May/June 2007

May/June 2007

May/June 2007

May/June 2007

ENVIRONMENTAL LAW
JUDICIAL LAW

• Clean Water Act; TMDLs.  In an opinion issued on May 17, 2007, the Minnesota Supreme Court held that the Minnesota Pollution Control Agency’s (MPCA) issuance of an NPDES permit for discharges from a new wastewater treatment facility proposed by the cities of Annandale and Maple Lake did not violate the Clean Water Act’s prohibition on permitting new discharges that will cause or contribute to the violation of water quality standards where improvements elsewhere would more than offset the additional discharges of the pollutant in question.

The cities of Annandale and Maple Lake jointly proposed to build a new wastewater treatment plant that would discharge 2,200 more pounds of phosphorous per year into the North Fork of the Crow River than the cities currently discharge.  The North Fork flows into the Mississippi River and contributes to the Lake Pepin watershed.  Lake Pepin has been identified as impaired under §303(d) of the Clean Water Act because of excessive phosphorus.  Total Maximum Daily Loads (TMDLs) have not been established for Lake Pepin

Regulations promulgated under the Clean Water Act prohibit issuance of a permit for a new source if the discharge "will cause or contribute to the violation of water quality standards." 40 C.F.R. §122.4.  The MPCA issued an NPDES permit for the plant on grounds that a new wastewater treatment facility to be built by the city of Litchfield would reduce phosphorous discharges to the North Fork by more than 53,000 pounds per year.  This reduction would more than offset the additional 2,200 pounds to be discharged by the Annandale/Maple Lake facility.

In 1995, the Minnesota Court of Appeals rejected the MPCA’s rationale, holding that the plain language of 40 C.F.R. §122.4 prohibited issuing the permit because the proposed facility would undeniably contribute to excess phosphorus in Lake Pepin and therefore contribute to violations of water quality standards.  The Minnesota Supreme Court reversed and upheld the MPCA’s decision to issue the permit.

As an initial matter, the Supreme Court determined that, although the MPCA did not promulgate 40 C.F.R. §122.4, the Court must nonetheless analyze the deference accorded the MPCA’s interpretation as though the regulation were the agency’s own regulation because the MPCA is charged with the day-to-day enforcement and administration of the regulation.  The Court then summarized the factors that influence whether it defers to an agency’s interpretation of its own regulation.  In applying these factors, the Court concluded that the regulatory language, "cause or contribute to the violation of water quality standards," is ambiguous when considered in light of the entire statutory scheme, the EPA’s administrative practice and policy, and the United Supreme Court’s holding in Arkansas v. Oklahoma, 503 U.S. 91(1992), which precludes a complete ban on discharge and instead requires the development of a long-range, area-wide program to alleviate existing pollution.

After concluding that the regulation is ambiguous, the Court considered whether the MPCA may consider offsets from another source in deciding whether to issue an NPDES permit for a facility when the offsets are contemporaneous and located in the same watershed.  Acknowledging that assessment of how a discharge of phosphorus affects a watershed is highly technical, the Court held that the MPCA has discretion in making a range of policy judgments, including whether to consider the offset.  Thus, when determining whether to issue an NPDES permit to a facility, the MPCA may properly consider contemporaneous offsets in the same watershed, even if the offsets result from another facility. In re Cities of Annandale and Maple Lake, A04-2033 (Minn. 05/17/07). www.lawlibrary.state.mn.us/archive/supct/0705/opa042033-0517.htm

— Robert F. Devolve
— Aleava R. Sayre
Leonard, Street and Deinard

May/June 2007

FEDERAL PRACTICE
JUDICIAL LAW

• Personal and Subject Matter Jurisdiction; Forum Non Conveniens. Settling a split in the circuits, the Supreme Court held that a court may dismiss an action on forum non conveniens grounds without first determining whether it has subject matter jurisdiction and/or personal jurisdiction over the defendants. Sinochem Int’l Co. v. Malaysia Int’l Shipping Co., 127 S. Ct. 1184 (2007).

• Certiorari; Attorney Fees; Prevailing Party. The Supreme Court recently heard argument on an appeal from an 11th Circuit decision holding that plaintiffs were prevailing parties entitled to attorney fees under 42 U.S.C. §1988 where they obtained a preliminary injunction (described by the 11th Circuit as the "primary relief they sought") but subsequently lost on summary judgment. Wyner v. Struhs, 179 Fed. Appx. 566 (11th Cir. 04/25/06), cert. granted, 127 S. Ct. 1055 (2007).

• Alleged Spoliation; Denial of Sanctions. The 8th Circuit affirmed district court orders denying spoliation sanctions, finding no evidence that relevant materials had been destroyed in an attempt to "suppress the truth." Greyhound Lines, Inc. v. Wade, ___ F. 3d ___ (8th Cir. 2007).

• Summary Judgment; Compliance with Local Rules. The 8th Circuit affirmed an award of summary judgment to a defendant based in large part on the plaintiff’s failure to file a statement of disputed facts in accordance with the Rule 56.1 of the local rules for the Southern District of Iowa. Many other districts within the 8th Circuit have similar rules governing statements of fact, though the District of Minnesota does not. Libel v. Adventure Lands of America, Inc., ___ F.3d ___ (8th Cir. 2007).

• Summary Judgment; Motions to Strike. Judge Schiltz has reiterated his statement that motions to strike documents submitted in connection with a summary judgment motion "are not authorized by either the Federal Rules of Civil Procedure or the local rules of this court." Counsell v. Nystrom & Assocs., Ltd., 2007 WL 628191 (D. Minn. 01/13/07).

