Great Plains Gasification Assocs. v. Comm'r

T.C. Memo. 2006-276

UNITED STATES TAX COURT

GREAT PLAINS GASIFICATION ASSOCIATES, A PARTNERSHIP, TRANSCO COAL
GAS COMPANY, A PARTNER OTHER THAN THE TAX MATTERS PARTNER,
Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10578-01. Filed December 27, 2006.

H. Karl Zeswitz, Jr., Kent L. Jones, and Mary E. Monahan,

for petitioner.1

Derek B. Matta, David Q. Cao, John F. Eiman, and Elizabeth

Girafalco Chirich, for respondent.

1
The petition was signed by petitioner’s counsel, F. Brook
Voght, who died on Sept. 16, 2003.
 - 2 -

MEMORANDUM FINDINGS OF FACT AND OPINION

THORNTON, Judge: This is a partnership-level proceeding

subject to the unified audit and litigation procedures of

sections 6221 through 6231.2

In the 1970s, reacting to a global energy crisis, the

Federal Government reached out to private industry to help

develop alternative energy sources, including synthetic fuels.

In response, five major energy companies, through their

subsidiaries, formed a partnership, Great Plains Gasification

Associates (the partnership), to develop, construct, own, and

operate a project to produce natural gas from coal (the project).

The partnership financed the project with about one-half billion

dollars of the partners’ equity contributions and a $1.5 billion

loan (the loan) from the Federal Financing Bank (FFB). The loan

was secured by a mortgage on the partnership’s assets and

guaranteed by the U.S. Department of Energy (DOE). The parent

2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years at
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.

The tax matters partner for Great Plains Gasification
Associates (the partnership) is ANR Gasification Properties Co.
(ANR). The tax matters partner for the partnership did not file
a petition for readjustment of partnership items. Transco Coal
Gas Co. (Transco), a partner of the partnership other than the
tax matters partner, satisfies the requirements of sec. 6226(b)
and (d) and timely filed the petition on behalf of the
partnership and Transco.
 - 3 -

corporation of one of the partnership’s general partners pledged

certain stock as security for DOE’s loan guarantee.

The partnership built the coal gasification plant in Mercer

County, North Dakota, near available coal reserves. Upon its

completion in 1984, the project was the only commercial-scale

operation of its type in the United States.

From an engineering perspective, the project was successful,

employing innovative catalytic processes to convert low-grade,

low-value lignite coal into high-Btu (British thermal units)

pipeline-quality synthetic natural gas. The plant achieved

average daily production of 125,000 mcf (thousand cubic feet).

It remains in production today.

Economically, however, the project was less successful. As

construction neared completion, energy prices dropped.

Anticipated initial losses from the project rose. Anticipated

cashflows fell. In 1985, the partnership defaulted on the DOE-

guaranteed loan. Pursuant to the guarantee agreement, DOE paid

off the loan; by subrogation, the partnership’s debt shifted from

FFB to DOE. In a June 30, 1986, foreclosure sale, DOE bid $1

billion for the partnership’s mortgaged assets, effectively

reducing the partnership’s outstanding $1.57 billion liability by

$1 billion in exchange for the mortgaged project assets.3

3
In October 1988, the U.S. Department of Energy (DOE)
released the partnership’s remaining debt when it took possession
(continued...)
 - 4 -

The partnership unsuccessfully contested the foreclosure

proceedings in litigation which concluded in November 2, 1987,

when the U.S. Supreme Court denied the petition for writ of

certiorari. For Federal income tax purposes, the partnership

reported disposing of the project assets as of that date.

By four separate notices of final partnership administrative

adjustments (FPAA), respondent took alternative “whipsaw”

positions, determining that the partnership had engaged in a sale

or exchange of the plant and related assets as of various dates

in 1985, 1986, 1987, and 1988. Respondent determined that, as of

these various alternative dates, the partners must recapture

previously claimed investment and energy tax credits, forfeit

certain deductions and losses relating to the project, and

recognize gain from disposition of project assets.

The primary issue for decision is whether for Federal income

tax purposes the partnership should be treated as disposing of

the project assets before November 2, 1987. We must also decide

whether the partnership must take into account the full $1.57

billion debt in the year in which the partnership disposed of the

project assets pursuant to the foreclosure sale.

3
(...continued)
of the stock that one partner’s parent company had pledged as
security for the loan guarantee.
 - 5 -

FINDINGS OF FACT

When the petition was filed, the partnership’s principal

place of business was in Houston, Texas.4

Evolution of the Great Plains Project

In the 1970s, natural gas shortages were widespread. Energy

companies began investigating new supply sources. One idea was

to use abundant domestic coal reserves to produce synthetic

natural gas in a process known as coal gasification.

American Natural Resources Co. (ANRC), operated two natural

gas distribution companies and two natural gas pipelines, in

addition to conducting oil and gas exploration. It also owned

rights in extensive coal reserves in North Dakota. ANRC had

studied the possibility of building a coal gasification plant

near these coal reserves. (This project would later become known

as Great Plains.) By the mid-1970s, ANRC was working on coal

gasification technologies and discussing the potential project

with Government officials.

Outside the United States, some coal gasification projects

were already operational, but existing technologies allowed coal

to be converted only into 500 Btu gas. United States pipelines,

by contrast, required 1,000 Btu gas. ANRC, as well as other

domestic energy companies, contemplated a project that would be

4
The parties have stipulated that pursuant to sec. 7482(b)
venue lies in the U.S. Court of Appeals for the Fifth Circuit.
 - 6 -

the first of its kind, employing new, still unproven technologies

to convert domestic coal into pipeline-quality natural gas.

DOE actively supported the project, which appeared to hold

great promise as an alternative energy source.5 Mr. Jack

O’Leary, who was then Deputy Secretary of Energy, encouraged

several interstate pipeline companies to form a consortium to

raise money for the Great Plains project. Ultimately, five

interstate pipeline companies agreed to form a partnership

(through their subsidiaries) to design, build, and operate the

plant. In addition to ANRC, these companies were Transco Energy

Co. (Transco Energy), Tenneco, Inc., Pacific Lighting Co., and

MidCon Corp.

The Partnership

The partnership, Great Plains Gasification Associates, was

formed in 1978 under North Dakota law. The five general partners

were wholly owned subsidiaries of the just-named pipeline

companies, with ownership percentages in the partnership as

follows:

5
Ultimately, DOE viewed the project as a “demonstration
program” within the meaning of sec. 207 of Title II of the
Department of Energy Act of 1978--Civilian Applications, Pub. L.
95-238, 92 Stat. 61, to produce alternative fuels from coal and
other domestic resources and to provide technical and
environmental knowledge to assess the long-term viability of
synthetic fuel production in the United States.
 - 7 -

Ownership
Partner Percentage

Tenneco SNG, Inc. (Tenneco) 30
ANR Gasification Properties Co. (ANR) 25
Transco Coal Gas Co. (Transco) 20
MCN Coal Gasification Co. (MidCon) 15
Pacific Synthetic Fuel Co. (Pacific) 10

The partners executed an Amended and Restated General

Partnership Agreement as of June 1, 1981 (partnership agreement),

in which the partnership assumed responsibility for the Great

Plains project. Pursuant to the partnership agreement, the

partnership’s management committee, composed of one

representative of each partner, had exclusive authority and full

discretion to manage the partnership’s business. No partner had

authority to act for, or assume any obligation or responsibility

on behalf of, the partnership without the management committee’s

prior approval. The management committee was authorized to act

either upon the approval, vote, or “consent” of partners holding

at least 65 percent of the total votes, which were allocated

according to partners’ ownership percentages. The partnership

agreement provided that it was governed by North Dakota law.

Pursuant to the partnership agreement, the partnership was

not permitted to acquire assets or incur liabilities until the

date when it acquired various preexisting project assets from

individual partners. After this date, the plant site and all

property acquired by the partnership to construct, operate, and

maintain the plant were to be the property of the partnership.
 - 8 -

Each partner was obligated to make cash contributions upon

notice from the management committee, as necessary to purchase

the preexisting project assets from other partners, to pay

project costs, and to pay costs incurred by the partnership. The

partners were prohibited from making voluntary contributions to

the partnership.

Funding for the Project

The partnership funded the Great Plains project from two

sources: (1) About $550 million of equity contributions from the

partners; and (2) a loan of about $1.5 billion provided under a

credit agreement with FFB (the credit agreement) and guaranteed

by DOE.

Partners’ Equity Contributions

The partners were required to contribute to the partnership

$1 of equity for every $3 borrowed under the credit agreement.6

Upon the occurrence of various specified events, the partners

could terminate their participation in the project after giving

the DOE Secretary at least 14 days’ advance notice and a chance

to discuss the matter with the partners’ representatives.7 After

6
Pursuant to an equity funding agreement, each partner’s
parent agreed to provide funds to its respective subsidiary as
necessary for the partner to make the required equity
contributions.
7
In general, partners were entitled to terminate
participation in the project at any time prior to the in-service
date if projected gross revenues from the project fell below
(continued...)
 - 9 -

terminating their participation pursuant to these provisions, the

partners would have no obligation to continue making equity

contributions.

The partners’ equity contributions to the partnership

ultimately totaled about $550 million.

The Credit Agreement

Pursuant to the credit agreement dated January 29, 1982, FFB

committed to lend the partnership up to $2.02 billion for the

design, construction, and startup of the project. The credit

agreement provided that if the partnership defaulted on the

payment of principal or interest, FFB should demand payment of

the partnership and provide notice of the default to DOE. If the

partnership or DOE failed to cure the default within 5 days, FFB

could terminate the credit agreement and declare the entire

outstanding debt due and demand payment by DOE pursuant to DOE’s

loan guarantee (discussed below). Pursuant to the credit

agreement, FFB agreed that “any recovery on a claim against

Borrower [the partnership] or any Partner which may arise under

7
(...continued)
certain levels; if estimated costs exceeded certain levels; if
the estimated in-service date slipped past June 1, 1986; if there
were no longer “reasonable assurance” that the project would
generate sufficient cash to permit the partnership to service its
debts and repay the partners’ equity contributions; or if DOE
gave the partnership notice that DOE had determined that there
was no longer reasonable assurance that the partnership would be
able to timely pay principal and interest on the guaranteed
indebtedness.
 - 10 -

this Agreement * * * shall be limited to the assets of the

Borrower and such Partner’s interests in such assets”.

Loan Guarantee Agreement

Pursuant to a loan guarantee agreement, also dated January

29, 1982, DOE agreed to guarantee the entire amount of principal

and interest on the debt incurred by the partnership under the

credit agreement.8 DOE’s guarantee was based on its

determination that the guarantee was necessary to encourage the

partners’ financial participation in the project.

Pursuant to the loan guarantee agreement, FFB was to make no

disbursements to the partnership until DOE reviewed and

authorized the proposed disbursements. DOE retained the right,

under specified circumstances, to terminate the Government’s

participation in guaranteeing additional disbursements for the

project. Pursuant to the loan guarantee agreement, if the

partnership failed to pay FFB principal or interest on the

indebtedness when due, the Secretary was authorized to cause the

principal amount of all the guaranteed indebtedness, with accrued

interest, to become due and payable from the partnership. If the

partnership failed to cure the default, the Secretary, upon

payment of the indebtedness to FFB, was authorized to take action

8
DOE was granted authority to guarantee the partnership’s
debt pursuant to the Federal Nonnuclear Energy Research and
Development Act of 1974, Pub. L. 93-577, 88 Stat. 1878, as
amended by the Department of Energy Act of 1978, Pub. L. 95-238,
92 Stat. 47.
 - 11 -

to enforce the partnership’s obligations under the guarantee

agreement.

