The Eleventh Circuit panel hearing the appeal in the case of Kardash, Sr. v. Commissioner, Case No. 16-14254, CA11 agreed that Mr. Kardash was not a villain and, in many ways, was a victim along with the IRS of a “the fraud conducted by his friends and coworkers at FECP, Ralph Hughes and John Stanton.”
But the Court found that, ultimately, Mr. Kardash ended up with funds that rightly belonged to the IRS and that IRC §6109, relying on applicable Florida state law, required him to pay those funds over to the IRS under the law of transferee liability.
Mr. Kardash was a minority shareholder and employee of Florida Engineered Construction Products Corporation (“FECP”), a company involved in manufacturing items used in construction, an activity it had been involved in since 1955. Mr. Kardash joined the company in 1979 and eventually became a minority shareholder and President of manufacturing and operations.
Mr. Kardash owned 575,000 shares of FECP stock. The other shares were held by Ralph Hughes (3,000,000), John Stanton (3,000,000) and Charles Robb (75,000). Actual control rested with Mr. Hughes and Mr. Stanton.
FECP’s activities in the first decade of the 2000s is described as follows in the opinion:
During the early 2000s, FECP’s revenues rose dramatically with the booming housing market. In 1999, FECP earned $39.9 million in revenue, but by 2005, FECP’s revenues had risen to $132.2 million. Unfortunately for FECP, however, 2005 represented the high-water mark for the company. By 2007, the housing bubble in Florida had already begun to burst, and FECP’s revenues shrank to $55.4 million.
Throughout this period, FECP paid no federal income tax and its majority shareholders, Hughes and Stanton, siphoned substantially all of the cash out of the company.2 The two are believed to have used hidden bank accounts and shell corporations to facilitate their fraud undetected. At no point was Kardash, who focused on managing FECP’s production operations, involved in the cash-siphoning scheme.
Eventually, not being paid taxes, the IRS showed up and determined that FECP owed the IRS $129,130,131.60. The IRS agreed to an installment agreement with FECP to be paid $70,000 a month, a payment that would not pay off the company’s debt for over 150 years. The IRS also began pursing funds that had been transferred to the shareholders.
As the Court noted, the IRS had success here:
Stanton and Hughes, the majority-shareholder masterminds of the cash-siphoning scheme, were easy targets. Stanton was ultimately convicted on eight counts of federal tax crimes and, per the terms of his sentencing order, required to pay restitution. The Commissioner likewise reached an agreement with the estate of Hughes, who had passed away in 2008. Robb and Kardash, however, contested the Commissioner’s determination of liability in the tax court below, arguing that they were not liable as transferees for FECP’s outstanding tax liability. Only Kardash’s transfers are the subject of this appeal.
The IRS initially was after two sets of payments to Mr. Kardash:
- Advance Transfers of $250,000 and $300,000 in 2003 and 2004 and
- Dividend Payments of $1.5 million, $1.9 million, and $57,500 in 2005, 2006 and 2007.
Mr. Kardash argued that these payments were made to him to compensate him for the loss of the lucrative bonuses he had previously received, thus represented transfers from the company to him for his services.
The Tax Court agreed that the advance transfers were meant to replace the bonuses, and thus did not represent fraudulent transfer which the IRS could recover from Mr. Kardash. However, the Court found the dividends, begin labeled such by the corporation and treated as such by Mr. Kardash on his tax return (where he treated as qualified dividends subject to a lower tax rate), were not received in exchange for anything of value—and thus were fraudulent conveyances under Florida law which the IRS could recover from Mr. Kardash under IRC §6109.
Mr. Kardash argued that the IRS had not first exhausted all reasonable efforts to collect from FECP before pursuing him and, in any event, the entity did not become insolvent until 2006 so the payments before that date could not be part of a fraudulent conveyance.
The appellate panel noted that IRC §6109 was meant to simplify the IRS’s ability to collect from transferees without having to enter into complicated state litigation—but it only applied if the IRS actually had such rights already. The provision allows the IRS to directly collect amounts for which it had a right either in equity or under law against a third party transferor.
The panel agreed that for the IRS to proceed in equity they would have to show both that the transferor was, or was rendered, insolvent by the transfer and that the IRS had exhausted all remedies against FECP before it went after Mr. Kardash. But, the panel continued, the state of Florida had enacted the Florida Uniform Fraudulent Transfers Act and, under that law, an exhaustion of remedies against the original debtor is not required in order for the creditor to move against a party receiving a fraudulent conveyance.
So, the question arose, were some or all of the dividend transfers fraudulent conveyances under Florida law? The appellate court agreed with the Tax Court’s holding that the dividends were not shown to be for Mr. Kardash’s services, thus he could not avail himself of the protection that the dividend transfers from the corporation were for value.
But, Mr. Kardash argued, since the corporation did not become insolvent until 2006, the 2005 dividend did not represent a fraudulent conveyance. However, the panel agreed with the Tax Court’s view that the dividend program was part of an intentional plan to drain the corporation of assets and that Mr. Kardash’s share of that transfer met the requirements for a fraudulent conveyance even if he was not aware of the plan in question.
As the panel notes:
Although Kardash was not privy to the machinations of Stanton and Hughes, his 2005 dividend payment was part of the same series of dividend payments that led to FECP’s insolvency. Kardash, Hughes, and Stanton were all paid dividends based upon their equity ownership in the company. The record does not reflect, for example, that FECP issued different classes of shares and that Stanton and Hughes perpetrated their fraud by triggering special dividends that were distributed solely to their class of shares. On the contrary, the record suggests that the dividends were paid on a per-share basis and that any discrepancy in the amounts paid to Kardash, Hughes, and Stanton can largely be attributed to the different number of shares that they owned.
Thus, the IRS had the right to recover from Mr. Kardash all of the dividend payments he received for all three years.