• Subpoena; Privilege Objection; Absence of Privilege Log. Judge Magnuson affirmed an order by Magistrate Judge Mayeron denying a motion to quash a third-party subpoena based on privilege objections, finding that the third-party had "failed to produce a privilege log or make a specific showing as to why [the] documents are in fact privileged." Ispat Inland, Inc. v. Kemper Environmental, Ltd., 2007 WL 737786 (D. Minn. 03/08/07).

• Privilege Log; Potential Waiver of Privilege. Judge Montgomery reversed an order by Magistrate Judge Boylan finding a waiver of privilege by the defendant in a patent case, but ordered the defendant to submit a revised privilege log "that fully complies with [Fed. R. Civ. P.] 26(b)(5)" and noted that waiver would "be an appropriate sanction for continued deficiencies" in the privilege log. Isensee v. HO Sports Co., 2007 WL 1118274 (D. Minn. 04/13/07).

• Motion for More Definite Statement; Claims Against "Defendants." Judge Frank denied a Fed. R. Civ. P. 12(e) motion for a more definite statement in employment-related litigation, finding that plaintiffs were entitled to assert their claims against "defendants" generally, and that "minimal out-of-court communication and/or pointed discovery between the parties would resolve any perceived ambiguity." Scribner v. McMillan, 2007 WL 685048 (D. Minn. 03/02/07).

• Attorney Fee Awards; Hourly Rates. Judge Tunheim granted a prevailing plaintiff’s motion for attorney fees of more than $300,000 in an excessive force case and, more importantly, approved a rate of $500 per hour for her lead counsel. King v. Turner, 2007 WL 1219308 (D. Minn. 04/24/07).

• Attorney Fee Awards; Hourly Rates. Judge Ericksen awarded a prevailing Rehabilitation Act plaintiff more than $147,000 in fees, but found that lead counsel was entitled to $220 per hour rather than the $250 per hour she had requested. M.P. v. Indep. Sch. Dist. No. 721, 2007 WL 844688 (D. Minn. 03/16/07).

— Josh Jacobson
Law Office of Josh Jacobson

May/June 2007

INTELLECTUAL PROPERTY
JUDICIAL LAW

• Patents; Obviousness. Patentees face several hurdles in obtaining (and maintaining) a patent in the United States, one of which is that the invention cannot be "obvious." Obviousness is a bit like obscenity — it’s hard to describe but you know when you see it. In the case under discussion, Teleflex obtained a patent on an adjustable car or truck pedal-assembly (like a gas pedal or brake pedal) with an electronic pedal position sensor. Plaintiff Teleflex sued respondent KSR for patent infringement. The trial court held that Teleflex’s invention was obvious because an adjustable pedal assembly was known and an electronic position sensor was known. The Court of Appeals reversed, however, citing no teaching, suggestion or motivation (TSM) to combine the known elements in the way the inventor had. Without such a teaching, suggestion or motivation, said the appellate court, the patent could not be obvious. The Supreme Court disagreed and reinstated the determination of obviousness. The Supreme Court first did away with the rigid requirement that TSM is always required to prove obviousness. "Throughout this court’s engagement with the question of obviousness, our cases have set forth an expansive and flexible approach inconsistent with the way the Court of Appeals applied its TSM test here," said the Supreme Court. Next, the high court discussed the limitation of combining known elements: "The combination of familiar elements according to known methods is likely to be obvious when it does no more than yield predictable results." Finally, the Court emphasized that trial judges should not shy away from granting summary judgment as to obviousness even in the face of conflicting expert testimony: "the district court can and should take into account expert testimony, which may resolve or keep open certain questions of fact. That is not the end of the issue, however. The ultimate judgment of obviousness is a legal determination." KSR Int’l Co. v. Teleflex, Inc., 550 U.S. __ (2007).

• Patents; Territoriality; Software. Patents granted by the United States are enforceable for infringement in the U.S. only, with one important exception: components of a patented invention cannot be shipped outside the U.S. to be assembled into the invention. In other words, it is an infringement to ship the components of a patented Cadillac (even one part at a time) to the U.K. and have the car assembled there. AT&T sued Microsoft claiming "master golden discs" containing the Windows operating systems were components of the patented invention that Microsoft was shipping outside the U.S. to be assembled into the invention. AT&T argued that when the master golden discs were copied onto computers outside the U.S. an infringement occurred. But the Supreme Court disagreed, finding that master gold discs were not components. The Court held that software code in the abstract is an idea without physical embodiment, and as such, it is not a component amenable to combination into the invention. Interpreting the reach of U.S. patents narrowly, the Court reasoned that an infringement occurs only when the very component that is shipped outside the U.S. is itself combined to form the invention. Microsoft Corp. v. AT&T Corp., 550 U.S. __ (2007).

— Tony Zeuli

Merchant & Gould

JUVENILE LAW
JUDICIAL LAW

• Child Protection; Jurisdiction; 18-Year-Old. In a published decision, the Court of Appeals considered the certified question of whether the district court retained jurisdiction to adjudicate an 18-year-old individual as a child in need of protection or services when the CHIPS petition was filed before the subject’s 18th birthday. The appellant child who was the subject of the CHIPS petition argued that the district court lost jurisdiction over the petition when it failed to adjudicate him in need of protection or services before his 18th birthday. Although the district court also certified as important and doubtful the question of whether a child is entitled to admit or deny the grounds alleged in a CHIPS petition if the child’s behavior is the basis for the petition, neither party appealed that certified question. The Court of Appeals held that when a district court assumes jurisdiction over a child in need of protection or services proceeding before the subject of the CHIPS petition turns 18 years of age, unless the habitual truant exception applies, that jurisdiction shall continue until the subject’s 19th birthday if the district court determines that continuation is in the subject’s best interest. Thus, while the Court of Appeals answered the certified question on appeal in the affirmative, it declined to answer that second question found to not properly be before it and remanded the matter back to the district court. In the Matter of the Welfare of the Child of: L.M.L. and S.B.L., Parents, A06-1867 (Minn. App. 04/24/07). www.lawlibrary.state.mn.us/archive/ctappub/0704/opa061867-0424.htm