Pursuant to the loan guarantee agreement, DOE agreed that

its recovery on any claim against the partnership or any partner

would generally be limited to the partnership’s assets and to the

partners’ interests in those assets. The partnership agreed, “To

the full extent permitted by applicable law,” to waive the

benefit of any redemption law that might otherwise have been

applicable to any right under this agreement. The loan guarantee

agreement states that it “shall be governed by and construed and

interpreted in accordance with the federal laws of the United

States. It is the intent of the United States to preempt any

state law conflicting with the provisions of this Agreement”.

Pursuant to the loan guarantee agreement, the partnership

was prohibited from engaging in any business other than the

project. All proceeds from the guaranteed debt were required to

be promptly applied to fund costs that were necessary,

reasonable, and directly related to the design, construction, and

startup of the project facilities.

Indenture of Mortgage

The credit agreement and the loan guarantee agreement were

secured by an Indenture of Mortgage and Security Agreement dated

January 15, 1982, between the partnership, as debtor and

mortgagor, and Citibank, N.A. (trustee), as trustee and
 - 12 -

mortgagee, acting in a fiduciary capacity for the benefit of the

United States and FFB. Property subject to the mortgage included

real estate owned by the partnership; plants, facilities, and

buildings owned by the partnership or leased by the partnership;

the partnership’s rights to and under certain contracts

(including gas purchase agreements, the project administration

agreement, and the coal purchase agreement, all of which are

discussed infra); and all other real or personal property “now

owned or hereafter acquired by Borrower”.

Pursuant to the mortgage, an “event of default” would

include termination in the project by any two or more partners

and the partnership’s failure to make timely principal or

interest payments. In the event of a default, the trustee was

entitled to take possession of the mortgaged property without

legal process, operate the mortgaged property, receive all income

from the operation, pay all expenses, and proceed to sell the

mortgaged property in foreclosure proceedings. The United States

was authorized to bid on and purchase the mortgaged property.

Sale proceeds were to be applied first to paying any interest and

principal then due on the note and then to repaying all amounts

paid by the United States pursuant to the guarantee. The

mortgage provided that the partnership agreed, “To the full

extent it may legally do so”, to waive “any and all rights of

redemption from sale under order or decree of foreclosure of this
 - 13 -

Mortgage”. The mortgage stated that it “shall be governed by and

construed and interpreted in accordance with” Federal law.

Pledge of ANG Stock

ANRC’s wholly owned subsidiary, ANG Coal Gasification Co.

(ANG), was formed in the early stages of the project to design

and manage construction of the project and to operate the project

after its completion. ANG held certain contractual and other

rights and permits relating to the project. As a precondition

for the loan guarantee agreement, DOE required ANRC to pledge its

ANG stock as additional security for the partnership’s

obligations under the loan guarantee agreement. Pursuant to the

ANG stock pledge agreement, dated January 29, 1982, if the

partnership defaulted on its debt, the DOE secretary was

authorized to take possession of the ANG stock certificates and

sell the ANG stock to such persons, including himself, as he

deemed expedient, applying the sale proceeds against the

partnership’s debt.

ANG Operates the Plant

Under the project administration agreement, dated January

29, 1982, the partnership appointed ANG as the partnership’s

agent to administer the project’s construction, startup, and

operation. As project administrator, ANG was responsible for the

design, construction, and operation of the gasification plant and

coal mine on behalf of the partnership. Pursuant to an agreement
 - 14 -

between ANG and DOE, dated January 29, 1982 (the project

administration agreement), if the partnership defaulted on its

obligations under the loan documents, ANG would, at the DOE

Secretary’s option, continue to act as administrator of the Great

Plains project.

In connection with the project administration agreement, ANG

and the partnership entered into a coal purchase agreement to

provide a source of lignite coal for the project. The agreement

was based upon coal rights previously obtained by ANG to buy and

receive from a third party sufficient coal to satisfy the

project’s requirements. ANG agreed to deliver for the

partnership’s account sufficient coal to support the plant’s

operation.

ANG served as the project’s sole operator until October

1988. After production commenced at Great Plains in 1984, ANG

had 800 to 1,200 full-time workers on site at the project.

Partnership Enters Gas Purchase Agreements With Pipeline
Affiliates

On January 29, 1982, the partnership entered into 25-year

gas purchase agreements with pipeline companies affiliated with

four of the partners (the pipeline affiliates). The gas purchase

agreements provided that, after the project’s in-service date,

the partnership was obligated to tender to the pipeline

affiliates all synthetic natural gas produced by the project, and

the pipeline affiliates were collectively obligated to purchase
 - 15 -

all this gas at specified prices or else to pay for gas tendered

but not taken.9

Plant Is Built and Begins Operation

Construction of the project began in 1981. The project was

placed in service for tax purposes in 1984. On July 28, 1984,

the plant delivered its first synthetic natural gas to the

interconnecting gas pipeline. Since then, the plant has

continuously produced and delivered synthetic natural gas.

Initial Eligibility for Investment and Energy Tax Credits

A substantial part of the project’s assets constituted new

section 38 property, qualifying for general business credits

(sometimes referred to as investment credits). In addition, a

substantial part of the project’s assets constituted alternative

energy property within the meaning of section 48(l)(3) and

constituted energy property eligible for the energy percentage

under section 46(b)(2)(A). The partners and DOE relied on the

availability of the investment and energy tax credits as a key

9
These contracts obligated the pipeline affiliates to a
payment rate substantially above the market price for the gas
produced; the price was to be reduced in periodic increments over
a 25-year period. Economic analyses indicated to the partnership
that the gas purchase agreements would result in an assured
market for the synthetic natural gas produced during the
project’s life and that revenues would be adequate to service the
debt and also contribute toward the return of invested equity.
By separate agreement, in the event a default by the partnership
led to the termination of the gas purchase agreements, those
agreements could be reinstated between the pipeline affiliates
and DOE on the same terms.
 - 16 -

consideration in structuring the financial terms of the project

and in deciding to pursue the project.

In 1982, the partnership requested an IRS ruling that the

partnership’s DOE-guaranteed loan from FFB would not be

considered “subsidized energy financing” under section

48(l)(11)(C). In a private letter ruling dated May 8, 1984, the

IRS ruled that, because the partnership was required to obtain

financing through FFB as a condition to obtaining a loan

guarantee from the DOE, the funds that the partnership borrowed

from FFB did not constitute subsidized energy financing under

section 48(l)(11)(C).10

Financial Difficulties With the Project

In the mid-1980s, as construction of the Great Plains

project neared completion, energy prices declined unexpectedly

and precipitously. As a result, projected initial short-term

losses from the project spiked; there was no longer reasonable

assurance that the project would generate sufficient cash for the

partnership to repay its debt to FFB on time. Nevertheless, the

10
In response to a subsequent ruling request by the
partnership, the IRS ruled in a private letter ruling dated July
25, 1984 (supplemented by letter rulings dated Feb. 12 and Mar.
11, 1985), that the partnership met the requirements for the
credit for fuel production from nonconventional sources under
sec. 29 (formerly sec. 44D). Because energy tax credits offset
the sec. 29 credits in full, however, the partnership and its
partners realized no tax benefit from the sec. 29 tax credits.
 - 17 -

project remained an important part of the partners’ business

plans.

On March 25, 1983, the partnership advised DOE that changing

economic conditions required changes in the project’s financial

structure. The same day, each partner notified DOE that it

believed that conditions existed that would permit it to vote to

terminate participation in the project pursuant to the partners

consent and agreement, but that it did not presently intend to

exercise this right.

Debt Restructuring Negotiations

In 1983, the partnership’s representatives began meeting

with officials of DOE and the Synthetic Fuels Corp. (SFC) to

negotiate additional financial assistance for the project. On

September 13, 1983, the partnership applied to SFC for interim

price supports for the synthetic natural gas to be produced by

the project. The partnership advised SFC that interim price

supports would make possible the plant’s completion and

operation. Plant construction was then 72 percent complete and

on schedule. Approximately $1.2 billion had been invested in the

project: $383 million represented the partners’ equity capital;

the balance was FFB debt guaranteed by DOE.

Negotiations between the partnership and SFC over price

supports dragged on until July 1985. In the meantime, DOE--which

was monitoring the SFC negotiations--began contingency plans with
 - 18 -

respect to the loan guarantee arrangement. DOE was especially

concerned about how the project would be funded if the partners

terminated participation. DOE lacked appropriated funds to

complete the project on its own. In October 1983, DOE Assistant

Secretary Jan Mares gave congressional testimony in which he

expressed DOE’s support for the price-support negotiations

between the partnership and SFC as part of a loan restructuring

to ensure the partners’ continued participation in the project.

Discussions Concerning Terminating Participation in the Project

On the heels of this congressional testimony, SFC issued a

statement deferring any decision on price support assistance for

the project, citing concerns that additional legislation might be

required for that purpose. The partners then advised DOE that,

because the partnership lacked assurance that SFC would negotiate

expeditiously for price guarantees, the partnership felt

compelled to initiate procedures under the loan guarantee

agreement to terminate the partners’ participation in the

project.

Consequently, on November 18, 1983, the partnership notified

DOE that the management committee was considering a determination

by the partners to terminate participation in the project. Each

partner provided written notice to DOE, pursuant to the loan

documents, that it believed conditions existed permitting the

partner to vote to terminate participation in the project because
 - 19 -

the project, as it was then structured, would generate

insufficient cash to meet the partnership’s obligations under the

credit agreement and to enable the partners to recoup their

equity contributions. Upon receiving these notices, DOE publicly

expressed optimism that the project would represent a “valuable

national asset for the long-term energy security of this

country”. DOE also expressed willingness to continue disbursing

guaranteed funds so long as the partners continued financing

their portion of the project.

Partners and SFC Sign Letter of Intent

On April 26, 1984, SFC and the partnership reached a

tentative agreement, memorialized by a letter of intent. SFC

proposed to provide the partnership up to $790 million of

financial assistance under a price guarantee agreement. In

return, pursuant to a profit-sharing arrangement, the partnership

would eventually pay SFC $1.58 billion out of the project’s

operating profits, after first paying the entire amount of the

DOE-guaranteed debt. In addition, under the tentative agreement,

the partners would reinvest in the project the dollar equivalent

of all tax benefits and profits obtained by the partnership for

the next 3-1/2 years; this provision would have amounted to an

additional equity contribution by the partners of about $690
 - 20 -

million.11 The parties agreed to recommend that SFC’s board and

the partnership’s management committee approve this tentative

price guarantee agreement.

In July 1984, while negotiations continued between the

partners and SFC, the gasification plant began producing

synthetic natural gas.

In January 1985, the partnership received from SFC a draft

price agreement; a draft loan agreement was expected soon

thereafter. To enable the partnership to meet its obligations

under the loan guarantee obligation, the management committee

called, at monthly intervals, for additional equity contributions

of $4 million in February 1985, of $6 million in March 1985, of

$3 million in April 1985, and of $1 million in May and June 1985.

