Supreme Court Update: Atlantic Marine Construction Co. v. Western District of Texas (12-929), United States v. Woods (12-562) and Ford Motor Co. v. United States (13-113)

December 9, 2013 Supreme Court Update

Greetings, Court fans!

In the midst of hearing arguments and filling in its dance card for the rest of the Term, the Court has found time to issue a few early opinions. Last week brought three: an important decision on the enforceability of forum selection clauses in Atlantic Marine Construction Co. v. Western District of Texas (12-929); a ruling applying the Internal Revenue Code's valuation misstatement penalty to sham transactions in United States v. Woods (12-562); and a per curiam decision granting cert and remanding Ford Motor Co. v. United States (13-113), a case involving interest due to taxpayers for overpayment, to the Sixth Circuit to consider subject matter jurisdiction.

The Court spoke with one voice in support of the near-universal enforcement of forum selection clauses in Atlantic Marine Construction Co. v. Western District of Texas (12-929). Virginia-based Atlantic Marine Construction contracted with the U.S. government to build a child development center at Fort Hood in the Western District of Texas, and then subcontracted with Texas-based J-Crew Management to work on the project. The subcontract contained a forum selection clause providing that disputes between the parties "shall be litigated in the Circuit Court for the City of Norfolk, Virginia, or in the United States District Court for the Eastern District of Virginia, Norfolk Division." But when a dispute arose, J-Crew ignored the clause and sued instead in the Western District of Texas. Atlantic Marine moved to dismiss, arguing that the forum selection clause made the Western District an inappropriate forum under 28 U.S.C. § 1406(a) and Federal Rule of Civil Procedure 12(b)(3). The district court denied the motion. It first concluded that 28 U.S.C. § 1404(a) offered the exclusive means of enforcing a forum selection clause implicating another federal forum, and then held that, the forum selection clause notwithstanding, Atlantic Marine failed to demonstrate that transferring the case to Virginia under § 1404(a) would be appropriate in light of various public and private interest factors, of which the forum selection clause was just one. The Fifth Circuit denied Atlantic Marine's petition for a writ of mandamus and concluded that the district court did not abuse its discretion by applying the balance-of-interests test required by § 1404(a).

In a unanimous decision written by Justice Alito, the Court first clarified that – contrary to Atlantic Marine's arguments – § 1406(a) and Rule 12(b)(3) were not appropriate provisions to invoke when seeking to enforce a forum-selection clause. Those provisions permit dismissal only when a venue is "wrong" or "improper" based exclusively on whether federal venue requirements – set forth in 28 U.S.C. § 1391 – are satisfied, and not on private contract provisions binding the parties to sue in particular fora. Instead, a party may seek to enforce a forum-selection clause specifying a federal forum through a motion to transfer under § 1404(a), which provides that "[f]or the convenience of parties and witnesses, in the interest of justice, a district court may transfer any civil action to any other district or division where it might have been brought or to any district or division to which all parties have consented." (Forum-selection clauses pointing to state or foreign forums may be enforced through the forum non conveniens doctrine.) And, resolving a circuit split, the Court explained that § 1404(a) in fact requires that a forum-selection clause be "given controlling weight in all but the most exceptional cases." While a court would typically address a § 1404(a) motion by assessing the convenience of the parties and other private and public interests as the district court did in this case, where the parties have agreed to a forum-selection clause, district courts must adjust their analysis because the plaintiff – having defied the forum-selection clause – must bear the burden of demonstrating that transfer to the bargained-for forum is unwarranted. Also, private interest arguments about convenience of the plaintiff or witnesses have no weight. Because public interest factors "will rarely defeat a transfer motion, the practical result is that forum-selection clauses should control except in unusual cases." The Court concluded: "When parties have contracted in advance to litigate disputes in a particular forum, courts should not unnecessarily disrupt the parties' settled expectations. . . . In all but the most unusual cases, therefore, ‘the interest of justice' is served by holding parties to their bargain."