• Termination of Parental Rights; Child Placement. In an unpublished decision, the Court of Appeals considered a child placement appeal arising after a termination of parental rights. The appellant, who was the children’s maternal grandmother, argued that the district court failed to give her a statutory preference to be the child’s custodian and that the record lacked evidence to rebut that statutory preference. Here the children who were the subject of this proceeding were United States citizens and were children of Mexican citizens who lived in Minnesota. When one child was diagnosed with shaken baby syndrome, both children were placed in foster care. Both parents’ parental rights were later terminated, after which the parents had a third child. This third child was the subject of the petition to terminate parental rights here under appeal. It was undisputed that the county Human Services Department did not do an adequate relative search when addressing the children’s placement. Their maternal grandmother, a Mexican citizen, came from Mexico to Minnesota and petitioned for custody of the children. After a trial on her petition, the district court denied the petition and directed the county to inform the foster parents that they could petition to adopt the children. The Court of Appeals held that Minn. Stat. §260C.212, subd. 2 does not guarantee the grandmother first priority in placement but declined to affirm the district court’s rejection of the grandmother as a possible custodian. It held that the county’s failure to do an adequate relative search and its subsequent failure to remedy that defect put the district court in an awkward position of having to make a decision on an incomplete record and based on inferences. The court held that the record did not support the inferences that were drawn by the court. The matter was remanded for further development of the record and for the district court to reconsider the grandmother’s petition. In the Matter of the Welfare of the Children of: R.A.T. and J.T. A06-1642 (Minn. App. 03/13/07). www.lawlibrary.state.mn.us/archive/ctapun/0703/opa061642-0313.htm

• Juvenile Delinquency; Requiring HIV Test. In a published decision a minor challenged the district court’s order requiring her to undergo a blood test for HIV. The case arose out of a situation where St. Paul police officers and probation officers were executing a juvenile arrest warrant. The minor who is the subject of this appeal was one of those being arrested. When she was being arrested, she became combative, punching one of the police officers and yelling that she was not going to go to jail. When she was put in handcuffs and was being escorted out of the home, she bit the officer in the upper right arm. Later in the arrest, she turned and spit in the fact of one of the officers. The majority of the spit struck the officer in the eye, mouth, and nose. The state then brought a petition against the juvenile alleging that she had committed fourth-degree assault of a police officer and of a corrections agent. The juvenile admitted the charges.

At the dispositional hearing, the state moved the district court for an order requiring the juvenile to undergo a test for HIV, arguing that because of the juvenile’s pregnancy, it was clear that she had been sexually active and that there was, consequently, a risk that she was infected with HIV. The juvenile opposed the motion, arguing that the state had failed to establish a sufficient basis for the test. The district court granted the state’s motion, and, as part of its disposition order, directed the minor to undergo an HIV test but ordered that the result be delivered to the court for in camera review. The juvenile moved to stay the district court’s order. The state responded that the motion was moot because the test had already been performed, and in an addition, the state offered the affidavit of a state public health epidemiologist who stated that although HIV infection as a result of mucus membrane exposure to the saliva of a person infected with HIV is extremely unlikely, it is mathematically possible. The epidemiologist further opined that possible exposure to HIV generates anxiety and stress for the person potentially exposed.

The district court granted the juvenile’s motion and stayed disclosure of the test result, noting that although state law provided for HIV testing if a juvenile is adjudicated delinquent based on one of several enumerated sex offenses or violent crimes, the list of offenses did not include the assault statute that the juvenile had violated. The district court sealed the test result and this appeal followed. The Court of Appeals held that an HIV test is not authorized under the statue governing juvenile dispositions. Therefore, the district court could not order the juvenile to undergo an HIV test as a disposition in a juvenile delinquency proceeding unless such a test was authorized by statute, and here, the statute only allowed for HIV testing of persons who had committed enumerated sex offenses or violent crimes. Therefore, the matter was reversed and remanded back to the district court. In the Matter of the Welfare of: E.S.C. A06-707 (Minn. App. 05/08/07). www.lawlibrary.state.mn.us/archive/ctappub/0705/opa060707-0508.htm

— Gary A. Debele
Walling Berg & Debele

May/June 2007

TAX
JUDICIAL LAW

• Employment Taxes: "Check-the-Box" Regulations. Taxpayer, the sole owner of several LLCs, failed to elect to have the businesses treated as "associations" under regulations, which led to their treatment as sole proprietorships, instead of separate taxable entities, for federal tax purposes. In response to a notice of determination issued by the commissioner, taxpayer challenged the validity of the agency’s "check-the-box" regulations. 26 C.F.R. §§301.7701-1 to 301.7701-3. Using the analytical framework of Chevron, the court stated that IRC §7701 is ambiguous when applied to recently emerging hybrid business entities such as the LLCs. Further, the regulations developed to fill the statutory gaps when dealing with such entities are eminently reasonable and should be given deference. Summary judgment was affirmed, and the plaintiff remained individually liable for the employment taxes at issue. Littriello v. United States, No. 05-6494 (6th Cir. 04/13/07).

