# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

167

ALS

147 T.C. No. 9

UNITED STATES TAX COURT

EXELON CORPORATION, AS SUCCESSOR BY MERGER TO UNICOM
CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
EXELON CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 29183-13, 29184-13.

Filed September 19, 2016.

P, a corporation engaged in the production, transmission, and
distribution of electricity to residential, commercial, and industrial
customers in Northern Illinois, sold its fossil fuel power plants in
1999 for $4.813 billion. Seeking to manage the taxable gain of $1.6
billion resulting from the sale, P pursued a series of like-kind
exchanges employing sale-leaseback strategies between P and
unrelated third parties C and M, each of the latter a tax-exempt public
utility. P fully funded the transactions using the proceeds from the
sale of its own power plants. In the transactions, C or M would lease
a power plant to P for a term exceeding the plant's useful life,
receiving in turn a lump-sum payment of cash, and P would sublease
the power plant back to C or M. Part of the amount paid to C or M
would be returned to P as a prepayment of the sublease, another part
would be set aside for investment and to secure a cancellation option

SERVED Sep 19 2016

-2allowing C and M to purchase back their power plants at the end of
the sublease periods, and the remainder would be retained by C and
M and used for their own needs. Since exercising the cancellation
options was expected to be the only economically viable option, the
parties to the transactions anticipated that at the end of the sublease
periods C and M would exercise their cancellation options and regain
ownership of the power stations leased to P. The primary tax benefits
that P expected to derive were from the deferral of income tax under
I.R.C. sec. 1031 and various deductions related to the replacement
properties. P identified appropriate replacement properties,
conducted due diligence, and closed the transactions within the
timeframes provided for in I.R.C. sec. 1031.
IIeld: The agreements between P and C and M are not true leases
but rather properly characterized as loans since the transactions did
not transfer the benefits and burdens of ownership to P. The
substance of the transactions is not consistent with their form.
IleM, further, P did not satisfy the requirements of I.R.C. sec. 1031
for the 1999 tax year since P exchanged power plants for an interest
in financial instruments.
IIeM, further, P is not entitled to depreciation deductions claimed
for 2001 with respect to its transactions with C and M.
IleM, further, P may not deduct interest or include rental income
with respect to the transactions with C and M for the 2001 tax year
since the transactions are not lease agreements for Federal tax
purposes under I.R.C. sec. 467.
IleM, further, P must include in income for the 2001 tax year
original issue discount income arising out of P's equity contribution,
which is to be repaid with interest through the cancellation options in
P's agreements with C and M.

-3Held, further, P is not entitled to deduct transaction costs related to
its transactions with C and M for its 2001 tax year and must instead
include them as an additional amount lent to C and M.
I]eld, further, P is liable for accuracy-related penalties under I.R.C.
sec. 6662 for the 1999 and 2001 tax years on the grounds of
negligence or disregard of rules or regulations. P did not show
reasonable cause and good faith under I.R.C. sec. 6664(c) to meet the
exception for those penalties.

David F. Abbott, Joel V. Williamson, Erin G. Gladney, Kristin M.
Mikolaitis, Andrew W. Steigleder, Michelle A. Spiegel, and Michael D. Educate,
for petitioner.¹

Matthew I. Root, Elizabeth P. Flores, Steven N. Balahtsis, Abigail F.
Dunnigan, Lisa M. Goldberg, Casey R. Kroma, and Michael T. Shelton, for
respondent.

¹Natasha Goldvug represented petitioner at trial. On October 28, 2015, she
filed a motion to withdraw as counsel for petitioner, which the Court granted on

October 29, 2015.

-4LARO, Judge: These cases are consolidated for purposes of trial, briefing,
and opinion. Respondent determined the following deficiencies and penalties in
petitioner's2 Federal income tax in timely issued notices of deficiency:

Year

Deficiency

Penalty
sec. 6662(a)

1999
2001

$431,174,592
5,534,611

$86,234,918
1,106,922

Petitioner timely filed petitions with the Court seeking redetermination of
these deficiencies and penalties.
The deficiencies at issue arise out of petitioner's participation in six
transactions that respondent labeled sale-in/lease-out (SILO) transactions in an
alleged like-kind exchange under section 1031.3 The transactions are as follows:
Counterparty

Transaction name

City Public Service
Municipal Electric Authority of Ga.
Municipal Electric Authority of Ga.