These additional equity contributions were based on the partners’

expectation that support for the project would be forthcoming and

their belief that the arrangement would be supported by DOE.

Bolstering that belief, in April 1985 DOE Assistant

Secretary Mares appeared before SFC’s board of directors on

behalf of newly named DOE Secretary John Herrington. Mr. Mares

endorsed the understandings reached by SFC and the partnership.

11
A Comptroller General’s report to Congress on the status
of the Great Plains project as of Dec. 31, 1984, noted that over
the project’s life, the partners would realize a lower rate of
return on their equity investments even with the $790 million
price support arrangement because of the partners’ additional
equity contributions, accelerated debt repayment, and the profit-
sharing arrangement.
 - 21 -

He urged the SFC board to move quickly to conclude the price

assistance agreement with the partnership. Similarly, in a May

21, 1985, letter to SFC, DOE Secretary Herrington also supported

an SFC assistance agreement; he urged that any support agreement

should ensure the long-term operation of the plant. By letter

dated May 22, 1985, SFC Chairman Edward Noble responded that to

ensure the long-term operation of the plant, DOE should

restructure the debt repayment schedule. Mr. Noble requested

further response from DOE before committing to final negotiations

with the partnership.

Also on May 22, 1985, DOE Assistant Secretary Mares gave

congressional testimony, describing the need for the price

guarantee assistance agreement. He testified that DOE believed

that, if SFC provided the intended financial assistance for the

project, the sponsors would be able to continue operating the

project beyond the year 2000. He testified that, in the event of

foreclosure on the project assets, the partnership would be

entitled by North Dakota law to a 1-year redemption period and

would be entitled to possession of the property and to its rents

and profits during that time. He testified that under North

Dakota law, although the partnership may have voluntarily waived

those rights in the loan documents, contracts in restraint of the

right of redemption are void and unenforceable.
 - 22 -

The Standstill Agreement

As of June 24, 1985, the partnership’s outstanding balance

on its FFB loans was approximately $1.446 billion. An interest

payment of over $70 million and a principal payment of $328.5

million were payable to FFB on July 1, 1985. A guarantee fee of

$7.684 million was also payable to DOE on July 31, 1985.

To finalize the price support agreement, SFC required

approval from the Treasury Department, the Office of Management

and Budget, and DOE. Because SFC needed time to obtain these

approvals, and the partners were approaching a date when they

would have to make substantial payments under the loan documents,

the parties negotiated a “standstill agreement”. Under the

standstill agreement, dated June 24, 1985, the partnership’s due

date for interest, principal, and the guarantee fee payments was

extended to August 1, 1985.12

The standstill agreement also required the partners to

withdraw their November 18, 1983, notices of consideration of

termination of participation and to continue diligently to

complete construction of the project, making timely equity

investments into the partnership. Addressing the possibility

12
Under the standstill agreement, the parties agreed that
the in-service date would occur at the close of business on Aug.
1, 1985. The determination of the in-service date was of key
importance to the Government, because the pipelines’ obligation
to take or pay for all gas produced from the plant became fixed
upon the in-service date.
 - 23 -

that the partners could still terminate participation under the

partners consent and agreement, the standstill agreement provided

that the partners could furnish notice of termination of

participation prior to noon on August 1, 1985, in which event

termination would be effective as of that date. A notice of

termination pursuant to this provision would relieve the partners

of the obligation to make further equity contributions to the

partnership.

Partnership and SFC Reach Price Support Agreement

On July 16, 1985, the partnership reached a final agreement

with SFC for a $720 million price guarantee.13 The agreement

required the DOE Secretary’s approval. It was not forthcoming.

DOE’s Rejection of Price Support Agreement

Notwithstanding DOE’s prior public support for the Great

Plains project and a price guarantee agreement, DOE rejected the

final agreement between SFC and the partnership in a 2-page

letter, dated July 30, 1985, and signed by DOE Secretary

13
Pursuant to this price guarantee assistance agreement, on
Aug. 1, 1985, the partnership would “default” on the payments due
FFB under the standstill agreement, and DOE would use an existing
$673 million reserve to “cure” that default on behalf of the
partnership; repayment of the remaining FFB indebtedness would be
rescheduled so that no significant burden for mandatory principal
payments would be incurred earlier than 1996; price guarantees
would be available. Under this agreement, 80 percent of the
cashflow would be used to repay the DOE-guaranteed debt, and
after that debt was repaid, SFC would be paid. Partners were to
make an additional equity investment of $190 million in the
project.
 - 24 -

Herrington. Acknowledging that this action was not the fault of

the project sponsors or SFC, this letter stated summarily that

the package “would not be in the best interests of the Nation as

a whole” and that DOE would not support the agreement “as

currently constituted”.

Partners Terminate Participation in the Project

On August 1, 1985, the partners learned of DOE’s rejection

of the financial assistance arrangement. The partners were

surprised and disappointed; they felt that DOE had doublecrossed

them by leading them on in negotiations before summarily

rejecting the agreement on the very day that the project was

declared in-service. The partners immediately exercised their

contractual rights under the partners consent and agreement to

decline to make further capital contributions to the partnership

that otherwise would have been required under the standstill

agreement and the loan guarantee agreement. The written notices

to terminate participation, dated August 1, 1985, were based on

the determination of the partnership’s management committee that,

after Secretary Herrington’s action, there was no longer

reasonable assurance that the project would generate sufficient

cash to permit the partnership to make timely principal and

interest payments on its outstanding debt and to make

distributions over a 10-year period following the in-service date

that were at least equal to the contributed equity. As
 - 25 -

previously indicated, these were the contractual premises for

termination of participation.

Although the partners terminated participation in the

project, the partnership continued its legal existence. No

partner withdrew from the partnership. The partnership’s

liabilities were unaffected. It was understood, however, that

the partners’ termination of participation would lead to an event

of default by the partnership under the loan guarantee agreement,

allowing DOE to assume control over the project.

The Partnership Defaults on the FFB Loan

After the partners declined to contribute further equity to

the partnership with respect to the DOE-guaranteed financing, the

partnership was unable to make the deferred principal, interest,

and guarantee fee payments due on August 1, 1985, under the

standstill agreement. The partnership’s failure to make these

payments constituted an event of default under the loan guarantee

agreement and the mortgage.

In August and September 1985, pursuant to the loan

guarantee agreement, DOE made payments to FFB totaling

approximately $1.57 billion. This sum represented the entire

amount of principal and interest that the partnership owed FFB

under the credit agreement and that correspondingly became due

from DOE under the loan guarantee agreement. Upon paying these

amounts due under the loan guarantee obligations, DOE became
 - 26 -

subrogated to FFB’s claims. By letter dated October 9, 1985, DOE

made written demand upon the partnership for payment of all

guaranteed indebtedness, together with accrued interest from

September 30, 1985.

DOE Takes Control of the Project

After the partnership’s default, DOE assumed control of the

Great Plains project. Legal title to the project and its assets,

however, remained with the partnership. In public statements,

DOE acknowledged that it was not the legal owner of the Great

Plains project and that it would not acquire legal ownership of

the facility until there was a foreclosure sale.

By letter dated August 1, 1985, DOE invoked its option to

cause ANG, as project administrator, to continue operating the

project in substantially the same manner as had been done for the

partnership. DOE advised the pipeline affiliates that it was

substituting the Secretary of Energy for the partnership as the

seller in the gas purchase agreements.

By letter to DOE dated August 2, 1985, the partnership

acknowledged receiving a copy of DOE’s prior-day letter to ANG.

The partnership advised DOE that, in order to permit the project

administrator to carry out its duties as instructed by DOE, the

partnership would exercise no responsibility or control over the

project as of August 1, 1985. Also on August 2, 1985, the

partnership advised vendors and suppliers working for the project
 - 27 -

that control over the Great Plains project had reverted to DOE

and that ANG was now acting solely at the direction and under the

control of DOE. The partnership advised the vendors and

suppliers that DOE had halted all capital improvements at the

project and was unwilling to fund such expenses; accordingly, the

partnership instructed the vendors and suppliers to cease

providing services, materials, or labor, or otherwise incurring

expenses for capital projects until further notice from DOE.

On or about August 13, 1985, DOE stated publicly that it

would allow the Great Plains project to continue operating

temporarily while DOE and officials for the State of North Dakota

discussed ways to meet DOE’s conditions for long-term plant

operation. Shortly thereafter, ANG and the United States reached

a revised project administration agreement. Under this

agreement, ANG was formally reappointed project administrator,

with complete authority, subject to the DOE Secretary’s

directions, to do all things necessary for the operation and

maintenance of the Great Plains gasification plant and related

facilities. Under this agreement, ANG was to be paid a

performance fee of approximately $3 million per year.

Accordingly, ANG employees (numbering at least 800)

continued to operate the project as they had before the partners

terminated their participation. Liaison between DOE and the

project administrator was conducted through designated employees
 - 28 -

of the project administrator and DOE’s regional office in

Chicago, Illinois. DOE was not, however, directly involved in

the plant’s day-to-day operations.

The Partnership’s Continued Activity

After DOE assumed control of the project, there were

continuing disputes between the partnership and DOE, including

disputes over the partnership’s and the partners’ liability for

project expenses incurred under the standstill agreement.14 In

September and October 1985, ANG and DOE requested the

partnership’s permission to sell certain “excess” project assets,

including parcels of real property, portable living quarters, and

some items of equipment. The partnership declined to approve the

sale.15

Although the partnership did not direct or control the Great

Plains project after DOE assumed of control of it on August 1,

14
After several months of negotiations, the parties agreed
that the partnership owed DOE $13.4 million. In July 1987, the
management committee met to approve this agreement and to call
for further equity contributions of $12.5 million from the
partners to the partnership. The partnership also made an
additional cash call to satisfy a settlement with the State of
North Dakota for sales and use tax liabilities.
15
In an Oct. 14, 1985, letter to the project administrator,
C. W. Rackley, chairman of the partnership’s management
committee, advised that authority to approve the sale no longer
rested with the Management Committee and suggested that the
request be directed to DOE. In a Nov. 1, 1985, letter to DOE,
Mr. Rackley indicated that in view of the pending foreclosure
action, the partnership had been advised that it would not be
appropriate for the management committee to approve the sale.
 - 29 -

1985, representatives of the partners and the partnership

continued to meet on matters concerning the partnership and the

project. There were numerous meetings of the partnership’s

management, tax, and finance committees. ANG continued to

maintain insurance on the project, paying the insurance premiums

out of project revenues. The partnership continued to be named

as the insured party on these insurance policies.

The Project’s Improving Financial Situation

During August 1985, DOE advanced approximately $1,597,000 to

cover project expenses. The advance was repaid to DOE in

December 1985 out of project revenues. After August 1985, DOE

provided no other funds for the project.