• Employment Taxes: Misappropriation of Funds by Payroll Service; Tax Liability. After being informed by the IRS of underpayments on payroll taxes in two separate years, taxpayer discovered the payroll accounting service it employed had misappropriated tax funds collected by the taxpayer. The owner of the payroll service was subsequently prosecuted for the illegal scheme, pled guilty to fraud and tax evasion, and was sentenced to 37 months in prison. The taxpayer asserted that it should not be liable for unpaid employment taxes because it was not responsible for the theft, and alternatively, it should be credited with the amount of that loss attributable to the crime committed by the payroll service. The 3rd Circuit disagreed. The court first cited the well-established principle that a taxpayer’s reliance on a third party to fulfill its tax obligations does not relieve the taxpayer of responsibility for those obligations. Taxpayers are liable for employment taxes regardless of whether the intermediary misappropriated funds collected to pay that obligation. Even though the funds were earmarked for payroll taxes and stolen by a third party that eventually faced criminal charges, the taxpayer cannot now claim that they are entitled to relief from their tax obligations. The complaint was dismissed. Pediatric Affiliates v. United States, No. 06-1979 (3rd Cir. 04/16/07).

• Procedure: Government Affidavits of Ordinary Procedures as Evidence of Proper Notice. Taxpayers brought suit alleging they had been deprived of their statutory right to a Collection Due Process hearing on the grounds that the IRS failed to notify them of their right to such a hearing. While the agency initially believed the required notification had not been sent, further research uncovered print-outs of notification letters that were dated within the required time frame. Taxpayers argued the government failed to show that the letters were actually placed into the envelopes sent to them and that the government’s affidavits that the printed copies of the letters maintained by the IRS in the regular course of its business were insufficient to establish notice. The court held that the deposition testimony of a government employee describing ordinary procedures, is, absent affirmative evidence to the contrary, entitled to an inference that the procedure was indeed followed. Even though the presence of the information in the computer system and the nature of ordinary practice were established based on personal knowledge, that knowledge was sufficient to infer what had actually happened. Because notice was timely, the court upheld summary judgment in favor of the commissioner. Haag v. United States, No. 06-2200 (1st Cir. 04/03/07).

• Procedure: Statute of Limitations on Collections; Suspension; Installment Plan. Taxpayer owed federal income taxes for the years 1989 and 1990, an assessment was made by the IRS in November of 1993, and the taxes were finally collected in February and April 2004. Subsequently, taxpayer brought a refund suit on the grounds that the IRS did not initiate collection activity within the ten-year time limit imposed by IRC §6502(a). The IRS conceded it did not seek to collect the back taxes within the original ten-year deadline; however, it noted that twice during the ten-year period taxpayer proposed paying in installments. The agency stated the levying of taxpayer’s wages was timely because the limitations period was suspended for 254 days while his proposals were under consideration and for an additional 30 days after the second installment offer was rejected. The taxpayer also challenged the validity of the IRS’ assertion since he did not receive the agreements in writing. However, the court held that although the Code and IRS regulations seem to suggest that any approved installment agreement be in writing, they can find no requirement that a taxpayer’s initial request for an installment agreement also be in writing. The statute of limitations was appropriately tolled while the IRS was considering each of the installment plans. Because this review period and the IRS’s rejection of the second request extended the collections deadline, the tax levy was timely. Seagrave v. United States, No. 06-3445 (7th Cir. 04/03/07).

• Income Tax: Sale of Lottery Earnings as Ordinary Income. Taxpayer won $17.5 million in the New York State Lottery which was payable in 26 annual installments, the first three of which were paid to the taxpayer and reported as ordinary income. Subsequently, the taxpayer sold her interest in the remaining payments to a third party for a lump sum of $7.1 million and reported that amount as a long-term capital gain on her 2000 return. The commissioner rejected this classification and issued a notice of deficiency for $1.31 million on the grounds that the proceeds from the sale should have been reported as ordinary income. The court agreed with the commissioner, stating that the definition of property is more limited where the "property" at issue is a right to receive ordinary income payments in the future. Even though, as the taxpayer contended, the value of the lump sum was determined by market forces outside of her control, that fact did not alter the character of the payments as ordinary income. Prebola v. Commissioner, No. 05-6953-ag (2d Cir. 03/27/07).

• Cooperative Tax: Discounted Payments to Member Stores; Patronage Dividends. Taxpayer corporation operated on a cooperative basis with shareholder-patrons consisting of retail grocery stores. For the years in question, taxpayer held food shows at which vendors and member stores met. At these shows, vendors would offer special show discounts to member stores placing orders with the taxpayer. In some instances, the special discounts took the form of a cash payment from the vendor to the member store based on the quantity of products ordered. The commissioner asserted that such "food show distributions" to petitioner’s shareholders are both income to the corporation and nondeductible patronage dividends paid by it to its members. The Tax Court, however, viewed them as trade discounts. The payments to the member stores were not paid with reference to the taxpayer’s net earnings, but instead were merely price adjustments passed along to the taxpayer on account of the orders placed by the member stores at the food shows. They had the effect of reducing the taxpayer’s gross sales and therefore do not constitute defective patronage dividends. Affiliated Foods, Inc. v. Commissioner, 128 T.C. No. 7 (03/29/07).

• Procedure: Interest Calculation on Tax Overpayments. Taxpayer corporation received overpayment refunds related to previous federal tax returns. Subsequently, the corporation sought a redetermination of the interest computed on its previous overpayments on the grounds that their accrued interest, as of the effective date of the GATT Amendment, should continue to accrue interest at the regular rate. The corporation asserted that the language of IRC §6621(a)(1) allows for the possibility of having different interest rates apply to different portions of the total amount owed by the government to a taxpayer. Like the Tax Court, the 5th Circuit rejected this reading of the Code. Based on the plain language of the GATT Amendment, the court agreed with the Tax Court conclusion that the GATT rate applied to accrued interest on tax overpayments over $10,000, as well as to the principal tax overpayment, after the effective date of the GATT Amendment. Exxon Mobil Corp. v. Commissioner, No. 06-60276 (5th Cir. 04/10/07).