Spruce
Scherer 1, Scherer 2, Scherer 3
Wansley 1, Wansley 2

2In this Opinion, references to petitioner include both Exelon Corp. and
Exelon Corp. as successor to Unicom Corp., which merged with Exelon Corp. on
October 20, 2000, and thereafter went out of existence.
3Unless otherwise indicated, section references are to the Internal Revenue
Code (Code) as applicable for the years in issue. Rule references are to the Tax
Court Rules of Practice and Procedure. Dollar amounts are rounded to the nearest

dollar.

-5The parties have agreed, with the Court's approval, to reduce the number of
transactions to be tried to three "test transactions": Spruce, Scherer 1 (Scherer),
and Wansley 1 (Wansley), and to apply the Court's methodology in this Opinion
to the remaining transactions.4
The parties have resolved two issues by filing stipulations of settled issues
with the Court. The parties have agreed that petitioner is entitled to the benefits of
interest netting as provided in section 6621(d) for 1999, the amount of which will
be determined after the parties submit Rule 155 computations. The parties have
also agreed that petitioner is not subject to the penalty under section 6662 for the
2001 tax year for an underpayment due to a substantial understatement of income
tax, although petitioner still may be subject to the section 6662 penalty for 2001
on account of negligence or disregard of rules or regulations.
We decide the following issues:
1. whether the substance of the test transactions is consistent with their
form. We hold that it is not;
2. whether petitioner has satisfied the requirements of section 1031. We
hold that it has not;
40ur rulings in this Opinion with respect to Wansley 1 will be determinative
for Wansley 2. Our rulings with respect to Scherer 1 will be determinative for
Scherer 2 and Scherer 3.

-63. whether petitioner is entitled to depreciation deductions claimed for 2001
with respect to the test transactions. We hold that it is not;
4. whether petitioner must include in income in 2001 original issue
discount income related to the test transactions. We hold that it must;
5. whether petitioner is entitled to deduct amortized transaction costs
related to test transactions for its 2001 tax year. We hold that it is not; and
6. whether petitioner is liable for penalties under section 6662 for the 1999
and 2001 tax years. We hold that it is.

FINDINGS OF FACT
Some of the facts have been stipulated. The stipulations of fact and the
facts drawn from stipulated exhibits are incorporated herein, and we find those
facts accordingly. At the time of filing the petitions, Exelon, the primary
petitioner, had its principal place of business in Chicago, Illinois. The parties
agree that these cases are appealable to the Court of Appeals for the Seventh
Circuit.
Background

I.

Exelon and Its Subsidiaries
Commonwealth Edison Co. (ComEd) was organized in Illinois on October

17, 1913, as a result of the merger of Cosmopolitan Electric Co. into ComEd.

-7Unicom Corp. (Unicom) was created in January 1994 as a holding company for
ComEd. Unicom Investment, Inc. (UII), was created on April 23, 1999, as a
wholly owned subsidiary of Unicom.
Exelon Corp. (Exelon), petitioner in these cases and the successor by
merger to Unicom and its consolidated subsidiaries (Unicom Group), was
incorporated in February 1999. Exelon became the parent corporation of PECO
Energy Co. (PECO) and Unicom through merger on October 20, 2000. As a result
of the merger of Exelon and Unicom, Unicom went out of existence. After the
merger, Exelon wholly owned PECO and owned more than 99% of ComEd.
Both Unicom and Exelon used the calendar year as their tax year. Both
companies were accrual basis taxpayers during all relevant periods.
II.

Unicom's Decision To Sell Fossil Fuel Power Generation Assets
A.

ComEd's Power Generation Business in 1999

In 1999 ComEd engaged in the production, transmission, and distribution of
electricity to residential, commercial, and industrial customers in Northern Illinois.
ComEd operated in Chicago, Illinois, under a nonexclusive electric franchise
ordinance. ComEd received approximately one-third of its ultimate revenues from
customers in Chicago.

-8In addition, ComEd operated its electric business outside of Chicago in 395
municipalities under nonexclusive franchises that were received under certificates
of convenience and necessity granted by the Illinois Commerce Commission
(ICC). ComEd owned and operated a full spectrum of assets necessary to produce
and deliver electricity to its customers, including power generation plants (both
fossil fueled and nuclear fueled), the high-voltage transmission system which
transported the electricity from the generators to the service areas, and the lowvoltage distribution system needed to provide the electricity to end users.
B.

