Ivan G. Pivaroff and his wife, Gwendolyn S. Pivaroff, owed Uncle Sam the sum of $8 million in tax liabilities, as a result of a 1998 decision by the U.S. Tax Court. The IRS finally got around to suing the Pivaroffs in 2008 to collect, and place tax liens against the Pivaroff's assets.
Through a number of entities, the Pivaroffs circulated $1 million offshore, and then back onshore into a limited partnership called Oahu LP. Next, Oahu LP loaned the $1 million to another Pivaroff company called Associated Enterprises Limited ("AEL"), in exchange for AEL giving Oahu LP a promissory note and mortgage deed against the couple's Las Vegas penthouse.
Later, the Pivaroffs filed for bankruptcy, and listed their penthouse in their schedules. When asked why this circular flow of money occurred, Ivan answered:
you can't loan money to yourself.
Hardly impressed, the IRS asserted that the mortgage was simply a sham that the Pivaroffs were trying to use to both protect their property from IRS collection, and repatriate $1 million for their personal use.
The Pivaroffs countered that there were gaps in the IRS's tax lien which caused it to release, and the mortgage (which they contended, apparently with a straight face, was valid) had a priority lien position over the IRS's lien.
The IRS moved for summary judgment to determine that its tax liens were valid, that the mortgage was a sham, and for a judicial sale (a/k/a sheriff's sale) of the Pirvaroffs' penthouse. The Pivaroffs filed a cross-motion, seeking a determination that the mortgage was valid, and for a judicial sale of the penthouse, with the proceeds presumably going to Oahu LP.
The U.S. District Court for the District of Nevada took up these issues. As to whether the IRS's lien was valid, the Court conducted a lengthy analysis of the Pivaroffs' tax liability, and how the lien came into place, and ruled in favor of the IRS.
This now brings us to the main issue in the case, being whether Oahu LP's mortgage was valid or a sham. The Court could have resolved this against the Pivaroffs on a procedural issue, but instead delved deeply into the merits of their claim that the mortgage should be respected:
The court also has substantive reasons to find that the mortgage is invalid. A mortgage is a valid transaction when there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax independent considerations, and is not shaped solely by tax-avoidance features. [ ] When there is a valid transaction, the government honors the resulting rights and duties when determining tax liabilities. [ ] Alternatively, entities and transactions are a sham when they lack "economic substance," and are, therefore, not recognized for federal tax law purposes. [ ] Loans that operate to circulate funds and lack any genuine indebtedness qualify as sham transactions. [ ]
AEL loaned $1,000,000 to Oahu LP for the penthouse. [ ] The funds that AEL loaned out ultimately came from three sources: [two other Pivaroff companies] and defendant Ivan Pivaroff. [ ] None of these entities have genuine indebtedness because two parties own and operate each of the relevant entities that are giving and receiving funds: the Pivaroffs. Furthermore, defendant Ivan Pivaroff's deposition confirms that the mortgage was a sham transaction when he explained that he used the various entities because "you can't loan money to yourself." [ ] Therefore, the mortgage for the penthouse is an invalid transaction that cannot shield the Pivaroffs from the federal tax lien.
[Internal citations and quotations omitted.]
The only issue remaining was whether the IRS could sell the penthouse by public sale, or whether the Pivaroffs should be allowed to sell it privately, and presumably for more money than the typical IRS fire-sale auction which is rarely going to net the best price.
There is actually a test for a Court to follow in determining whether to allow a private sale instead of a fire-sale auction. This test looks at four factors:
(1) Whether the IRS would be prejudiced by a private sale;
(2) Whether a third-party has a significant monetary interest in the property;
(3) Whether a third-party would be prejudiced by the private sale; and
(4) Whether the type of property being sold made it more amendable to a private sale than an auction.
Here, there was no true third party which had an interest in the sale (Oahu LP didn't count since its interest was already determined to be a sham), and no other compelling reasons why the penthouse could not be sold at an IRS auction like any other property, so the Pivaroffs lost on this issue too.
Game, set, match, IRS.
ANALYSIS
Sham loans are simply a fact of life in the creditor-debtor world. While debtors place great faith in them, quite unjustifiably, usually all it takes is for the creditor to peek behind the curtain to see that they really are just the debtor trying to dummy up a deal to thwart his creditors. Once sunlight in shed over these loans, their effectiveness melts like a hot pat of butter left on the Las Vegas strip in the middle of the summer.
That debtors believe so strongly in sham loans derives from three sources: First, the almost always wrong belief that they are smarter than their creditors; second, their painful ignorance that most judges have seen sham loans before and know how to look right past them (particularly in the remedies departments of the larger counties, where a given judge might see three or four sham loans in a given week); and, third, there is no shortage of very low-level "asset protection planners" who peddle them to the masses.
Not only do sham loans rarely work, but they often have the effect of irritating the judge, and turning the judge firmly against a debtor who is then percbut eived to be playing games with the Court -- and that is an 8-ball that debtors almost never come from behind during the rest of the proceedings.
On a different note, this opinion is also an example of something that I have been pointing out for the last decade, which is the convergence of the tax law concept of "economic substance" with the creditor-debtor concept of "economic substance". This opinion firmly ties them together, by pointing out that if a loan will not be respected for tax law purposes, then it will likely not be respected for civil law purposes either. While tax law is nothing like dispositive on the issue, the courts in reviewing transactions are increasingly giving the tax law considerations much greater weight in making determinations that affect the creditor-debtor issues.
Which is to say that not all interrelated loans will be treated as sham loans, but if there really has been a yielding of title and control to some other entity, such as a trust, and the transaction has economic substance and is not intended to defeat creditors, then the loan will probably be likely to survive scrutiny, even if the money originally came from the debtor prior to any claims arising him (if the money was circulated after a claim arose, good luck upholding that).
The devil is once again in the details, meaning the planning and structuring. A debtor who, like the Pivaroffs, simply runs the money around the barn without any good reason to do so except to stiff their creditors, will usually fail. Conversely, a debtor (importantly, having no intent to cheat any creditor) who actually turns over title and control to the money to a bona fide third party, will likely have a much greater chance that the third-party's loan documents and security agreements will be respected.
But this takes a lot of deep analysis, good planning and structuring, and immaculate documentation -- something that was light years from the Pivaroffs' hinky scheme here.
If you just run money around the barn, then don't be surprised when the barn falls on you.
As here.
CITE AS
U.S. v. Pivaroff, 2016 WL 3896824 (D.Nev., Slip Copy, July 18, 2016). http://goo.gl/cVQidJ
This article at http://goo.gl/MX2MYU