• Procedure: Review of Substantive Claims Rejected; Claims Previously Considered on Appeal. After additional taxes were assessed on a late-filed return, the commissioner instigated collection activities against the taxpayer. Subsequently, the taxpayer requested an abatement of the assessed additions on the grounds that the taxpayer’s accountant, who possessed petitioner’s tax documents, was hospitalized at the time petitioner’s taxes were due. This request was assigned to an appeals officer, who reviewed the circumstances of the late filing and declined to abate the additions to tax. Taxpayer then timely requested a CDP Hearing, again requesting abatement for the same reasons. The settlement officer determined the abatement request had already been considered by Appeals, and thus, could not be raised again in a collection review hearing. The Tax Court conducted a thorough review of IRC §6330(c), which prohibits a taxpayer from raising in a collection review proceeding an issue that was "raised and considered" at a previous administrative or judicial proceeding. The court determined that the commissioner’s interpretation of IRC §6330(c)(2)(B), as found in Section 301.6330-1(e)(3) Q & A — E2, Proced. and Admin. Regs., was reasonable given the original Appeals conference provided a meaningful opportunity to dispute an underlying tax liability. The court reserved judgment as to whether an offer for a conference with Appeals is sufficient to preclude subsequent collection review consideration if the taxpayer declines the offer without participating in such a conference. Lewis v. Commissioner, 128 T.C. No. 6 (03/28/07).

• Procedure: Timely Filing Rule; Petition Sent via UPS Ground Shipping. Taxpayer received a notice of deficiency in regard to two tax years. Under the 90-day timeframe to submit a petition to the Tax Court, the taxpayer was required to file such petition by October 5th. The petition was received by the court on October 10th and dated October 6th; however, the taxpayer alleges he submitted the package for delivery on the evening of the 5th. The Tax Court found two problems with the taxpayer’s assertions that his submission was timely. First, while the timely filing rule of IRC §7502 applies to petitions sent through both the United States mail and designated private delivery services(PDS), UPS Ground shipping has never been designated by the commissioner as a PDS. Second, even if the timely filing rule did apply, the date on the package indicates the petition was not timely filed. The court stated the date on which an item is recorded electronically to the database of UPS is treated as the postmark date for purposes of §7502. In view of these facts, the court held the petition was not timely filed pursuant to either IRC §6213(a) or §7502. Raczkowski v. Commissioner, T.C. Memo. 2007-72 (03/29/07).

• Procedure: Bond not Required in Estate Election to Defer Estate Taxes. Taxpayer estate filed a Notice of Election under IRC §6166 in which the estate elected to defer payment of the balance on the estate tax return. Commissioner responded to this filing by claiming the estate was required to either post a bond, or in lieu of a bond, provide a special lien as security in order to qualify for deferred payment. After the estate challenged this determination, the commissioner issued a notice of determination stating that the estate may not make a deferment election under IRC §6166. The estate subsequently filed a petition for a declaratory judgment under IRC §7479. Despite challenges from the commissioner, the Tax Court first determined it had jurisdiction under §7479 to review the substantive requirements of §6166. Further, the statutory scheme of §6166 indicates the bond requirement is discretionary and was never intended as a mandatory requirement to deferral. By adopting such a bright-line rule, the commissioner shirked his administrative duty to state findings of fact and reasons supporting his decisions that sufficiently reflect a considered response to the evidence. The commissioner’s motion for summary judgment was denied. Estate of Roski v. Commissioner, 128 T.C. No. 10 (04/12/07).

• Procedure: Innocent Spouse Determination; Bankruptcy Filing by Former Spouse. Taxpayer and her former husband filed a joint return for the year in question. After the commissioner issued a notice of deficiency to the taxpayer regarding that tax year, the taxpayer submitted a claim for innocent spouse relief pursuant to IRC §6015. The commissioner then sent a timely notice of filing of petition and right to intervene to the former husband, who proceeded to file a notice of intervention. The former husband also subsequently filed for bankruptcy, which led to his assertion that such a filing gives rise to the automatic stay in regard to any Tax Court proceeding "concerning the debtor." 11 U.S.C. 362(a). The Tax Court found that the stay did not apply. The court interpreted the phrase "concerning the debtor" narrowly in holding that the automatic stay should not apply unless the Tax Court proceeding affected the tax liability of the debtor in bankruptcy. Because a determination as to innocent spouse relief does not affect the intervening former spouse’s personal tax liability, the automatic stay of the Bankruptcy Code does not preclude the court from proceeding with the case. Kovitch v. Commissioner, 128 T.C. No. 9 (04/04/07).

• Practice: Malpractice Claim; Scope of Representation. Plaintiff corporation had hired defendant law firm for representation in regard to a dispute involving $20 million in federal withholding taxes the IRS was seeking from the corporation. The firm proceeded to win the plaintiff’s case in Tax Court, though the corporation refused to pay the designated fees when the firm presented a $1.4 million bill, which included a "success fee" consisting of 150 percent of Davis Polk’s billed time. The corporation subsequently commenced a malpractice action alleging that, although it won the tax case, it suffered substantial damages as a result of defendants’ failure to advise that it was only secondarily liable for payment of taxes as per the agreement with its parent. The New York Court of Appeals held that no cause of action for legal malpractice existed under the circumstances of case. Here, the language of the retainer agreement indicated the firm was retained to litigate the amount of tax liability and not to determine whether the tax liability could be allocated to another entity. Although the corporation had recently become an independent entity and there may have been an issue as to liability, that issue was outside the scope of the firm’s representation. As such, defendants exercised the ordinary reasonable skill and knowledge in representing the corporation and no malpractice action could be taken against them. AmBase Corp. v. Davis Polk & Wardwell, No. 51 (N.Y. App. Div. 04/26/07).

