample provision for the appointment of a trustee when needed.” S. Rep. No. 989, 95th Cong. 2d Sess. 29 (1978). Consequently § 105 (b) “does not prohibit the appointment of a receiver in a related adversary proceeding if otherwise authorized and appropriate.” 2 LAWRENCE P. KING, COLLIER ON BANKRUPTCY ¶ 105.06, at 105-84.7 (15th Ed. 2004). Accord, Craig v. McCarty Ranch Trust (In re Cassidy Land and Cattle Co.), 836 F.2d 1130, 1133 (8th Cir. 1988); In re Memorial Estates, Inc., 797 F.2d 516, 520 (7th Cir. 1986)(“The power cut off by section 105(b) of the Bankruptcy Code is the power to appoint a receiver for the bankrupt estate, that is, a receiver in lieu of a trustee.”).





Dated this 13th day of January, 2005.
/s/ Randolph J. Haines
Randolph J. Haines
U.S. Bankruptcy Judge
Copy of the foregoing mailed
this 13th day of January, 2005, to:
Terry A. Dake, Esq.
11811 North Tatum Boulevard, Suite 3031
Phoenix, AZ 85028-1621
Attorney for Trustee
Louis Movitz
P. O. Box 3137
Carefree, AZ 85377-3137
Trustee
Mark W. Roth, Esq.
Hebert Schenk P.C.
4742 North 24th Street, Suite 100
Phoenix, AZ 85016-4858
Attorney for Fiesta
/s/ Pat Denk
Judicial Assistant

 

UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF KENTUCKY
AT LOUISVILLE
CIVIL ACTION NO. 3:04CV-143-H
FRANK A. LITTRIELLO PLAINTIFF
V.
UNITED STATES, et al. DEFENDANT
MEMORANDUM OPINION

Kentuckiana Healthcare, LLC (the “Company”), a limited liability company formed under the laws of Kentucky, operated a nursing home in Scottsburg, Indiana, under the trade name Scott County Healthcare Center. It failed to pay withholding and FICA taxes for some of the tax periods ending between 12/2000 and 3/2002. Frank Littriello (“Littriello”), the plaintiff in this case, was the sole member of the Company during the tax periods in question. The IRS notified Littriello of its intent to levy his property to enforce previously filed notices of federal tax liens for the Company’s unpaid withholding and FICA taxes.1 Littriello requested a due process hearing with the IRS Appeals office in Louisville, Kentucky.

The Appeals Office determined that Littriello was individually liable for the Company’s unpaid withholding and FICA taxes. It held that under Treas. Reg. § 301.7701-3(b)(1)(iii), a single member limited liability company that did not elect to be treated as a corporation is considered as a disregarded entity for federal tax purposes. As such, its activities are treated in the same manner as a sole proprietorship, division or branch of the owner under Treas. Reg. §301.7701-3(a). Through this federal action Littriello seeks judicial review and redetermination of that decision.

The real dispute here concerns the validity of the so-called “check-the-box” regulations for corporations and partnerships. Treas. Reg. § 301.7701-1 through 3. Littriello contends that the check-the-box regulations constitute an invalid exercise of the Treasury’s authority to issue interpretive regulations under Internal Revenue Code (“IRC”) § 7805(a) and are, thus, unenforceable. If the regulations are invalid, then the Company alone is liable for the taxes at issue. The Commissioner argues that the regulations are valid and that as applied here Littriello is individually liable for the Company’s tax obligation. Both sides have moved for summary judgment.

I.

The IRS and the Treasury Department proposed the check-the-box regulations in 1996 to simplify entity classification for tax purposes, believing that the prior regulations had become unnecessarily cumbersome, complex and risky for affected entities. The current regulations function in a relatively straightforward fashion. The Internal Revenue Code treats business entities differently depending upon whether the business entity is classified as a corporation or a partnership. IRC § 7701(a)(3) defines the term “corporation” to include associations, joint-stock companies, and insurance companies. IRC § 7701(a)(2) defines the term “partnership” to include any syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation. The regulations provide that for the purposes of IRC § 7701(a)(3) any unincorporated business entity that is not a publicly traded partnership covered by IRC § 7704 may elect whether or not to be classified as an association. Thus, an unincorporated business entity like the Company can generally elect whether or not to be subject to the corporate tax. A default treatment applies under a variety of circumstances where a business entity chooses not to be considered a corporation. If an unincorporated business entity with more than one member elects not to be treated as an association, it will be treated for federal tax purposes as a partnership. If an unincorporated business entity with only one member elects not to be treated as an association, it will be treated for federal tax purposes as a disregarded entity and taxed as a sole proprietorship. Treas. Reg. §301.7701-3(a).