For the 6 months following August 1, 1985, cumulative

revenues from the Great Plains project exceeded cumulative

expenses. The project continued to operate with a positive

cashflow in 1985, 1986, and 1987, accumulating a surplus of more

than $130 million. For the 11 months ended June 30, 1986, the

project generated positive cashflow of about $57 million. For

the year ended June 30, 1987, the project generated positive

cashflow of about $16 million. ANG continued to use project

revenues to operate the gasification plant, with excess revenues’

being segregated in separate accounts.
 - 30 -

The Partners’ Ongoing Efforts To Reopen Negotiations With DOE

On August 23, 1985, Transco Energy’s CEO, Mr. Jack Bowen,

met with DOE Deputy Secretary Boggs to discuss a possible workout

of the partnership’s debt. This meeting occurred even as the

partners were embarking on a public relations campaign directed

at North Dakota citizens, lobbyists, the White House, and members

of Congress, to bring DOE back to the negotiating table.

As discussed in greater detail infra, on August 29, 1985,

DOE initiated court proceedings to foreclose on the project

assets. The next day, Transco Energy submitted to DOE a

“discussion draft” outlining key elements for the partnership’s

continued participation in the project. This discussion draft

contemplated that the partnership would retain title to the plant

and proposed making interest on the DOE-guaranteed debt

contingent on project cashflow. The discussion draft included no

provision for additional capital contributions by the partners.

Between August and November 1985, Mr. Bowen had more

meetings and telephone conversations with various high-level DOE

officials regarding a possible workout. The other partners were

kept informed of these discussions. Mr. Bowen offered to have

all the partners meet directly with DOE, but DOE indicated a

preference to work through only one contact until a proposal was

sufficiently developed to require input from all the partners.

DOE agreed to prepare a proposal for the partners’ consideration.
 - 31 -

Each partner was represented at a December 6, 1985, meeting

between the partnership management committee and DOE

representatives. At this meeting, the partners discussed

restructuring the $1.57 billion outstanding debt into a

contingent-interest debt, similar to what had been envisioned in

the price support agreement that the partnership had reached with

SFC in July 1985.16

In a December 19, 1985, telephone call with Transco Energy

representatives, DOE General Counsel Mike Farrell indicated that

the “discussion draft” Transco Energy had submitted on August 30,

1985, was a “non-offer”. In particular, DOE was unwilling to

allow the partners to retain title to the plant, retain all tax

benefits from the project, and yet have the right to terminate

participation. Advised that title to the plant and the resulting

tax benefits were the partners’ only source of cash in the event

of a revenue shortfall, Mr. Farrell indicated that there was

probably some “wiggle room” on the tax benefits issue.

On January 29, 1986, ANRC submitted to DOE an outline of a

restructuring proposal.17 The proposal would have allowed the

16
Presumably, interest continued to accrue on the debt.
The parties, however, have ignored interest accruals in referring
to the $1.57 billion debt. For simplicity, we do the same.
17
Under the proposal, the partnership would retain
ownership of the plant and continue to be responsible for its
operation, DOE would withdraw its foreclosure action, and the
partnership’s debt would be restructured into a contingent-
interest obligation.
 - 32 -

partnership to retain ownership of the plant and would have

required, among other things, that the partnership recommence

operating the project, covering cash shortfalls through further

cash investments in the project up to an amount equivalent to the

tax credits previously earned from the project. On January 30,

1986, representatives of Transco Energy and ANRC met with DOE

Deputy Secretary Boggs and DOE General Counsel Farrell regarding

the restructuring proposal. The DOE representatives stated that

they found “nothing offensive” in the proposal and that DOE would

consider it and respond.

The partners continued to meet and discuss these matters.

The other partners were divided over whether to join ANRC’s

proposal to DOE. At an April 1, 1986, meeting, Transco and

Pacific agreed to participate in ANRC’s proposal, although

Pacific indicated that it intended to “take a passive position

for the present”. Tenneco and Midcon declined to participate in

ANRC’s proposal on the ground that the tax benefits they had

realized from the project were insufficient to justify the

additional capital contributions contemplated under the proposal.

Neither Tenneco nor Midcon sought, however, to obstruct the other

partners’ efforts to retain the partnership’s future involvement

in the project.

In the meantime, other events threatened to overtake the

negotiations with DOE. In February 1986, DOE had asked the

public for “expressions of interest” in acquiring or
 - 33 -

participating financially in the project’s operation.18 As

discussed in greater detail infra, on April 7, 1986, a Federal

District Court directed the mortgage on the partnership’s $1.5

billion debt to be foreclosed; the court scheduled the

foreclosure sale for May 18, 1986 (subsequently extended to June

30, 1986).

Partners Request Letter Ruling

On May 22, 1986, ANR and Transco filed with the IRS a

request for a ruling that the partnership’s default on the

indebtedness and related events had not resulted in recapture of

investment or energy credits or given rise to gain recognition.

The partners viewed such a ruling as fundamental to pending

proposals to use prior tax benefits to fund additional capital

infusions into the project. The partners did not want to be in

the whipsaw position of having both to recapture the tax benefits

and to use them to fund the project. ANR and Transco requested

the IRS to expedite consideration of the ruling request to enable

them to submit their restructuring proposal to DOE and prevent

the impending foreclosure sale of the project. (As discussed in

greater detail infra, in September 1986 the IRS ruled that the

events as of May 22, 1986, had not resulted in recapture of

investment or energy credits or given rise to gain recognition.)

18
On Apr. 4, 1986, ANRC filed a statement of interest,
which was one of nine received by DOE.
 - 34 -

Final Debt-Restructuring Proposals

On May 28, 1986, ANRC and Transco Energy submitted to DOE a

formal restructuring proposal. This proposal contemplated

restructuring the DOE debt and providing $210 million of capital

infusions to fund continued project operations, contingent upon

receipt of a favorable IRS ruling that no recapture of taxable

credits or recognition of taxable gain had yet occurred.

Although Pacific did not join this formal submission, it was

aware of it and contemplated continuing participation in the

project if a restructuring agreement could be reached and the IRS

provided a favorable ruling.

By letter dated June 9, 1986, DOE rejected the May 28, 1986,

proposal. DOE insisted that any proposal must include a

“substantial cash payment” to DOE toward partial retirement of

the $1.57 billion debt, “such that the payment outweighs the tax

benefits subject to recapture if the Project is acquired by an

outside party”.

An internal Transco memorandum dated June 20, 1986, from a

lawyer in Transco’s legal office, reported communications that

day with Mr. S. Kinnie Smith, Jr., ANR’s vice chairman and legal

counsel, advising Mr. Smith that Transco did not see a

“significant reason” to pursue an appeal of the foreclosure order

and did not wish to “dilute” Transco’s appeal on gas contract

issues by “interjecting rather weak arguments relating to
 - 35 -

foreclosure procedures”. The memo indicated that Mr. Smith had

already spoken with Tenneco and Pacific “both of whom did not

want to participate in an appeal, and therefore did not want to

have the partnership itself file an appeal”.

By this time, the foreclosure sale of the project assets,

previously scheduled for June 30, 1986, was imminent. In a June

24, 1986, meeting with DOE General Counsel Farrell, ANRC made a

final proposal. An introductory page of bullet points regarding

the proposal bore the caption “THE PLANT UNDER PRESENT

CIRCUMSTANCES IS WORTHLESS”. The proposal included an immediate

$100 million payment to DOE, additional cash infusions of $40

million from current partners, and a $90 million letter of credit

for project working capital. The proposal also contemplated that

a significant part of the project’s cashflows would be applied to

pay down the DOE debt. The proposal identified ANRC, Transco

Energy, and Pacific as the “participating partners”. In a letter

dated June 25, 1986, DOE General Counsel Farrell summarily

rejected this final proposal.

A June 26, 1986, Transco interoffice memorandum indicated

that, on the basis of conversations with ANR personnel, ANR “does

not plan to submit a revised proposal because in their view it

would be futile - unless a favorable signal and change in

direction comes from the DOE within the next two working days.

P.S. - In short, it sounds like the gig is up”.
 - 36 -

As discussed at greater length below, on June 30, 1986, the

foreclosure sale was held as scheduled, DOE purchased the

project’s mortgaged assets, and ANR filed an appeal of the

foreclosure proceeding.

The Foreclosure Proceedings

DOE Initiates Foreclosure Proceedings

As previously noted, on August 29, 1985, DOE had initiated

proceedings in the United States District Court for the District

of North Dakota (the District Court) seeking foreclosure of the

mortgage and sale of the mortgaged property. The Government

moved for summary judgment. The partnership resisted, contending

that the foreclosure should be conducted in accordance with North

Dakota law, which it contended gave the partnership redemption

rights for up to 1 year after the foreclosure sale.

District Court Decision

On January 14, 1986, the District Court granted the

Government’s motion for summary judgment, holding that Federal

law applied and gave the partnership no redemption rights. In

its memorandum and order, however, the District Court observed

that there was no precedent involving this particular loan

guarantee program, that a determination under the balancing test

of United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979), was

a “close question”, and that of the various options presented to

the Court by the parties, “All have merit”.
 - 37 -

On April 7, 1986, the District Court entered an Order and

Decree of Foreclosure and Sale that: (1) Directed the mortgage

be foreclosed and the mortgaged assets sold by public auction on

May 28, 1986; and (2) held that the partnership and the partners

were not entitled to redemption rights.

On April 18, 1986, the partnership filed a motion to amend

the District Court’s April 7, 1986, Order and Decree so as to:

(1) Clarify that recovery was limited to the partnership’s assets

and the interests of the partners therein; (2) correct the

property descriptions; and (3) defer the foreclosure sale for at

least 6 months to enable pending workout negotiations to continue

between certain partners and DOE. With regard to this latter

point, the motion stated that the partnership had claimed and

passed through to its partners investment tax credits of

approximately $250 million and deductions of approximately $390

million and that a substantial part of these credits and

deductions would be subject to recapture if the plant were

disposed of in less than 5 years. The motion indicated that

pending proposals by some of the partners to continue operating

the plant and to restructure the DOE-guaranteed indebtedness

depended upon the continued availability of the economic value of

these tax benefits. The partnership requested a period for

“equitable redemption” and contended that the foreclosure sale

should be deferred pending the partners’ ongoing efforts to
 - 38 -

restructure the debt. The State of North Dakota intervened,

urging delay of the foreclosure sale and citing adverse economic

impacts from closing the plant.

By order dated May 8, 1986, the District Court denied the

partnership’s motion for a period of equitable redemption,

concluding that it lacked authority to grant such relief where

the order of foreclosure had already been entered. The District

Court also noted that the partnership and the partners “talk of

‘redemption’, but it is apparent that ‘re-negotiation’ would be a

more accurate description”. Nevertheless, the District Court

postponed the foreclosure sale date from May 28 to June 30, 1986,

to permit the notice of sale to be republished with corrected

property descriptions.