Deregulation of the Electric Industry and Unicom

The 1990s marked a shift in the regulatory framework for the electric
industry. Before 1996 most electric utility companies were vertically integrated
conglomerates which, similarly to ComEd, owned a full spectrum of assets for
production and delivery of electricity to the customers. By April 1996 the Federal
Energy Regulatory Commission (FERC) had issued final rules requiring
nondiscriminatory access to the transmission grid controlled by vertically
integrated utilities.
These rules opened the market to smaller utilities and power generators and
provided an opportunity for the formation of "wholesale" energy companies.
Instead of investing in their own transmission capacity, smaller energy producers

-9could now use the transmission system already in place regardless of who owned it
to deliver power to their customers.
Many States pursued their own restructuring strategies for electric industry
deregulation, some of them requiring separation of power generation from sales to
final customers. On December 16, 1997, Illinois enacted the Electric Service
Customer Choice and Rate Relief Law, codified at 220 Ill. Comp. Stat. Ann. 5/16101 to -130 (West 2013). Unlike other States, Illinois did not enact deregulation
legislation requiring divestiture of power generation and allowed electric utilities a
choice of how they wished to pursue the transition.
These regulatory changes resulted in the transformation of the power
industry by the early 2000s from a number of separate vertically integrated utilities
to a network of businesses where the various elements of the supply chain were
being operated separately and interacted through market-based contracts and
power exchanges.
To face the challenges of the changing market, Unicom decided to evaluate
its operations in Illinois, including its nuclear and fossil fuel power plants.
Although Unicom management believed the company was well positioned to
succeed in the new market structure, the study revealed that Unicom would have
to make significant changes to its operation model in order to stay competitive

- 10 long term. Unicom and ComEd considered multiple options, including continued

operation with accelerated depreciation, indefinite suspension from operation, a
sale of assets to a third party, and retirement or closure of assets. Unicom needed
of cash to maintain and expand its nuclear generation facilities and distribution
system. After determining that operation of fossil fuel power plants would bring
less value than immediate sale, Unicom decided in July 1998 that it was time to
divest itself entirely of its fossil-fueled power generation business. At that time
Unicom estimated it would receive approximately $2.5 billion from the sale.
C.

Unicom's Sale of the Fossil Fuel Power Plants

Unicom started looking for an appropriate buyer for its fossil fuel power
plants in 1999. One prospective buyer offered Unicom $3 billion for the plants.
Unicom's management, however, believed that the company could get a better
deal. Eventually, Edison Mission offered Unicom $4.8 billion for the fossil fuel
power plants, almost twice the initial estimate.
The $4.8 billion offer would enable ComEd to upgrade its nuclear plants
and make the necessary investments in its distribution system. On March 22,
1999, ComEd entered into an asset sale agreement with Edison Mission (EME
agreement). To effect the sale, ComEd transferred its interests in the fossil fuel
power plants to UII pursuant to an agreement dated May 11, 1999, subject to the

- 11 EME agreement. UII agreed to pay ComEd $4.813 billion for the assets, in the
form of a demand note in the amount of $2.35 billion and the difference in
interest-bearing term notes.

After receipt of the assets, UII would immediately transfer the assets to
Edison Mission and receive $4.813 billion in cash. Immediately after receipt of
the cash, UII would pay the $2.35 billion aggregate principal due to ComEd under
the demand note. UII would pay the amount due under the demand note with
interest-bearing term notes. Upon the notes' maturity, UII would pay the principal
amount of the notes. Edison Mission acted through its subsidiary, Midwest
Generation. Deloitte & Touche LLP Valuation Group (Deloitte) performed a
valuation allocating the sale price among the transferred power plants.
On December 15, 1999, UII closed the sale to Edison Mission with respect
to two plants, the Collins Generating Station (Collins station or Collins power
plant) and the Powerton Generating Station (Powerton station or Powerton power
plant) for $930 million and $870 million, respectively. These stations together
had a book value of approximately $1.3 billion at the time of the sale. Pursuant to
EME agreement terms, UII transferred the Collins and Powerton stations to State
Street Bank & Trust Co. (State Street), the qualified intermediary for the putative
like-kind exchange described more fully in the following sections, and State Street

- 12 then transferred the stations to Edison Mission in exchange for the consideration
described above.
In its filings with the ICC, ComEd represented that the sale would not
impair ComEd's obligations to provide power to customers because ComEd would
be buying back the output generated by the sold power plants for a number of
years and would also be able to buy energy on the open market. ComEd planned
to reinvest some of the proceeds in its remaining lines of business and to pay the
transaction expenses.
III.