II.

The Court now considers the validity of the check-the-box regulations.2 Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1989), governs the analysis for reviewing agency regulations. The Supreme Court established a two-part analysis:

When a court reviews an agency's construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute.

Id. at 842-43 (footnotes omitted). The Sixth Circuit has employed Chevron when assessing the validity of interpretive Treasury regulations. Hospital Corporation of America & Subsidiaries v. Commissioner, 348 F.3d 136, 140 (6th Cir. 2003); Ohio Periodical Distributors, Inc. v. Commissioner, 105 F.3d 322, 324-326 (6th Cir. 1997).

A.

Under step one of the Chevron analysis the Court looks to whether the intent of Congress is clear on the precise issue of business classification for federal tax purposes. The IRC defines “partnership” and “corporation” as being mutually exclusive. A business entity for tax purposes is defined either as a partnership or as a corporation. Littriello contends that the check-the-box regulations violate this manifest intent because two identical business entities may elect different classifications. The Commissioner responds that the term “association” in the statutory definition of a corporation is ambiguous.

Read together IRC § 7701(a)(2) and § 7701(a)(3) do not seem to make a clear distinction between an “association” which is treated for tax purposes as a corporation and a “group pool or joint venture” which is treated for tax purposes as a partnership. The definition of the “corporation” in the IRC dates from the Revenue Act of 1918 and the definition of the term “partnership” was added in 1932. Since then, Kentucky has endorsed the limited liability company as a popular business form. Business entities formed under state law most often seek to combine the limited liability of a corporation with the tax benefits of a partnership exacerbating the ambiguity in the definitions section of the statute. A business entity registered in Kentucky as a limited liability company does not fall squarely in either the partnership or corporation category as defined in the IRC. This is undoubtedly true in most other states as well. Indeed, the ambiguity is part of the reason for providing unincorporated business entities with a choice of treatment. Therefore, the Court concludes that the Commissioner’s argument that the statute is ambiguous on this point is more persuasive than Littriello who seeks to impose clarity where the Court finds none.

B.

Step two of the Chevron analysis requires the Court to decide “whether the agency’s answer is based on a permissible construction of the statute.” Id. at 843. The Treasury promulgated the check-the-box regulations pursuant to its general authority to issue “needful rules and regulations for the enforcement of [the IRC].” IRC § 7701(a). The regulations at issue interpret the definitions sections of the IRC. The classification of a business entity affects how the IRS assesses tax liability.

Littriello argues that the plain meaning of the Internal Revenue Code forecloses the possibility of an elective regime because “taxation as intended by Congress is based on the realistic nature of the business entity.” Pls.’ Mot. for Summ. J. p 8. Littriello’s primary evidence in support of this contention appears to be the previous Treasury regulations, effective prior to January 1, 1997. Former Treas. Reg. § 301.7701-2(1960). These regulations, commonly referred to as the Kintner regulations, looked to six corporate characteristics to determine the tax status of a business entity. The Kintner regulations enumerated the factors used by the Supreme Court in Morrissey v. Commissioner, 296 U.S. 344 (1935) to define the characteristics of a pure corporation: (1) associates; (2) an objective to carry on a business and divide the gains there from; (3) continuity of life; (4) centralization of management; (5) liability for corporate debts limited to property; and (6) free transferability of interests. Most every business entity has associates and an objective to carry out a business and profit. Before the check-the-box regulations, any business entity the IRS found to meet three of the remaining four corporate characteristics was classified as a association and taxed as a corporation. Business entities that contained only two of the remaining four where classified and taxed as a partnership. Former Treas. Reg. § 301.7701-2(a)(1).

Littriello is correct that under the former regulations the Company might have been classified differently. Of course, under the current regulations, the Company could have elected to be classified differently. Moreover, Congressional intent does not attach to the previous regulations. Indeed, Congress appears only to have spoken on this issue through the existing statutes. The check-the-box regulations are only a more formal version of the informally elective regime under the Kintner regulations. A business entity could pick at will which two corporate characteristics to avoid in order to qualify as a partnership under the Kintner regulations. The importance of the change is that under the current regulations a business entity may elect to be taxed as a corporation without specific reference to its corporate characteristics.

While some reasonable arguments support Littriello’s position, the Court ultimately finds them unpersuasive. Under the circumstances, the check-the-box regulations seem to be a reasonable response to the changes in the state law industry of business formation. The rise of the limited liability corporation presents a malleable corporate form incompatible with the definitions of the IRC. The newer regulations allow similar flexibility to the Kintner regulations, with more certainty of results and consequences. Considering the difficulty in defining for federal tax purposes the precise character of various state sanctioned business entities, the regulations also seem to provide a flexible permissible construction of the statute.