The June 30, 1986, Foreclosure Sale

On June 30, 1986, the foreclosure sale was held. The lone

bidder was DOE, which bid $1 billion for the partnership’s

mortgaged assets.19 The U.S. Marshal filed with the District

Court a Marshal’s Return and Report of Sale and a Certificate

19
As discussed in more detail infra, certain assets
necessary for operating the project were not among the
partnership’s mortgaged assets but were instead owned by ANG (the
subsidiary of ANRC, which also owned ANR, a general partner in
the partnership). As a precondition for the loan guarantee
agreement, DOE had required ANRC to pledge as security all its
ANG stock. Petitioner asserts, and respondent does not dispute,
that DOE purposefully bid less than the full amount of the $1.57
billion debt, intending subsequently to use the balance of the
debt to obtain the ANG stock.
 - 39 -

of Sale stating that DOE had purchased the mortgaged assets of

the project for $1 billion at the public foreclosure sale.20

Objections to the Foreclosure Sale

On July 7, 1986, ANR filed with the District Court

objections to the foreclosure sale. The premise of the

objections was that the sale had been improperly conducted

without providing the partnership redemption rights under

applicable North Dakota foreclosure statutes or equitable rights

of redemption under Federal common law. On July 14, 1986, the

District Court overruled ANR’s objections and confirmed the

foreclosure sale. The court noted that “the legal entity

foreclosed upon, the partnership, has not objected to the sale”

and questioned whether ANR had standing to object.

On July 16, 1986, the Marshal issued the Marshal’s Deed to

DOE, and the deed was recorded in the local property records.

Appeal of the Foreclosure Proceedings

On June 30, 1986, ANR, as a general partner of the

partnership, filed a notice of appeal in the foreclosure

20
The $1 billion was applied to pay principal of about $891
million and accrued interest of about $109 million. Although the
record is silent on this point, it seems unlikely that any funds
actually changed hands in this transaction. Pursuant to the
indenture of mortgage, DOE was authorized to bid for and purchase
the mortgaged assets, and the trustee was directed to apply the
proceeds to repay DOE the amounts DOE had previously paid FFB
pursuant to the guarantee agreement. The net result of these
transactions would have been simply to reduce the partnership’s
obligation to DOE by $1 billion.
 - 40 -

litigation to the U.S. Court of Appeals for the Eighth Circuit.

The notice of appeal, which was served on all the partners,

identified the appellants as the five individual named partners

of the partnership and the partnership itself. The four partners

other than ANR did not actively participate in the appeal, but

they also did not actively oppose it, provided that ANR bore the

associated legal expenses. ANR viewed a successful appeal of the

foreclosure order as a way to force DOE back to the negotiating

table. In addition, if the appeal had been successful, it would

have benefited all the partners inasmuch as North Dakota law, if

applicable, would have given the partnership rights to redeem the

plant for 1 year after the foreclosure sale, while possessing and

operating the plant during that 1-year period and retaining the

cashflows generated.

On October 17, 1986, the United States filed its brief in

the U.S. Court of Appeals for the Eighth Circuit, contending that

the District Court properly ruled that North Dakota law should

not apply. In its brief, the Government did not challenge ANR’s

authority or standing to file the appeal. The Government’s brief

asserted, however, that the real motive for ANR’s filing the

appeal was to postpone the foreclosure sale so as to “save the

Great Plains partners as much as $347 million in tax recapture

liability”.
 - 41 -

On March 11, 1987, the Eighth Circuit issued its opinion in

United States v. Great Plains Gasification Associates, 813 F.2d

193 (8th Cir. 1987). The Court of Appeals affirmed the judgment

of the District Court, though on different grounds, holding that

the North Dakota redemption statute did not apply to the

foreclosure of a loan, such as the FFB loan, that was guaranteed

pursuant to the Federal Nonnuclear Research and Development Act

of 1974.21 In so doing, however, the Court of Appeals confirmed

the nature of the redemption rights that North Dakota law would

otherwise afford, stating:

Were we to reverse the district court and look to
North Dakota law for our rule of decision Great Plains
would have the right to redeem at any time up to one
year after judicial sale. N.D. Cent. Code § 32-19-18
(1976). During this period Great Plains would be
entitled to the possession, rents, use, and benefit of
the plant. N.D. Cent. Code § 28-24-11 (1974). * * *
[United States v. Great Plains Gasification Associates,
supra at 195.]

The Court of Appeals did not question ANR’s standing to pursue

the litigation as a partner of the partnership.

Petition for Writ of Certiorari

On July 15, 1987, ANR, as a general partner of Great Plains

Gasification Associates, filed a timely petition for a writ of

certiorari with the U.S. Supreme Court, seeking review of the

judgment of the Eighth Circuit. The petition, filed by a legal

21
The Court of Appeals for the Eighth Circuit held further
that the District Court did not err in refusing to grant the
partnership an equitable right of redemption.
 - 42 -

team headed up by former Solicitor General Rex E. Lee, contended

that there was a recurring conflict among the circuits as to

whether Federal or State law should apply to proceedings under

federally guaranteed private loans such as the partnership’s FFB

loan. In its brief in opposition to the petition for writ of

certiorari, the United States did not suggest that ANR lacked

authority or standing to pursue that litigation. On November 2,

1987, the Supreme Court denied the petition for writ of

certiorari, and the foreclosure litigation came to an end.

The Partnership’s Ratification of ANR’s Appeal

The partners had monitored the appeal and petition for writ

of certiorari. On September 3, 1987, the partnership’s

management committee had adopted resolutions that expressly

ratified ANR’s actions relating to the foreclosure litigation.

By its terms, the ratification was effective retroactive to the

date these actions were taken by ANR, as if ANR “had obtained the

prior authorization of the Management Committee”. The

resolutions also authorized the partnership’s legal committee to

determine the manner in which the litigation would be conducted

on the partnership’s behalf in the event the Supreme Court

granted the petition for writ of certiorari.

Discharge of Remaining Debt

As previously noted, ANRC owned the outstanding stock of

ANG, which was the project administrator. ANRC had pledged this
 - 43 -

stock as additional security for the partnership’s obligation to

DOE under the loan guarantee agreement. ANG held deeds,

easements, and contract rights (the ANG project assets) that were

needed to operate the project but that had not been titled in the

partnership’s name. Consequently, DOE had not acquired the ANG

project assets in the foreclosure sale that was conducted on June

30, 1986. At the foreclosure sale, the Government had applied

only $1 billion of the approximately $1.57 billion debt to

acquire the partnership’s assets that were subject to the

mortgage. The Government had intentionally kept the remaining

balance of the indebtedness in reserve for subsequent use in

acquiring the ANG stock.

In November 1987, DOE considered foreclosing on the ANG

stock. In a settlement agreement entered into on October 13,

1988, ANRC assigned its ANG stock to DOE, which then released the

partnership’s outstanding indebtedness. In the settlement

agreement, ANRC acknowledged that the fair market value of the

ANG stock and all remaining collateral securing the partnership’s

obligations under the guarantee agreement was less than the

partnership’s outstanding indebtedness to DOE. The settlement

agreement recites that ANRC was entering into the settlement

agreement partly “to avoid the expense of litigation to

foreclose” DOE’s lien on the ANG stock pursuant to the pledge

agreement.
 - 44 -

DOE Sells the Project Assets

Once the Supreme Court denied ANR’s petition for writ of

certiorari in the foreclosure litigation, DOE began making plans

to sell the project assets. In a press release dated December 9,

1987, DOE identified 15 potential buyers of the project. One of

these potential buyers was the Coastal Corp. (Coastal), which had

acquired ANRC in March 1985. Ultimately, however, DOE selected

Basin Electric, a North Dakota cooperative, as the successful

bidder. On October 31, 1988, the United States sold the project

assets to two subsidiaries of Basin Electric--Dakota Gasification

Co. and Dakota Coal Co.

The Partnership Continues To Operate

Throughout 1988 and 1989, the partnership’s management,

legal, finance, and tax committees continued to meet and report

to the partners on open issues, including tax issues related to

the project. The partnership’s tax committee concluded that the

partnership ceased to own the project for tax purposes on

November 2, 1987, the date that the Supreme Court denied the

petition for writ of certiorari in the foreclosure proceedings.

Respondent’s September 1986 Letter Ruling

As previously noted, on May 22, 1986, while negotiations

about a possible debt workout were ongoing with DOE, ANR, and

Transco had filed with the IRS a request for a private ruling

regarding potential tax consequences from the partnership’s
 - 45 -

default on the project indebtedness. On September 10, 1986, the

IRS issued Private Letter Ruling 8649051 (the September 1986

letter ruling). In this 28-page ruling, the IRS concluded that,

as of May 22, 1986 (the date of the ruling request), the

partnership had not abandoned the project or made other

disposition of the project. The ruling stated:

There are two facts involved here that negate the
argument that * * * [the partnership] has abandoned the
Project. First, * * * [ANR] and * * * [Transco] are
continuing to seek a solution to the financial
difficulties facing the Project by negotiating an
agreement with * * * [DOE] that would permit * * * [the
partnership’s] continued participation in the Project.
Second, by refusing to grant approval for * * * [DOE]
to sell excess assets of the Project, * * * [the
partnership] has shown that it has not abandoned all
rights or involvement in the Project or control over
the Project’s assets.

Approximately 10 years after the IRS National Office issued

this letter ruling, the Houston IRS District Office submitted to

the IRS National Office factual and legal objections to the

ruling, contending that the partners’ original ruling request had

omitted or misstated material facts that resulted in an incorrect

ruling. On October 17, 1997, the IRS National Office issued

Technical Advice Memorandum 9811002, which rejected the

objections of the IRS Houston District Office, stating:

although the ruling request omitted certain information
that bore some relevance to the underlying tax issues
and characterized other information differently than
the District, these additional facts and alternate
characterizations, when taken together, were not
material. Therefore, the * * * [ruling] is to be
applied by the district director in the determination
 - 46 -

of the tax liability of * * * [Transco] and * * *
[ANR].

Partnership’s Return Position and Respondent’s Determinations

On its 1987 Form 1065, U.S. Partnership Return of Income,

the partnership reported that the “partial foreclosure sale” of

the coal gasification plant became final on November 2, 1987, the

date the Supreme Court denied the petition for a writ of

certiorari. On its 1987 return, the partnership reflected

income, deductions, losses, and tax credits from the project on

the basis that its ownership of the plant ended November 2, 1987,

reported gains and losses resulting from the “partial foreclosure

sale”, and reported basis of foreclosed assets to enable the

partners to determine recapture of tax credits. The partnership

reported $1 billion as the proceeds from the “partial foreclosure

sale”. In a disclosure statement, the partnership stated that it

was treating the $1 billion foreclosure sale price as “the amount

of the taxpayer’s nonrecourse indebtedness that was discharged as

a result of the disposition of certain assets by the foreclosure

sale”. The partnership asserted that DOE was continuing to

assert a claim against the partnership for approximately $681

million.22

By four separate notices of final partnership administrative

adjustments (FPAA) issued May 24, 2001, respondent took

22
We infer that this amount included interest on the debt.
 - 47 -

alternative, whipsaw positions, determining that the partnership

had engaged in a sale or exchange of the plant as of various

dates in 1985, 1986, 1987, and 1988, requiring recapture of tax

credits, recognition of gain resulting from the discharge of the

indebtedness, and other tax consequences as of these various

alternative dates. In the FPAA for the partnership’s 1985 tax

year, respondent asserted that the partnership engaged in a sale

or exchange of the project and related assets on or before August

1, 1985. In the FPAA for the partnership’s 1986 tax year,

respondent asserted that the partnership engaged in a sale or

exchange of the plant and related assets on June 30, 1986, or in

the alternative, on July 14, 1986. In the FPAA for the

partnership’s 1987 tax year, respondent asserted that the

partnership engaged in a sale or exchange of the plant and

related assets on January 1, 1987, or in the alternative, on

November 2, 1987. In the FPAA for the partnership’s 1988 tax

year, respondent asserted that the partnership engaged in a sale

or exchange of the project and related assets on January 1, 1988.