• State and Local Tax: Public Financing of Arena for Private University. St. Louis University sought financing from the city of Saint Louis to support the construction of a 13,000-seat arena intended for sporting events, graduation ceremonies, and other community events. In response, the city enacted three ordinances establishing tax-increment financing assistance for the university’s redevelopment project. A Masonic organization subsequently sought to have the ordinances declared unconstitutional under Missouri law on the grounds that the ordinances constituted financial aid to a university under the control of a religious doctrine or creed. The court found that the university is not a religious institution simply because of its affiliation with the Jesuits or the Roman Catholic Church. Even though university bylaws require the president to be Jesuit, he is bound by the decisions of an independent, lay board of trustees, and further, nothing in Missouri’s constitution disqualifies aid to a university headed by a member of a religious order. Since the university’s proposed arena was intended to redevelop a blighted area of the city and to provide an avenue for secular student and community events, the purpose of the ordinances was not to advance religion and they were therefore constitutional. St. Louis University v. The Masonic Temple Ass’n, No. SC88075 (Missouri 04/17/07).

• Tax Exempt: Misappropriation of Funds; Revocation of Section 501(c) Status. The commissioner issued a determination that the Rameses School of San Antonio no longer qualified as an exempt organization under the requirements of IRC §501(c)(3). The IRS made the determination that the school furthers private interests after reviewing reports compiled by a state agency and after completing a thorough investigation of its own, both of which indicated the misappropriation of funds by the school’s founder and operator. The record indicates that said founder held several accounts at a local bank from which she made cash withdrawals that reflected no documented and established business purpose. Business purpose was similarly found to be lacking for thousands of dollars of expenditures directed to retail stores, credit card companies, financial institutions, and other businesses. The taxpayer failed to produce records suggesting any documented system either of loans to, and repayments by, the founder. Based on these circumstances, the Tax Court held the school operated for the benefit of private interests and a part of net earnings inured to the benefit of its founder. As such, its classification as an IRC §501(c) organization was appropriately revoked. Rameses School of San Antonio, Texas v. Commissioner, T.C. Memo. 2007-85 (04/10/07).

• Depreciation: Real Improvement/Equipment Classification in Winery Case. Taxpayers were operators of a sole proprietorship that included both a grape vineyard and winery. For tax purposes, taxpayers had classified and consistently treated the trellis components and irrigation equipment on its property as depreciable equipment. The commissioner subsequently declared a deficiency on the grounds that such property was improperly classified in terms of class life and depreciation recovery period. The Tax Court stated that the appropriate recovery period is based on the "class life" of the asset, which generally falls into two broad categories: permanent improvements to real property and nonreal property improvements such as machinery and equipment. In determining the classification of these assets, the court considered the factors from Whiteco, including whether the property is capable of being moved, whether the property is designed to remain permanently in place, the intended length of affixation, the difficulty in removing the property, the damage the property would sustain upon removal, and the manner of affixation of the property to the land. Whiteco Indus., Inc. v. Commissioner, 65 T.C. 664 (1975). Using these factors, the court found the trellising was properly classified by the taxpayer as farm machinery or equipment. "The posts and stakes used by petitioners, in combination with the wires, constitute a machine that is adjusted, modified, and changed in order to train grapevines to produce high-quality grapes for the production of wine." The more limited usages of the irrigation systems, however, led to the conclusion that such assets are properly classified as land improvements. Trentadue v. Commissioner, 128 T.C. No. 8 (04/03/07).

• Income Tax: Payments Received Pursuant to Veterans’ Rehabilitation Program. For the year in question, taxpayer participated in a VA-administered therapeutic and rehabilitative work program in which he worked in the facilities department of a local community college. The taxpayer was paid in excess of $16,000 from the VA for his work during the year. The commissioner determined the taxpayer had improperly excluded this amount from his gross income and accordingly issued a notice of deficiency. The Tax Court disagreed with the inclusion. The court cited IRC §5301(a), which exempts from taxation payments of benefits due or to become due under any law administered by the secretary of veterans affairs. Because the taxpayer participated in the therapeutic program administered by the VA, and because distributions from the VA for such work "do not resemble common labor for value exchanges," the court held that the distribution indeed constitutes a veterans’ "benefit" and is therefore excludable from gross income. Wallace v. Commissioner, 128 T.C. No. 11 (04/16/07).

• State/Local Tax: Minnesota; Timeline for Challenging Special Assessments. Taxpayer challenged a special assessment made on his property by the city of Minneapolis and filed appeals with both the city clerk and the Hennepin County District Court. The district court found that failing to file objections prior to the public hearing provides a basis for dismissal, and therefore granted summary judgment to the city. On appeal, the Court of Appeals held that because the city elected to use its home rule charter in making the special assessment, the charter rules govern the appeals process with which a disgruntled property owner must comply. The court interpreted the charter rule to establish that a taxpayer has 30 days from the city’s adoption of the special assessment to file a notice of appeal with the mayor or city clerk, and an additional ten days to file with the district court. Here, the Minneapolis City Council approved the special assessment on May 13, 2005; therefore, the taxpayer’s filing of his appeal with the city clerk on June 10 and the filing of his appeal with the district court on June 20 were timely. The district court erred in granting summary judgment to the city. Curiskis v. City of Minneapolis, A06-982 (Minn. App. 04/17/07).