C.

Littriello advances a number of arguments that the Court finds not sufficiently persuasive to change its basic analysis. Littriello says that the check-the-box regulations violate the basic principle of treating like entities alike under the IRC. It is fundamentally wrong, according to Littriello, that two business entities identical in every relevant respect would be classified and thereby taxed differently solely because of a box checked on a form. A single member LLC with all six of the pure corporation characteristics could elect not to be treated as a corporation for federal tax purposes. Conversely a single member LLC with no traditionally corporate characteristics could nevertheless elect to be classified and taxed as a corporation perhaps with the goal of limiting the assets available to that organization’s tax liability. This elective function is of course the very point of the check-the-box regulations. In today’s business environment, not all corporations are alike and not all partnerships share the same characteristics. In response to an ambiguous statutory definition coupled with a variety of legally created business forms, the Treasury decided that entities may choose their form for tax purposes within the limits of the IRC. Business entities get the good and the bad with their choice. This new criterion added with the check-the-box regulations appears eminently reasonable.

In a somewhat related argument, Littriello argues that the check-the-box regulations impermissibly alter the legal status of his state law created LLC. This construction of the statute, the argument goes, is impermissible because it disregards the separate existence of the LLC and its sole member created under state law.3 The Court finds this argument unpersuasive because the check-the-box regulations apply only for federal tax liability purposes. Littriello will not be held liable for other debts of his LLC, he is only being held liable for the relevant tax liability under the IRC. The Court concludes that the reasonableness of this approach considered with the Treasury’s general authority to interpret what is on its face an ambiguous statutory provision supports a finding that the check-the-box regulations are valid.

Littriello also argues that, at least with regard to taxes withheld from employees of the Company, his obligation is a debt owed the IRS as its agent not a tax liability. As a member of an LLC, Littriello would not be liable for that LLC’s debts under Kentucky law. While Littriello’s is a novel argument, the Court agrees with the IRS that taxes withheld from employees of the Company are the responsibility of the employer, here Littriello, not as an agent but as a taxpayer. IRC § 3402.

Finally, Littriello argues that IRC § 6672 is the IRS’s sole statutory recourse. To impose tax liability against him under this section, the IRS must prove that Littriello was the responsible person for the lapses in turning over withheld wages which it has not done. This argument lacks merit because the IRS has imposed tax liability upon Littriello as the owner of a sole proprietorship. The Commissioner’s assertion that the IRS has not pursued a claim against Littriello under IRC § 6672 is well taken and supported by the evidence. Moreover, that the IRS might have more than one possible avenue for enforcement does not imply an impermissible construction of the statute.

The Court will grant Defendant’s motion for summary judgment on the issue of the validity of the check-the-box regulations. The Court will enter an order consistent with this Memorandum Opinion.

cc: Counsel of Record
May 18, 2005

1 Defendant seeks to have the Commissioner of Internal Revenue (the “Commissioner”) substituted as the proper defendant. Littriello makes no objection to this suggestion.

2 The Court can find no appellate or district court opinions considering the validity of the check-the-box regulations. One Tax Court opinion, Dover Corporation v. Commissioner of Internal Revenue, 122 T.C. 324 (2004), discusses the regulations and notes that “some commentators” had questioned whether they constitute a valid exercise of regulatory authority. Id. at 330-31 (n.7). Neither party challenged the validity of the regulations in that case.

3 Littriello relies heavily on U.S. v. Galletti, 541 U.S. 114 (2004) contending that Galletti is in conflict with disregarding a state law entity. In Galletti, the Supreme Court held that the assessment of a general partnership as the relevant taxpayer under IRC § 6203 extended the time for collecting from that employer’s general partners who were liable for payment of partnership's debts. To the extent that it is relevant at all, this case supports the Commissioner’s contention that the definition of a taxpayer is not made with reference to a person’s legal status under state law.
 

IRS Regs 1.469-1T(e)(6)
Activity of trading personal property--
1.469-1T(e)(6)(i) In general.
An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)).
1.469-1T(e)(6)(ii) Personal property.
For purposes of this paragraph (e)(6), the term "personal property" means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof).
1.469-1T(e)(6)(iii) Example.
The following example illustrates the application of this paragraph (e)(6):
Example
A partnership is a trader of stocks, bonds, and other securities (within the meaning of section 1236(c)). The capital employed by the partnership in the trading activity consists of amounts contributed by the partners in exchange for their partnership interests, and funds borrowed by the partnership. The partnership derives gross income from the activity in the form of interest, dividends, and capital gains. Under these facts, the partnership is treated as conducting an activity of trading personal property for the account of its partners. Accordingly, under this paragraph (e)(6), the activity is not a passive activity.