In each of these FPAAs, respondent asserted identically: “The

full amount of the outstanding nonrecourse mortgage, including

all accrued interest, is included in the amount realized on

disposition of the plant.”
 - 48 -

OPINION

I. Date of the Partnership’s Disposition of Project Assets

We must decide the date as of which the partnership should be

treated for Federal tax purposes as having disposed of its

interest in the Great Plains project. The parties have

stipulated, consistent with respondent’s September 1986 letter

ruling, that “no sale, exchange or other disposition of the Great

Plains gasification plant or any assets related thereto by Great

Plains Gasification Associates occurred on or before May 22,

1986”.

On brief, respondent argues that the partnership disposed of

the project assets on June 30, 1986, the date of the foreclosure

sale.23 Respondent argues primarily that the foreclosure sale

itself constituted the disposition. Alternatively, respondent

argues that the partnership abandoned its interests in the project

on or by June 30, 1986.

Petitioner contends there was no disposition or abandonment

of the project assets until the foreclosure litigation terminated

on November 2, 1987.

23
In one sentence, respondent’s opening brief posits
alternatively that the disposition occurred on July 14, 1986,
“the date the sale was confirmed by the District Court”. Apart
from this fleeting reference, however, respondent’s brief makes
no separate argument for July 14, 1986, as the disposition date.
 - 49 -

A. Did the June 30, 1986, Foreclosure Sale Constitute
Disposition by the Partnership?

A “transfer upon the foreclosure of a security interest”

constitutes a disposition of mortgaged property so as to trigger

recapture of a portion of investment tax credits and business

energy credits previously claimed with respect to the property.24

Sec. 1.47-2(a)(1), Income Tax Regs. Similarly, a foreclosure

sale constitutes a disposition of property pursuant to section

1001(a).25 See Helvering v. Hammel, 311 U.S. 504 (1941); Aizawa

v. Commissioner, 99 T.C. 197, 198 (1992), affd. 29 F.3d 630 (9th

Cir. 1994); Ryan v. Commissioner, T.C. Memo. 1988-12, affd. sub

nom. Lamm v. Commissioner, 873 F.2d 194 (8th Cir. 1989).

If local law provides the mortgagor a right to redeem the

property, the foreclosure sale generally is not final for tax

purposes until the right of redemption expires. Derby Realty

Corp. v. Commissioner, 35 B.T.A. 335, 338 (1937); Hawkins v.

Commissioner, 34 B.T.A. 918, 922-923 (1936), affd. 91 F.2d 354

24
In general, a taxpayer must recapture a portion of
previously allowed investment tax credits or business energy
credits if the underlying property is disposed of before the
close of the useful life taken into account in computing the
credits. See Jacobson v. Commissioner, 96 T.C. 577, 593 (1991),
affd. 963 F.2d 218 (8th Cir. 1992).
25
Tax consequences may vary depending upon whether the debt
is recourse or nonrecourse, particularly in determining whether
any amount realized from the foreclosure sale represents income
from discharge of indebtedness. See Aizawa v. Commissioner, 99
T.C. 197, 200-201 (1992), affd. 29 F.3d 630 (9th Cir. 1994).
 - 50 -

(5th Cir. 1937). As this Court explained in Ryan v.

Commissioner, supra:

This is because the foreclosure action is the amalgam
of two separate events. First, there is an
extinguishment of the underlying indebtedness, giving
rise to income. Cf. secs. 108, 61(a)(12), I.R.C. 1954.
Second, there is a disposition of the property securing
the debt, a sale or exchange. The all events test
requires both of these events to occur before income is
realized.

* * * * * * *

A foreclosure action that is being appealed is not
‘final’ in the normal sense of that word.

Pending foreclosure litigation has “the same effect as would

the fact that there was a period in which the right of redemption

under a foreclosure sale could be exercised.” Morton v.

Commissioner, 104 F.2d 534, 536 (4th Cir. 1939), revg. 38 B.T.A.

534 (1938). The year in which litigation terminates is the year

in which the claimed item is to be taken into account for Federal

tax purposes. See Found. Co. v. Commissioner, 14 T.C. 1333, 1354

(1950).

Citing Morton v. Commissioner, supra, and Rev. Rul. 70-63,

1970-1 C.B. 36, respondent acknowledges on brief: “a bona fide

contest as to the existence of redemption rights may postpone a

disposition, even if such rights are ultimately held not to

exist.” Respondent contends, however, that the foreclosure

litigation was not bona fide. Respondent contends that “the

redemption rights were worthless and would not have been

exercised even if the courts had awarded them” because financial
 - 51 -

considerations made it improbable that the partnership would have

redeemed the property.

Respondent focuses too narrowly, we believe, on the question

of whether the partnership would have exercised the redemption

rights, had they been awarded, to repurchase the project assets

from DOE outright. Such an inquiry would improperly lead us

“into endless speculation on petitioner’s financial situation and

financial hopes”. Derby Realty Corp. v. Commissioner, supra at

341 (rejecting any “supposed principle of probability of

redemption”); cf. Abelson v. Commissioner, 44 B.T.A. 98 (1941)

(concluding that redemption rights were wholly without value and

abandoned by the taxpayer who took no further action after the

foreclosure sale to pursue redemption rights). Moreover,

respondent fails to appreciate that the public policy served by

redemption rights is not merely in providing the mortgagor an

opportunity to repurchase property sold in foreclosure but also

in “‘allowing time for the mortgagor to refinance and save his

property, [and] permitting additional use of the property by the

hard-pressed mortgagor’”. Nelson & Whitman, “Reforming

Foreclosure: The Uniform Nonjudicial Foreclosure Act”, 53 Duke

L.J. 1399, 1404 (2004) (quoting Hart, “The Statutory Right of

Redemption in California”, 52 Cal. L. Rev. 846, 848 (1964)).

North Dakota law reflected this broader purpose of redemption

rights, as the Court of Appeals for the Eighth Circuit expressly
 - 52 -

acknowledged in ruling upon the partnership’s suit for rights of

redemption:

Were we to reverse the district court and look to
North Dakota law for our rule of decision Great Plains
would have the right to redeem at any time up to one
year after judicial sale. N.D. Cent. Code § 32-19-18
(1976). During this period Great Plains would be
entitled to the possession, rents, use, and benefit of
the plant. N.D. Cent. Code § 28-24-11 (1974). * * *
[United States v. Great Plains Gasification Associates,
813 F.2d at 195.]

Clearly, the 1-year redemption period, with attendant rights

to possess the plant and receive its profits, would have had

substantial value to the partnership. The project had generated

significant cashflow both before and after the foreclosure sale.26

According to credible testimony, the partners intended to use the

1-year redemption period to pursue further negotiations with DOE

to restructure the debt; the cashflow generated during the 1-year

redemption period would have allowed the partnership to sweeten

the pot in negotiating with DOE.

Respondent speculates that, in the light of DOE’s

unreceptiveness to the debt restructuring proposals put forward

immediately before the foreclosure sale, DOE would have also been

unreceptive to any further efforts to restructure the debt during

any redemption period. There is simply no way of knowing,

however, how DOE might have responded if the partnership had been

26
For the 11 months prior to the foreclosure sale, the
project had generated positive cashflow of about $57 million.
During the year after the foreclosure sale, the project generated
positive cashflow of about $16 million.
 - 53 -

awarded the redemption rights, especially in the light of DOE’s

long track record of mixed signals and reversals over the history

of the Great Plains project. But even if we were to assume, for

sake of argument, that respondent’s speculations are sound, the

fact remains that the partnership would have benefited materially

from the cashflows generated by the project during the redemption

period.

In support of his position that the litigation over the

disputed redemption rights should not postpone the finality of

the foreclosure sale, respondent relies on L&C Springs Associates

v. Commissioner, T.C. Memo. 1997-469, affd. 188 F.3d 866 (7th

Cir. 1999). Respondent’s reliance on that case is misplaced.

L&C Springs Associates held that a realization event with respect

to mortgaged real estate occurred in the year before the

foreclosure sale, when the taxpayer effectively abandoned the

mortgaged property.27 L&C Springs Associates, unlike the instant

case, did not involve the effect of ongoing foreclosure

litigation on the finality of the foreclosure sale.

Respondent does not appear to dispute that the foreclosure

litigation presented genuine legal issues as to whether the

partnership retained redemption rights under North Dakota law.28

27
As discussed infra, we conclude that the partnership did
not abandon the project prior to the conclusion of the
foreclosure litigation.
28
Similarly, respondent does not expressly advance any
(continued...)
 - 54 -

Respondent contends, however, that “this is largely beside the

point”. Respondent states on brief: “The question is not

whether the legal issues were bona fide, but whether the

litigation was brought by Petitioner to achieve the stated

purpose.” Respondent contends that ANR, and not the partnership

or Transco, undertook the foreclosure litigation “as a desperate

attempt to delay the adverse tax consequences, not to redeem the

property”. Respondent cites Lutz v. Commissioner, 396 F.2d 412

(9th Cir. 1968), revg. 45 T.C. 615 (1966) for the proposition

that litigation postpones tax consequences of a disposition only

when the taxpayer is the party actually litigating the dispute.

Respondent’s bottom line seems to be that even if the foreclosure

28
(...continued)
argument that the possibility of the foreclosure litigation’s
succeeding was too speculative to justify deferring tax
consequences of the foreclosure sale. Cf. Boehm v. Commissioner,
146 F.2d 553 (2d Cir. 1945) (loss for worthless stock was not
deferred pending outcome of shareholders’ derivative action of
unproven value), affd. 326 U.S. 287 (1945); Found. Co. v.
Commissioner, 14 T.C. 1333, 1354 (1950) (loss on construction
contract with a foreign Government was properly deferred until
conclusion of litigation over breach of contract, where the
taxpayer held a “reasonable view” that it could prevail on its
claim). We note, however, that in the foreclosure proceeding,
wherein the partnership contended that the foreclosure should be
conducted in accordance with North Dakota law allowing for a 1-
year redemption period, the District Court characterized the
partnership’s position as having “merit” even though it
ultimately resolved this “close question” against the
partnership. Indeed, in May 1985, DOE Assistant Secretary Mares
had testified before Congress that the partnership would be
entitled under North Dakota law to a 1-year redemption period,
during which it would be entitled to possession of the property
and to its rents and profits. Mr. Mares testified that any
waiver of those rights by the partnership would be void and
unenforceable under North Dakota law.
 - 55 -

litigation presented bona fide legal issues, the litigation

itself was not bona fide. We are not persuaded by respondent’s

arguments.

ANR filed the appeal of foreclosure order in its capacity as

a general partner of the partnership. In that capacity, pursuant

to applicable provisions of North Dakota partnership law, ANR had

actual and apparent authority to bind the partnership with

respect to the appeal. See N.D. Cent. Code sec. 45-06-01 (1976).

The other partners were aware of the litigation and were willing

to let ANR take the lead in the litigation and to pay for it.

