Article

April, 2007

Effect of Rule 144 Restrictions and Redemption Agreement;
Actual Purchases Four Months After Valuation Date Ignored To a Great Extent,
Estate of Gimbel

Copyright© 2007 by Bessemer Trust. N.A. All rights reserved.

In Estate of Gimbel v. Comm’r, T.C. Memo. 2006-270, the court valued a large block of stock subject to Rule 144 dribble-out restrictions and the effect of a redemption agreement. The estate owned 13% of the stock of Reliance, a NY stock exchange company. Almost all of those shares were unregistered, and subject to the Rule 144 dribble out rules (in any 3 month period, the greater of 1% of the outstanding class of stock to be sold or the average weekly trading volume for the prior four weeks). The parties estimated that it would take 39 months to sell the restricted shares under the dribble-out rules. In addition, the Company had a formal Redemption Plan, and two weeks before the decedent’s death, the CEO said at a steel conference that the Company had a “record year” and would consider repurchasing Reliance shares at around $19/share [but did not say how many shares would be repurchased, and the company was considering a large acquisition that would have required significant cash and credit, and the largest prior repurchase was about $11 million]. In fact, the Company repurchased 63% of the estate’s shares 4 months after the date of death at a price that reflected a 7.027% discount from the average trading price on the date of death. The estate claimed a 20.7% marketability discount on the Form 706, but an additional trial expert determined a 17% discount. The IRS claimed an 8% discount in the deficiency notice, and the IRS’s trial expert concluded that a 9% discount was appropriate. The court held: (1) It was reasonably foreseeable on the date of death that the Company would repurchase only about 20% of the estate’s stock, and the court used the IRS’s expert conclusion of a 13.9% discount for that block; (2) As to the remaining 80%, the IRS expert said that an owner would use hedging contracts (i.e. costless collars) that would reflect a 5% discount, but the court concluded that hedging contracts were not available for this stock, and used the taxpayer’s expert’s conclusion of a 14.4 % discount considering the present value of the future payments and the risk that the stock might decline during the dribble out period. (The court refused to apply a private placement analysis, because there was no strategic purchaser.)The overall discount was 14.2%.

The court also addressed the effect of actual purchases after the valuation date. In fact, the Company repurchased 63% of the estate’s shares 4 months after the date of death at a price that reflected a 7.027% discount from the average trading price on the date of death. The court concluded that it was reasonably foreseeable on date of death that the Company would repurchase about 20% of the estate’s stock (rather than the 63% actually purchased 4 months later), and the court used the IRS’s expert conclusion of a 13.9% discount for that block (as opposed to the 7.0% discount in the actual repurchase). The actual redemption of 63% of the shares at a lower discount did not control as to the valuation of that 63% block. The court gave the standard reasoning: “Post death events are generally disregarded…However, subsequent events which are reasonably foreseeable as of the valuation date may be considered.”

The appraisal attached to the Form 706 did not consider the redemption agreement and the company’s history of prior repurchases at all—in spite of the fact that the Company in fact purchased 63% of the estate’s stock at a price that reflected only a 7.0% discount. Perhaps that was the primary red flag that triggered the audit and the lawsuit.

Attorneys have reported other cases involving contractual restrictions on selling stock (for example, special company restrictions on selling Rule 144 stock) in which government experts have utilized a costless collar analysis, applying a 20% discount. We may find an emerging trend by IRS appraisers to use a hedging analysis more frequently in an attempt to limit discounts.