• State/Local Tax: Determining Assessment Validity. Taxpayer challenged two assessments by the county that would have resulted in a tax increase in excess of $1 million. On motion for summary judgment, the taxpayer alleged that at the time of the assessments, the county assessor knew about improvements that had been made to the property and that the fact it was undervalued constituted a failure of judgment, not a failure of knowledge. The county asserted it was not aware of the existence of some of the property improvements and had not considered the classification of some of the property, causing an undervaluation which was remedied by the reassessments. The court stated that in order to determine whether the general assessment statute or omitted property statute applies, factual determinations are required. The court must determine the county assessor’s intent at the time of the original assessments and whether the reassessments were indeed meant to correct errors in judgment. These disputed material facts involve intent and state of mind at the time of the original assessments and the reassessments; therefore, summary judgment was not appropriate. Am. Crystal Sugar Co. v. County of Polk, CX-06-373, C4-06-367 (Minn. Tax Ct. 03/30/07).

ADMINISTRATIVE DEVELOPMENTS

• Server Problems Prompt Filing Extension. The rush of last-minute taxpayers submitting electronic returns on the deadline date created problems for one of the nation’s largest e-filing companies. Intuit, Inc. stated that the filing of several hundred thousand returns on the evening of April 17th caused server slowdowns, and submissions that typically take several minutes, were taking hours to process. Intuit products experiencing these difficulties include TurboTax, ProSeries, Lacerte and TurboTax Freedom. In response to this issue, the IRS extended the filing deadline for taxpayers affected by these problems to April 19th. IRS News Release IR-2007-91 (04/18/07).

• Taxpayer Assistance Blueprint to Congress. The IRS recently announced it has submitted the Taxpayer Assistance Blueprint to Congress in response to the congressional mandate for a five-year plan to improve taxpayer service. The joint effort of the IRS, the IRS Oversight Board, and the National Taxpayer Advocate focuses on establishing the baseline of needs, preferences and behaviors of taxpayers, improving the process for making service-related resource and operational decisions, improving services, and defining both short-term performance and long-term business goals. The Blueprint is said to constitute the "most extensive IRS research ever conducted into the needs, preferences and behaviors of taxpayers and partners who assist them in complying with the tax laws, such as volunteer and paid tax return preparers." IRS News Release IR-2007-84 (04/11/07).

• Circular 230 Penalties. The IRS issued guidance pertaining to the Circular 230 monetary penalties that may be incurred by practitioners, employers, firms, and other entities. Under the rule, the secretary is authorized to impose sanctions, including monetary penalties, against a practitioner who is incompetent or disreputable, who fails to comply with the regulations prescribed under §330, or who, with intent to defraud, willfully and knowingly misleads or threatens a client or potential client. This guidance is meant to clarify the amount of penalties that may be imposed and the imposition of separate monetary penalties. The agency invites all comments regarding these rules. IRS Notice 2007-39, 2007-16 C.B. 1037.

• Capital Produced in the Ordinary Course of Business. The IRS has issued final regulations for §263A of the Code that clarify when self-constructed assets are produced on a routine and repetitive basis in the ordinary course of business for purposes of the simplified service cost method and the simplified production method. The regulations state that such a "routine and repetitive" definition will be found where units of tangible personal property are mass-produced, that is, numerous substantially identical assets are manufactured within a taxable year using standardized designs and assembly line techniques, and the applicable recovery period of such assets under §168(c) is not longer than three years. T.D. 9318, 2007-17 C.B. 990.

• Continuity of Interest Rule in Corporate Reorganizations. Final and temporary regulations provide guidance under IRC §368 regarding the satisfaction of the continuity of interest requirement for corporate reorganizations. In addition to complying with the statutory requirements, a transaction generally must satisfy the continuity of interest requirement in order to qualify as a tax-free reorganization. That requirement, in substance, demands that a substantial part of the value of the proprietary interests in the target corporation be preserved in the reorganization. The new regulations address certain transactional characteristics indicative of whether there is sufficient continuity, including the signing date rule, fixed consideration, shareholder elections, contract modifications, contingent consideration, anti-dilution provisions, and other issues. T.D. 9316, 2007-16 C.B. 962.

• Dispositions of Stock for Corporations Filing Consolidated Returns. New regulations aimed at corporations filing consolidated returns establish an antiavoidance rule related to the disposition of stock of a subsidiary at a loss. The guidance states that losses reflected in the basis of subsidiary stock at the time of deconsolidation may not be recognized and reimported into the group, regardless of whether the stock losses are recognized when the subsidiary is a member of the group. The IRS indicated that duplication of a group loss distorts group income, and is therefore inappropriate, regardless of whether or not a duplicative recognition of the loss occurs while the subsidiary is a member. T.D. 9322, 2007-18 C.B. 1100.

• Limitations on Contributions to Qualified Plans. Final regulations further define the limitations on benefits and contributions under qualified plans under IRC §415, which governs contributions and other additions to defined contribution plans. Specifically, the final regulations create rules regarding when amounts received following severance from employment are considered compensation and when such amounts are permitted to be deferred. T.D. 9319, 2007-18 C.B. 1041.

• Treatment of MACRS Property in Like-Kind Transactions. The IRS has issued final regulations addressing the depreciation of property subject to the accelerated cost recovery system under IRC §168. Specifically, the regulations provide guidance on how to depreciate MACRS property acquired in a like-kind exchange under IRC §1031, or resulting from an involuntary conversion under IRC §1033, when both the acquired and relinquished property are subject to MACRS in the hands of the acquiring taxpayer. The IRS stated that previously issued temporary regulations failed to sufficiently address transactions of that sort. T.D. 9314, 2007-14 C.B. 845.

LEGISLATION

• Taxpayer Protection Act of 2007. On Tax Day, the House passed the Taxpayer Protection Act of 2007 by a vote of 407 to 7. The act, among other purposes, is designed to counteract some of the main threats to modern taxpayers, including the unauthorized use of identity and crimes related to the use of misleading IRS domain names. The act also provides greater protection to taxpayers by allowing more time to seek returns on wrongful levies by the IRS and by requiring the agency to make additional outreach efforts related to the Earned Income Tax Credit. At this writing the act remains to be approved by the Senate. H.R. 1677, 110th Congress (2007).

