Cohen v. Cohen, 34 Misc. 3d 1207A, 2012 N.Y. Misc. LEXIS 25 (Jan. 5, 2012)
In 1972, Stanley and Lorraine created a for-profit college known as Five Towns College and were its sole shareholders until 2002. In 1992, they created a grantor trust as part of a sophisticated estate plan. They had three children: Janet, David,, and Martin. The trust was intended to hold real property on which Five Towns College was to be located. Stanley was the president of the college. With a $900,000 down payment from Stanley, the trust financed the rest of the land purchase with a local industrial development agency bond and a loan from a local bank. Stanley paid off the mortgage over the next several years, taking back a promissory note from the trust in the amount of $2,454,670.
Under the terms of a lease agreement between the trust and the college, the college had an option to purchase the property at a specific point in the future at the higher of $3,000,000 or the fair market value of the property. The lease agreement was apparently amended to reduce the college’s option to purchase to the value of 30 vacant one-acre residential lots. Additionally, the college entered into a loan agreement with the trust for $10 million to be used for the exercise of its purchase option. Allegedly, the resulting debt was to be forgiven.
In 2002, Stanley and Lorraine created a family limited partnership for the purpose of transferring their stock in the college to their children. They gave six limited partnership shares and sold six limited partnership shares to each child, resulting in each child owning 22 percent of the limited partnership. For the six shares sold to each child, the child executed a promissory note. Allegedly, the college made distributions to the children, at Stanley’s direction, to enable the children to pay the interest on the notes.
In 2004, Lorraine died. According to David and Janet, Stanley began using his position as president of the college to pay himself large sums that would otherwise have been used to pay the children and make rent payments to the trust. In 2008, Stanley fired Janet as general counsel to the college. In retaliation, she petitioned the probate court for an accounting of the trust. Stanley then tried to remove her as a partner of the family limited partnership.
Meanwhile, David also filed an action against Stanley, seeking an accounting of the family limited partnership, removing Stanley from the partnership and restricting the powers of Stanley and the college to prevent any additional payments to Stanley. In 2009, Janet brought an additional action against Stanley, the college and its board of trustees, alleging breach of fiduciary duties.
In evidence presented to the court, many improprieties came to light. Both Janet and David presented sworn affidavits in which they claimed that Stanley was well aware of his children’s inability to repay the various promissory notes involved in the plan, and assured them that he would cause distributions to be made from the partnership for purposes of repaying the notes. They also claimed that Stanley admitted the issuance of the notes was a formality intended to avoid gift tax liability. Stanley’s trust and estate lawyer presented an affidavit in which he disavowed knowledge of the sham transactions. According to the various affidavits, payments on the notes were not made from the children’s personal funds. Despite previous statements suggesting otherwise, David and Janet denied that tax fraud was the purpose of the family limited partnership and trust.
In 2011, the college and its board of trustees intervened in the actions brought by David and Janet, and moved for summary judgment dismissing their complaints. The college asserted that the purpose of the family limited partnership and the trust was tax fraud, and that enforcement of the partnership agreement and trust agreement would result in judicial enforcement of illegal contracts. Additionally, the college alleged that it paid salaries to the three children and to Stanley, which were taxed only as personal income and not as profits of the family limited partnership as required by Internal Revenue Code § 162(a)(1).
David and Janet challenged the college’s intervention, arguing that the college lacked standing to challenge the enforceability of the partnership and trust agreements. They also argued that even if the underlying transactions resulted in the imposition of the gift tax, the failure of Stanley and Lorraine to pay gift tax would not affect the enforceability of the partnership and trust agreements. They also argued that the college came to the court with unclean hands because the college was aware of Stanley’s actions and aided him in the implementation of the plan. Finally, given that the college knew of the agreements since 1992 and 2004, they argued that the college was barred by laches for waiting until late 2010 to bring its motion. As part of their challenge, David and Janet asked for sanctions against the college for its motion.
The Supreme Court of New York for Suffolk County, although sympathetic to the college’s arguments, ultimately dismissed the college’s motion for summary judgment. The court held that the issue of standing was not relevant to the proceeding, because New York case law permits a court to allow a motion based on illegality that invokes principles of public policy, regardless of the movant’s standing. The court also dismissed David and Janet’s argument that the college’s motion was barred by the doctrine of unclean hands and laches, because public policy prevented the court from ignoring the potential illegality of Stanley and Lorraine’s estate plan. Despite its rejection of David and Janet’s challenges to the college’s motion for summary judgment, the court concluded that David and Janet had raised genuine disputes as to material facts — particularly, the legitimacy of the partnership and trust. The court dismissed the college’s motion for summary judgment but also dismissed the motions for sanctions against the college, noting that the issues raised by the college were far from frivolous.