The other partners gave at least tacit approval to ANR’s pursuing

the appeal which, if successful, would have protected the rights

of the partnership and the other partners. Indeed, on September

3, 1987, the partnership’s management committee formally ratified

ANR’s actions in this regard. Respondent seems to suggest that

this formal ratification was invalid or ineffective but has

advanced no convincing evidentiary or legal basis for this

theory.29

29
Respondent suggests that the ratifying resolutions were
invalid, because they did not conform to various procedural steps
required by the partnership agreement and because the copy of the
ratification resolution in the record is unsigned. Other
contemporaneous evidence indicates, however, that the
ratification resolutions were in fact adopted by the management
committee. For instance, in a letter to the law firm of
Fulbright & Jaworski, dated Sept. 14, 1987, C.W. Rackley,
chairman of the partnership’s management committee, stated that
he had been “duly authorized” to make various representations
regarding the foreclosure litigation. Attached to the letter was
(continued...)
 - 56 -

Respondent notes that ANR and the partnership had a tax

incentive to delay final disposition of the project assets and

contends that ANR’s pursuit of the appeal and the partnership’s

ratification of ANR’s actions were simply “window dressing”.

Respondent seems to suggest that the foreclosure litigation

lacked economic substance. We disagree. Viewed in its totality,

the record convinces us that petitioner and the partnership had

legitimate and substantial business reasons, apart from tax

considerations, to appeal the foreclosure litigation as part of

their sustained effort to restructure the debt and salvage their

half-billion dollar investments in the project. Cf. N. Ind. Pub.

Serv. Co. v. Commissioner, 115 F.3d 506, 512 (7th Cir. 1997)

(business actions “are recognizable for tax purposes, despite any

tax-avoidance motive, so long as the corporation engages in bona

fide economically-based business transactions”), affg. 105 T.C.

341 (1995).

In sum, we conclude and hold that the transfer of the

project assets pursuant to the foreclosure sale was not finalized

until November 2, 1987, when the Supreme Court denied the

petition for writ of certiorari in the foreclosure litigation.30

29
(...continued)
a copy of the ratification resolutions, which Mr. Rackley’s
letter stated “were duly adopted by the Management Committee of
the Partnership on September 3, 1987”.
30
For similar reasons, we reject respondent’s claim, raised
in cursory fashion on brief, that as of June 30, 1986, the
(continued...)
 - 57 -

B. Whether the Partnership Abandoned the Property

On brief, respondent argues alternatively that even if the

June 30, 1986, foreclosure sale did not constitute a final

disposition of the partnership’s project assets, the partnership

had abandoned the project as of June 30, 1986, or alternatively,

as of July 14, 1986 (the date the District Court overruled ANR’s

objections and confirmed the foreclosure sale).31 Respondent has

conceded, consistent with the holding of his September 1986

letter ruling, that no abandonment had occurred as of May 22,

1986. As we understand respondent’s somewhat mercurial position

in this proceeding, events occurring between May 22 and June 30,

1986, or possibly between May 22 and July 14, 1986, or possibly

30
(...continued)
project assets were owned by the United States and consequently,
pursuant to secs. 1.47-2(a)(2) and 1.48-1(k), Income Tax Regs.,
the project assets ceased to qualify as sec. 38 property as of
June 30, 1986. It is not the foreclosure sale itself but the
“transfer upon the foreclosure” that represents the final
disposition of assets that would trigger tax credit recapture.
Sec. 1.47-2(a)(1), Income Tax Regs. As respondent has conceded,
a bona fide contest as to the existence of redemption rights
postpones a disposition pursuant to a foreclosure sale.
31
On opening brief (but not on reply brief), respondent
contends broadly that both the partnership and Transco had
abandoned their interests in the project as of June 30, 1986.
Inconsistently, respondent’s response to petitioner’s motion in
limine, filed Jan. 31, 2005, states: “Respondent no longer
contends that the Court should consider the issue of whether the
partners abandoned their partnership interests in GPGA.” We deem
respondent to have waived any claim that Transco abandoned its
partnership interest or its interests in the project (which arose
only by virtue of Transco’s partnership interest). Consequently,
we need not address whether such a partner-level inquiry is
appropriate in this TEFRA proceeding.
 - 58 -

on June 30, 1986, or possibly on July 14, 1986, constituted an

abandonment by the partnership of the project assets.32 We

disagree.

The existence or timing of an abandonment is “inherently a

factual matter that requires a practical examination of all the

circumstances”. L&C Springs Associates v. Commissioner, supra at

870. The courts have applied different standards for analyzing

the timing of abandonment losses and the timing of abandonment

gains. Generally, a determination of an abandonment loss

requires an intention on the owner’s part to abandon the asset,

along with an “affirmative act” of abandonment. A.J. Indus.,

Inc. v. United States, 503 F.2d 660, 670 (9th Cir. 1974); see L&C

Springs Associates v. Commissioner, supra; Middleton v.

Commissioner, 77 T.C. 310, 322, affd. per curiam 693 F.2d 124

(11th Cir. 1982). On the other hand, where, as in the instant

case, abandonment of an asset would result in income recognition

32
As previously noted, although respondent occasionally
posits July 14, 1986, as an alternative date of abandonment,
respondent’s arguments do not otherwise direct our attention to
any circumstances or analysis supporting that date. Respondent
has been inconstant in his position as to whether he believes the
partnership abandoned the project before June 30, 1986, or on
that date. In a Jan. 5, 2005, hearing on petitioner’s motion for
summary judgment, respondent’s counsel advised the Court that
respondent’s position “is that there was no abandonment or other
disposition of the property until June 30” (emphasis added).
Inconsistently, on brief respondent contends that the partnership
abandoned the project “by June 30, 1986” (emphasis added).
Respondent’s arguments on brief, focusing largely on pre-June 30,
1986, events, suggest that this evolution of respondent’s choice
of prepositions is purposeful.
 - 59 -

or recapture of tax credits or deductions, an overt act of

abandonment is unnecessary if, under the facts and circumstances,

“it is clear for all practical purposes that the taxpayer will

not retain the property”. L&C Springs Associates v.

Commissioner, supra at 870; see Cozzi v. Commissioner, 88 T.C.

435, 445-446 (1987); Brountas v. Commissioner, 74 T.C. 1062, 1074

(1980).

Consistent with his September 1986 letter ruling, respondent

has stipulated that the partnership did not dispose of the

project before May 22, 1986 (the date of the letter ruling

request). Notwithstanding this stipulation, however, respondent

suggests that even before May 22, 1986, the partnership was in

the process of “gradually” abandoning the project. In support of

his position, respondent points to many of the same circumstances

that were considered in the September 1986 letter ruling.

Respondent notes, among other things, that on August 1, 1985, the

partners and partnership gave DOE written notice that they were

terminating their participation in the project; that various

partners, with varying degrees of interest and of active

participation of other partners, attempted unsuccessfully for

many months to negotiate with DOE to restructure the debt; and

that, in respondent’s view, certain of the partners had

effectively abandoned the project. As the September 1986 letter

ruling concluded, however, and as respondent now concedes, these
 - 60 -

pre-May 22, 1986, circumstances did not amount to an abandonment

of the project by the partnership.

The gist of respondent’s argument, as we understand it, is

that events occurring after May 22, 1986, and no later than July

14, 1986, tipped the balance, transforming what respondent views

as the partnership’s gradual abandonment-in-process into actual

abandonment, somewhat as ever-colder water will finally make ice.

The post-May 22, 1986, events that respondent points to in

support of this theory are essentially these: On May 28, 1986,

ANRC and Transco Energy submitted to DOE a new proposal, which

DOE rejected on June 9, 1986; on June 20, Transco informed ANR

that it would not participate in appealing the District Court’s

foreclosure order; on June 24, 1986, ANRC and Transco Energy

submitted to DOE yet another proposal, which DOE rejected on June

25, 1986; and the foreclosure sale occurred on June 30, 1986,

without any bids from the partnership or any partner.

We are unpersuaded that there was such a change in the

partnership’s business climate immediately after May 22, 1986, as

to say that the partnership should be deemed to have abandoned

the project assets on (or by) July 1 or 14, 1986, if, as

respondent concedes, the partnership had not abandoned them

before then. Rather, it appears to us that the post-May 22,

1986, events were mainly a continuation of the partners’ ongoing,

albeit ultimately unsuccessful, efforts to protect their

significant investments in the project.
 - 61 -

Respondent suggests that the May 1986 proposal and June 1986

proposal lacked genuine substance because they omitted certain

elements previously demanded by DOE and were motivated purely by

tax considerations.33 We disagree. Extensive, uncontradicted

testimony convinces us that these were reasonable business

proposals put forward by the partnership’s principals in good-

faith negotiations with DOE.

Ultimately, the project assets were taken from the

partnership involuntarily through the foreclosure process. Even

then, the partnership did not abandon the assets. To the

contrary, as previously discussed, ANR, with at least the tacit

approval of the partnership’s other partners and ultimately with

33
In support of his claim that there was no substantive
nontax purpose for these proposals, respondent cites several
internal memoranda written and exchanged by the partners. Among
those internal memoranda is a Tenneco interoffice communication
dated August 26, 1987 (Exhibit 314-R), which states in part:

The * * * [4 partners other than ANR] previously
refused to actively participate in the appeal because
of the desire to minimize legal exposure on other
matters and the lack of optimism associated with the
litigation. Transco and Pacific * * * have changed
their position and would vote to ratify * * * [ANR’s]
efforts. Midcon is still opposed. A change in our
position would allow the opinion process to go forward.

At trial, petitioner raised evidentiary objections to this
document based on authenticity and completeness. The Court
overruled the objection as to completeness but reserved ruling on
the authenticity objection, inviting the parties to address the
issue on brief. Petitioner has not addressed this issue on
brief. Consequently, we deem petitioner to have waived
authenticity objections to this document, and we shall receive
Exhibit 314-R into evidence.
 - 62 -

their formal approval, pursued bona fide litigation over the

foreclosure order.

This case bears some similarity to Energy Res. Ltd. Pship.

v. Commissioner, T.C. Memo. 1992-386. In that case, a

partnership constructed an oil cleansing refinery, using revenue

bonds guaranteed by the U.S. Small Business Administration (SBA)

and secured by a mortgage on the facility. In 1983, shortly

after the facility became operational, financial and technical

difficulties forced the partnership to shut the facility down.

The partnership went into bankruptcy. Eventually, SBA assumed

maintenance and security responsibility for the plant.

Nevertheless, the partnership, through its principals, continued

efforts to raise additional funds for the project, proposed

various types of arrangements to potential purchasers, resisted

efforts by SBA to foreclose on the property, and engaged in

negotiations with SBA and the bankruptcy court. In 1984, the

bankruptcy court granted SBA’s motion to sell the plant to a

third party. In holding that the partnership had not abandoned

the plant when it was shut down in 1983, this Court observed that

the level of activity displayed by the partnership’s principals

showed that they considered the project to be of continuing

utility and was “sufficiently extensive, repeated, continuous, or

substantial” to negate a conclusion that they had abandoned the

project.
 - 63 -

Similarly, in the instant case, the efforts of the

partnership’s principals to restructure the debt and to appeal

the foreclosure order convince us that they considered the

project to be of continuing utility and had not abandoned it as

of June 30 or July 14, 1986.