Unicom's Search for Tax Planning Opportunities
After Unicom announced the planned sale of the fossil fuel power plants in

May 1999, it became clear that there would be a large taxable gain resulting from
the sale. Unicom diligently searched for opportunities to minimize the tax impact
and to reinvest some of the proceeds of the sale.
Richard Roling, assistant vice president of tax and assistant comptroller at
Unicom from the early 1990s through 2001, was responsible for the tax function at
Unicom, including filing tax returns, planning, research, and ensuring compliance
with the tax laws. In 1999 Mr. Roling reported to Robert E. Berdelle, controller of
Unicom at the time. Mr. Berdelle's responsibilities included safeguarding
Unicom's assets, maintaining books and records, and issuing financial reports and

- 13 regulatory filings. Furthermore, Mr. Berdelle supervised Unicom's tax
department, along with Unicom's business planning and other functions.
Mr. Roling approached Arthur Andersen (Unicom's auditor at the time),
Pricewaterhouse Coopers (PwC), and Deloitte to identify the appropriate tax
strategy. Arthur Andersen presented Unicom with a strategy involving a foreign
currency swap, but Mr. Roling rejected it because it was too complex and did not
align with the existing Unicom business. PwC first presented the idea of a likekind exchange coupled with a sale-leaseback to Unicom sometime in August and

September 1999.
In essence, PwC suggested that its strategy would allow Unicom to defer the
recognition of gain on Unicom's sale of the fossil fuel power plants through a
section 1031 like-kind exchange into a "passive leveraged lease investment."
Instead of paying the tax on the gain, Unicom would be able to reinvest that sum.
The deferred tax would be financially similar to a 0% borrowing note. By
reinvesting it, Unicom could receive a significant yield premium. Moreover,
leveraging the new lease in such a manner would leave Unicom in substantially
the same cash position.
The PwC strategy envisioned a lease term in the range of20-25 years with
an "enhancement and defeasance structure providing for AA rated or better

- 14 enhancement of the lessee's entire financial obligations to Unicom." PwC
compared the costs for maintaining the new lease investment with maintaining a
typical debt private placement. Under the strategy, Unicom would lease the
exchange assets to the lessee under a triple net lease with an end-of-term fixed
purchase option. Unicom would pass on a portion of its tax deferral benefit to the
lessees through a reduction in rental obligation. The lessee would "defease its
rental obligations, and thereby monetize the lower rental cost into an upfront cash
benefit."5

PwC pointed out to petitioner that municipal utilities and rural electric
cooperatives seeking to monetize tax benefits they could not use because of their
tax-exempt status would be interested in entering into a sale-leaseback transaction.
PwC also suggested that taxable entities desiring to obtain low cost/off-balancesheet financing alternatives might also be interested.
After the initial consultation with PwC, Mr. Roling decided to present the
idea of the like-kind exchange to his superiors.

5The final structure of the like-kind exchange and sale-leaseback was
different, as explained further in this Opinion.

- 15 IV.

Unicom's Decision To Enter Into the Test Transactions
Mr. Roling first presented the PwC strategy to Mr. Berdelle. Although Mr.

Berdelle initially did not fully understand the strategy, he decided it had promise
and was in line with Unicom's tax strategy. John C. Bukovski, the chief financial
officer of Unicom, gave Mr. Roling permission to move forward with the like-kind
exchange strategy and present it to the Unicom's board of directors for
consideration and approval.
On October 5, 1999, two months after receiving ICC approval to sell
ComEd's fossil fuel power plants, ComEd submitted a notice to the ICC stating
that it was considering entering into a like-kind exchange for at least several of the
fossil fuel power plants.
On October 14, 1999, Unicom and PwC executed an agreement whereby
Unicom retained PwC to act as its financial adviser in connection with the
proposed like-kind exchange strategy. On October 20, 1999, Mr. Berdelle
provided information on the strategy to Unicom's board of directors. He presented
the strategy during the board meeting held on October 27, 1999, seeking and
receiving approval for various preliminary steps necessary to pursue the concept
and preserve the option of entering into a like-kind exchange transaction.

- 16 Mr. Berdelle assembled a team to further evaluate the like-kind exchange
opportunity. That team consisted of a number of Unicom's employees from
various departments, including the tax department, treasury and finance
departments, engineers, and outside consultants. Core members of the team,
including Mr. Berdelle, Robert Hanley, a tax department employee, and Mr.
Roling, would meet weekly, if not more often, to discuss the status of the project.
Neither Mr. Roling nor anyone on his staff in the tax department had any
experience with like-kind exchanges. Because Unicom did not have the internal
expertise necessary to adequately assess all of the legal and technical aspects of
the proposed like-kind exchange, Unicom employed a number of consultants and
advisers to work on the project, including performing due diligence of potential
replacement properties.
Unicom retained a Chicago law firm, Winston & Strawn LLP (Winston &
Strawn) to advise on the legal aspects of the transaction, including its tax
consequences. In addition, in March or April of 2000 Unicom engaged Stone &
Webster Management Consultants, Inc. (Stone & Webster), to provide engineering
and environmental reports on prospective replacement properties. Unicom
retained Deloitte to conduct an appraisal of the relinquished properties and
potential replacement properties in November 1999. In addition, petitioner

- 17 engaged PwC (financial and accounting adviser), Arthur Andersen (accounting
adviser), Sidley Austin (regulatory counsel), Vinson & Elkins (Texas counsel),
and Holland & Knight (Georgia counsel).
V.