— Kathryn Sedo
University of Minnesota Law School

TORTS & INSURANCE
JUDICIAL LAW

• Duty for Third Party Criminal Acts; Assumption of Risk Defense. The minor plaintiff was a live-in employee of the defendant. After a coemployee was convicted of sexually abusing her, the plaintiff sued the defendant for negligently failing to protect her from the coemployee. The district court granted summary judgment based on assumption of risk.

The Court of Appeals reversed. While a person generally has no duty to protect another from a third party criminal act, a duty arises where there is (1) a special relationship and (2) the harm is foreseeable. When the plaintiff’s parents entrusted her to the defendant, the defendant agreed to shelter and feed the plaintiff and to protect her from unreasonable risk of harm. Also, the defendant admitted having seen the employee and plaintiff "fooling around on a couch, and it was more than what a father-daughter should be doing"; this was sufficient to raise an issue of foreseeability.

The court also ruled that the defense of assumption of risk is not available in civil cases where the third-party tort was statutory rape. Because consent is not a defense to a charge to that crime, the defense should also be excluded in a civil suit. The court reasoned that this rule would better achieve the Legislature’s intent to prevent minors from being sexually abused. Aja Bjerke v. Suzette E. Johnson, A06-117, (Minn. App. 02/13/07). www.lawlibrary.state.mn.us/archive/ctappub/0702/opa060117-0213.htm

• Workers Compensation; Failure to Give Notice of Settlement. Plaintiff sustained work-related injuries when his motorcycle collided with an automobile. He filed for workers compensation benefits and commenced a personal injury action against the driver of the automobile. While the workers compensation claim was pending, he settled the personal injury lawsuit for $100,000, but he failed to notify the employer or the insurer, as required by Minn. Stat. §176.061, subd. 8a.

The parties to the workers compensation case agreed that he was entitled to $20,550.00 representing 27.4 weeks of temporary total disability. However, the compensation judge found that since the plaintiff had not given notice to the insurer and had failed to rebut a presumption of prejudice, he must forfeit his statutory one-third of the recovery (under Womack v. Fikes), leaving the entire net proceeds of the settlement available as a credit to the insurer.

The Supreme Court reversed. While acknowledging that in many situations the failure to provide notice would be sufficiently egregious and prejudicial to warrant a penalty in the nature of a forfeiture, in cases such as this where settlement is reasonable and the employer suffers no loss of value to its subrogation rights, forfeiture is inappropriate. David T. Adams v. DSR Sales, Inc. and Milwaukee Insurance Group, A06-1402, (Minn. 02/15/07). www.lawlibrary.state.mn.us/archive/supct/0702/opa061402-0215.htm

• No-Fault Act; Excess UM Benefits. A courier was injured in a motor vehicle accident with an uninsured motorist. The courier owned the vehicle that he was driving at the time of the accident, but the vehicle was insured under his employer’s policy. At the time of the accident, the courier’s spouse owned a different vehicle insured by Illinois Farmers Insurance Company. The courier sought excess uninsured motorist (UM) benefits under the Farmers policy. Farmers denied the demand on the ground that the policy excluded coverage for vehicles that the insured owned but did not insure under the policy.

The Court of Appeals affirmed the district court’s decision that Farmers’ policy exclusion was unenforceable. The Court of Appeals noted that such exclusions apply only if (1) the insured attempts to convert coverage from first-party to third-party benefits, or (2) the accident involved an uninsured vehicle. The court reasoned that because the No-Fault Act does not specify the manner in which a vehicle must be insured, the employer’s policy was sufficient to insure the courier’s vehicle for purposes of the act. The court held that Farmers’ policy exclusion was unenforceable because the courier was not attempting to convert coverage and was operating an insured vehicle.

The court also held that the courier’s status as an "additional insured" under the employer’s policy did not render him a "named insured’ under the act so as to disqualify him from seeking excess UM benefits from Farmers. William Stewart v. Illinois Farmers Ins. Co., A06-759, (Minn. App. 02/27/07). www.lawlibrary.state.mn.us/archive/ctappub/0702/opa060759-0227.htm

• Affirmative Defense; Insufficiency of Service of Process. Plaintiff attempted service on defendant company by leaving a summons and complaint with the office receptionist. Defendant answered but alleged improper service as an affirmative defense. Plaintiff sent defendant a copy of the affidavit of service, stated that service appeared proper, and inquired whether defendant intended to pursue the service defense. Defendant did not respond substantively to this letter, an interrogatory, or other written communications to this effect, but advised plaintiff orally that it would not pursue that defense. When the statute of limitations on plaintiff’s claim expired, however, defendant moved for summary judgment based on insufficiency of service of process. The trial court denied the motion and struck defendant’s affirmative defense from the pleadings.

The Court of Appeals affirmed, reasoning that defendant’s failure to supplement its answers to interrogatories or otherwise disclose its basis for the insufficient-service defense until after the relevant statute of limitations expired was improper under the Minnesota Rules of Civil Procedure and unfairly prejudiced plaintiff. To hold otherwise would encourage parties to delay discovery until after the relevant statute of limitations expired and bring a motion to dismiss, thereby depriving the deficient party all opportunity to cure. Jennifer Thorson v. Zollinger Dental, P.A., d/b/a Advance Family Dental, A06-935, (Minn. App. 03/13/07). www.lawlibrary.state.mn.us/archive/ctappub/0703/opa060935-0313.htm

— Michael Klutho
— David Turner
Bassford Remele, A Professional Association