Consequently, we hold that for Federal tax purposes the

there was no sale, exchange, abandonment, or other disposition of

the project assets until November 2, 1987, when the foreclosure

litigation ended.

II. When Was the Partnership’s Indebtedness Discharged?

In August 1985, the partnership defaulted on its $1.57

billion debt to FFB under the credit agreement. Shortly

thereafter, pursuant to the loan guarantee agreement, DOE paid

off the debt. The partnership’s obligation to FFB then shifted

to DOE, not as a new debt, but by subrogation, with DOE stepping

into FFB’s shoes as creditor. See Putnam v. Commissioner, 352

U.S. 82, 85 (1956); Lair v. Commissioner, 95 T.C. 484, 490

(1990).

In July 1986, pursuant to the indenture of mortgage, the

partnership’s assets were “sold” to DOE at foreclosure for $1

billion; this amount was applied against the partnership’s debt

to DOE. Petitioner asserts, and respondent does not dispute,

that DOE purposefully bid less than the full amount of the

partnership’s $1.57 billion debt so as to have available the

remaining debt to acquire the ANG stock, which ANRC had pledged
 - 64 -

as additional security for the partnership’s debt to DOE. In

October 1988, pursuant to a settlement agreement between ANRC and

DOE, ANRC assigned its ANG stock to DOE, which then released the

remaining $570 million indebtedness.

The parties disagree as to when this $570 million debt

balance should be treated as having been discharged. Petitioner

asserts that only $1 billion of the debt was discharged by the

foreclosure sale and that the remaining $570 million of the debt

was not discharged until October 1988, when ANRC assigned its ANG

stock to DOE pursuant to the settlement agreement. Respondent

contends that because the debt was nonrecourse, pursuant to

Commissioner v. Tufts, 461 U.S. 300 (1983), the partnership must

take into account the entire amount of the $1.57 billion

indebtedness in the year in which the foreclosure sale became

final (1987, pursuant to our analysis supra).

A foreclosure sale constitutes a sale for tax purposes.

Helvering v. Hammel, 311 U.S. 504 (1941). The amount realized

from a foreclosure sale includes the amount of liabilities “from

which the transferor is discharged as a result of the sale”.

Sec. 1.1001-2(a)(1), Income Tax Regs.; see Crane v. Commissioner,

331 U.S. 1, 14 (1947); Aizawa v. Commissioner, 99 T.C. at 200-

201. When debt is discharged in a foreclosure sale, tax

consequences may vary depending upon whether the discharged debt

is recourse or nonrecourse. In the case of nonrecourse debt, the

amount realized on the foreclosure sale includes the entire
 - 65 -

amount of debt discharged. See, e.g., Commissioner v. Tufts,

supra. In the case of recourse debt, on the other hand, the

amount realized generally equals the net proceeds received from

the foreclosure sale rather than the entire recourse liability.34

Aizawa v. Commissioner, supra; cf. Chilingirian v. Commissioner,

918 F.2d 1251 (6th Cir. 1990) (amount realized from foreclosure

sale included amount of recourse debt discharged, where the

discharge was closely related to the foreclosure sale), affg.

T.C. Memo. 1986-463 .

Whether the partnership’s debt was nonrecourse is properly

determined at the partnership level in this TEFRA proceeding.

See Hambrose Leasing 1984-5 Ltd. Pship. v. Commissioner, 99 T.C.

298, 308 (1992); sec. 301.6231(a)(3)-1(a)(1)(v), Proced. & Admin.

Regs. Indebtedness is generally characterized as “nonrecourse”

if the creditor’s remedies are limited to particular collateral

for the debt and as “recourse” if the creditor’s remedies extend

to all the debtor’s assets. Raphan v. United States, 759 F.2d

879, 885 (Fed. Cir. 1985). For indebtedness incurred by a

partnership, Treasury regulations that were in effect at relevant

times defined a nonrecourse liability as one with respect to

34
Thus, the characterization of discharged debt as recourse
or nonrecourse may affect the character of any gain or loss on
the transaction. In this proceeding, the parties have presented
no issue as to the character of any gains realized by the
partnership.
 - 66 -

which “none of the partners have any personal liability”.35 Sec.

1.752-1(e), Income Tax Regs.; see 1 McKee et al., Federal

Taxation of Partnerships and Partners, par. 8.02, at 8-6 (3d ed.

1997).

Pursuant to the terms of the loan guarantee agreement, DOE’s

recovery on any claim was limited to the partnership’s assets and

to the partners’ interests in those assets. Pursuant to the

indenture of mortgage for the loan guarantee agreement, the

collateral for the debt included all project assets, including

all real or personal property “now owned or hereafter acquired

by” the partnership. Insofar as the record reveals, the

partnership had no significant assets apart from the project

assets that were foreclosed upon. Indeed, pursuant to the

partnership agreement and loan guarantee agreement, the

partnership was not authorized to acquire nonproject assets or to

engage in any business other than the project. After DOE took

control of the project and acquired the project assets, there was

35
In support of his argument that the debt was nonrecourse,
respondent cites, without elaboration, current Income Tax Reg.
sec. 1.752-1(a)(2). This regulation provides that, for purposes
of allocating a partnership’s liabilities among its partners, “A
partnership liability is a nonrecourse liability to the extent
that no partner or related person bears the economic risk of loss
for that liability”. These regulations are generally effective
for liabilities incurred after Dec. 28, 1991. Sec. 1.752-5(a),
Income Tax Regs. The predecessor temporary regulations, which
were similar to the final regulations in this regard, were
generally effective for liabilities incurred on or after Jan. 30,
1989. T.D. 8274, 1989-2 C.B. 101. Accordingly, the regulations
cited by respondent were not in effect at any time relevant to
this case.
 - 67 -

no realistic possibility that the partnership was going to

acquire additional assets.36 In these circumstances, the

partnership’s liability on the debt was effectively limited to

the project assets that collateralized the indebtedness, and the

partners’ liabilities were effectively limited to their interests

in those project assets. In these circumstances, the debt was in

substance nonrecourse against the partnership and the partners.

We do not believe that the partners should be considered to have

had any personal liability for the partnership’s debt within the

meaning of the then-applicable regulations.37

This conclusion is consistent with the manner in which the

partnership treated the debt on its 1987 Form 1065. The

partnership reported disposing of the project assets in a

“partial foreclosure sale” on November 2, 1987. The partnership

treated the $1 billion foreclosure sale price as “the amount of

the taxpayer’s nonrecourse indebtedness that was discharged as a

result of the disposition of certain assets by the foreclosure

36
Under the partnership agreement, partners were required
to make capital contributions to the partnership only as directed
by the management committee for the purpose of purchasing project
assets and paying project costs and other costs incurred by the
partnership. The partners were prohibited from making voluntary
contributions to the partnership. The record does not suggest
the partnership ever acquired additional assets after the project
assets were transferred to DOE.
37
Petitioner has not raised, and accordingly we do not
consider, any argument that the partnership’s debt should be
considered recourse by virtue of ANRC’s pledge of its ANG stock.
 - 68 -

sale” (emphasis added).38 Petitioner has offered no reason why

this characterization by the partnership of its indebtedness as

nonrecourse should be disregarded here.

Instead, petitioner contends that it is immaterial whether

the debt is considered to be recourse or nonrecourse, because

even if it were nonrecourse, only $1 billion of the debt was

extinguished in the foreclosure sale.39 Petitioner notes that the

debt was directly secured by the ANG stock which ANRC had pledged

and that DOE did not acquire the pledged stock and release the

remaining debt until October 1988. Consequently, petitioner

contends, whether the debt is considered to be recourse or

nonrecourse, the amount realized on the foreclosure sale should

not exceed the $1 billion of the partnership’s debt actually

discharged at the time of the foreclosure sale.

38
An opinion letter, dated Dec. 16, 1986, provided to
Coastal Corp. (which had purchased ANRC) by the law firm of
Fulbright & Jaworksi, stated that the amount realized by the
partnership upon the foreclosure sale “would include the
outstanding amount of the Partnership’s indebtedness to the DOE.
Commissioner v. Tufts, 461 U.S. 300 (1983).”
39
At various places in its 202-page opening brief and 102-
page reply brief, with little analysis and no citation of
authority and without acknowledging that the partnership treated
the debt as nonrecourse, petitioner asserts that the liability
was recourse. That assertion, however, does not appear in the 2-
page section of petitioner’s opening brief or the 3-page section
of petitioner’s reply brief specifically addressing the timing of
the discharge of the partnership’s indebtedness.
 - 69 -

We disagree. Whether a debt has been discharged is

dependent on the substance of the transaction and not mere

formalisms. Cozzi v. Commissioner, 88 T.C. at 445.

The moment it becomes clear that a debt will never
have to be paid, such debt must be viewed as having
been discharged. The test for determining such moment
requires a practical assessment of the facts and
circumstances relating to the likelihood of payment.
* * * Any “identifiable event” which fixes the loss
with certainty may be taken into consideration. * * *
[Id.]

See also Friedman v. Commissioner, 216 F.3d 537, 546 (6th Cir.

2000), affg. T.C. Memo. 1998-196; Brountas v. Commissioner, 74

T.C. 1062, 1073 (1980). The conclusion of the foreclosure

litigation was the identifiable event whereby it became clear

that the partnership’s debt would never be repaid by the

partnership. Indeed, according to petitioner’s own

representation, DOE bid only $1 billion in the foreclosure sale,

rather than the entire amount of the debt, “precisely so that it

would retain the ability separately to acquire the remaining

collateral”, the ANG stock, from ANRC. Petitioner thereby

implicitly acknowledges that DOE had no intention of attempting

to recover any part of the remaining debt from the partnership.

Subsequent events bear out that conclusion. Insofar as the

record reveals, DOE never made any other claims against the

partnership for the debt. In October 1988, when DOE reached the

settlement agreement with ANRC, it discharged all the remaining

debt in exchange for the ANG stock even though, as stated in the
 - 70 -

settlement agreement, the value of the ANG stock was less than

the debt balance.

Petitioner’s reliance upon Aizawa v. Commissioner, 99 T.C.

197 (1992), is misplaced. Aizawa held that where an unpaid

deficiency judgment on a recourse debt survived the foreclosure

sale, and there was a “clear separation” between the foreclosure

sale and the unpaid recourse liability which survived the

foreclosure sale, the amount realized under section 1001(a)

equaled the foreclosure sale price rather than the full unpaid

mortgage principal. By contrast, in the instant case, as

previously discussed, the partnership’s and the partners’

liabilities were effectively limited to the partnership’s project

assets that collateralized the indebtedness. Consequently, then,

these liabilities did not survive the foreclosure sale, since DOE

acquired all the partnership’s project assets in the foreclosure

sale. Insofar as the record reveals, DOE neither sought nor

obtained any deficiency judgment against the partnership or any

partner for the debt balance remaining after the foreclosure

sale.

In sum, we conclude and hold that the partnership must take

into account the full amount of the $1.57 billion debt as the

amount the partnership realized upon disposition of the project

assets upon the conclusion of the foreclosure litigation on

November 2, 1987. See Commissioner v. Tufts, 461 U.S. 300

(1983).
 - 71 -

In light of the foregoing,

Decision will be entered

pursuant to Rule 155.