United States v. Woods (12-562) took up the tax case of former Minnesota Vikings owner Billy Joe "Red" McCombs and Gary Woods, his business partner. The two created an offsetting-option tax shelter, which was a popular means during the 1990s of generating large paper losses to offset taxable income. Through a dizzying yet tedious array of transactions involving the creation and dissolution of various business entities, the two men were able to claim a tax basis of $48 million in entities into which they had invested only $3.2 million, and ultimately claimed $43 million in ordinary and capital paper losses. The IRS was not impressed with their sleight of hand. Following an audit, it determined that the claimed losses were invalid and issued to each partnership a Notice of Final Partnership Administrative Adjustment ("FPAA") concluding that the partnerships were shams created solely for the purpose of tax avoidance and stating that the IRS would disallow all of the losses claimed by the partners. The IRS further determined that the partners had zero tax bases in the partnerships and that any tax underpayments would be subject to a 40-percent penalty for gross valuation misstatements. Reviewing the FPAAs, the district court held that the IRS properly determined that the partnerships were shams but held that the valuation-misstatement penalty didn't apply. While an appeal was pending, the Fifth Circuit decided in a similar case that, under circuit precedent, the valuation-misstatement penalty did not apply when a transaction is disregarded because it lacks economic substance. A different Fifth Circuit panel then affirmed the district court in Woods.

The Court took the case to resolve a circuit split over the application of the valuation-misstatement penalty in cases like this one. It looked at jurisdiction first. The case before the court was a "partnership-level" proceeding, in that the IRS was responding to improprieties in the tax returns of the sham partnerships. But since partnerships themselves do not pay taxes but instead pass their tax burdens on to individual partners, the question arises whether a court addressing a partnership-level proceeding may determine penalties that will apply to the partners themselves. The relevant statute permits courts in partnership-level proceedings to determine "the applicability of any penalty . . . which relates to an adjustment to a partnership item." Here, although the penalty directly related to misstatements by the partners of their tax basis, the Court – in a unanimous decision written by Justice Scalia – determined that the structure of the statute permits courts in partnership-level proceedings to determine the applicability of any penalty that could result from an adjustment to a partnership item, even if imposing the penalty would require determinations about non-partnership issues such as a partner's tax basis. The Court stressed that the applicability determination is provisional only, and individual partners remain free to raise arguments against actually imposing the penalty in partner-level proceedings.

The Court then turned to the merits. At the time of the transactions at issue, the statute addressing valuation misstatements provided that if a reported value or adjusted basis exceeded the correct amount by 400 percent or more it was a "gross" valuation misstatement subject to a 40 percent penalty. By its plain terms – and notwithstanding the petitioner's arguments – the statute applied in this case because, once the partnerships were deemed to be shams, no partner could legitimately claim a basis greater than zero – and certainly not the $48 million McCombs and Woods actually claimed. In case there was any doubt, an IRS regulation specifically provides that when an asset's true value or adjusted basis is zero "[t]he value or adjusted basis claimed . . . is considered to be 400 percent or more of the correct amount," so the resulting valuation misstatement is automatically considered to be gross. The Court also rejected the petitioner's argument – a rationale endorsed by the Fifth and Ninth Circuits – that any tax underpayment would be "attributable" not to misstatements of basis, but to the determination that the partnerships were shams. To the justices, the sham partnership determination and the basis misstatement were inextricably linked: "This is not a case where a valuation misstatement is a mere side effect of a sham transaction. Rather, the overstatement of outside basis was the linchpin of the . . . tax shelter and the mechanism by which Woods and McCombs sought to reduce their taxable income. . . . In short, the partners underpaid their taxes because they overstated their outside basis, and they overstated their outside basis because the partnerships were shams."

The Court simultaneously granted cert in Ford Motor Co. v. United States (13-113) and sent the case back to the Sixth Circuit to consider jurisdiction. The merits of the case center on how much interest the federal government must pay Ford Motor Company for tax overpayments it made to the IRS during the course of an audit. Ford initially made payments of some $875 million to the government as deposits to stop the accrual of interest that would otherwise occur during the audit; later, Ford asked the government to treat the funds as advance deposits on any additional tax Ford owed. As it turns out, Ford had actually overpaid taxes in prior years, so it owed nothing and was entitled to interest on the $875 million. The relevant statute states that interest begins to run "from the date of overpayment," but the parties disagree about what date that should be: the date Ford first made the deposits, or the date it asked the IRS to treat the funds as tax payments. The district court and the Sixth Circuit sided with the government on the merits. But when Ford petitioned for cert, the government argued for the first time that the only basis to find a waiver of sovereign immunity that would permit Ford's claim to be adjudicated in federal court is the Tucker Act; if the government is correct, only the Court of Federal Claims – and not the federal district court – had jurisdiction over the action. The Court, in a per curiam decision, sent the case back to the Sixth Circuit to consider the government's jurisdictional argument and to consider what impact its jurisdictional determination might have on the merits of the case.

That's all for now – we'll be back soon with whatever the Court sends our way.

Kim, Jenny & Julie