Identification of Properties To be Relinquished in the Like-Kind Exchange
On or about December 9, 1999, six days before the closing of the sale under

the EME agreement, Unicom identified the Collins and Powerton stations as the
properties it would try to exchange for like-kind replacement properties. Mr.
Roling concluded, on the basis of the valuations from Deloitte, that the fair market
value of the Collins station at that time was $930 million, with an expected taxable
gain of $823 million, while the fair market value of Powerton station was $870
million, with an expected taxable gain of $683 million. Unicom did not plan to
execute a like-kind exchange for any of the other fossil fuel power plants it was
selling.
VI.

Identification of Like-Kind Replacement Properties and Due Diligence
A.

Identification of Replacement Properties

Because section 1031 has a strict timeframe for identification--on or before
the 45th day after the date on which the relinquished property is transferred--and
acquisition of replacement property--within 180 days of the date on which the
relinquished property is transferred (or, if earlier, the transferor's tax return due

- 18 date for the year in which the transfer of the relinquished property occurs)-Unicom started looking for potential replacement properties before the closing of
the sale under the EME agreement.
By November 1999 PwC had identified 26 prospective lessees. Unicom did
not participate in the initial identification process. On or about November 9-10,
1999, PwC, on behalf of Unicom, sent proposals to a number of potential lessees
for the sale-leaseback portion of the like-kind exchange. PwC contacted both
taxable and tax-exempt entities. City Public Service (CPS) and Municipal Electric
Authority of Georgia (MEAG) were among the potential lessees contacted by
PwC. Each proposal sent by PwC contained statements indicating that Unicom
was simultaneously soliciting other prospective lessees for expressions of interest
and that the proposal was subject to due diligence by Unicom and its consultants.
After receiving initial expressions of interest from several potential lessees,
Unicom and its advisers analyzed the submitted materials.
The closing of the sale of the two fossil fuel power plants under the EME
agreement on December 15, 1999, started the clock under section 1031. Unicom
and UII had to identify like-kind replacement properties by January 29, 2000 (45
days from closing), and had to acquire the properties by June 12, 2000 (180 days
from closing).

- 19 On January 28, 2000, Unicom timely submitted to State Street, the qualified

intermediary, its identification of like-kind replacement properties for both the
Collins and Powerton stations. Unicom identified the Spruce station and certain
related common facilities owned by CPS as a replacement for the Collins station.
Unicom identified a 15.1% undivided interest in the Wansley station and a 30.2%
undivided interest in the Scherer station (both owned by MEAG) as a replacement
for the Powerton station. Those partial interests in the Wansley and Scherer
stations were at that time owned by MEAG as a tenant in common along with
Georgia Power Co., Oglethorpe Power Corp., and the City of Dalton, Georgia.
B.

Due Diligence on Replacement Properties

1.

Engineering and Environmental Analysis

Walter Hahn, a mechanical engineer with expertise in plant operability and
over 25 years' experience working on power plants, was ComEd's director of
technical services in 2000. Mr. Hahn coordinated engineering and environmental
analysis efforts for the like-kind exchange project at ComEd. To perform the
analysis, Mr. Hahn hired Stone & Webster, an engineering consulting firm that
ComEd had previously used for other engineering studies.
Stone & Webster assessed the power plants' contemporaneous condition
and expected remaining life, the projected capital costs, operating and

- 20 maintenance expenses, and environmental issues relating to the future operations
and maintenance of the replacement stations and conducted an environmental
permit review and permit compliance assessment. Stone & Webster's review
process involved data collection, site visits, and the review and analysis of all
information obtained before drafting reports and offering conclusions.
Stone & Webster's team found the Wansley and Scherer stations to be well
maintained and in clean and orderly condition, probably in the top 2%-3% of units
in the country in generation, efficiency, and overall availability and reliability.
Stone & Webster's team found that the Spruce station was also well maintained,
was running at good efficiency, and could run at high capacity factors. However,
Stone & Webster did uncover certain problems with the plants. For example,
Stone & Webster identified stress corrosion cracking in the low pressure turbine
sections of the Wansley station. Stone & Webster also raised concerns about the
potential for the U.S. Environmental Protection Agency to take action relating to
maintenance activities at Wansley. At the Scherer station, Stone & Webster
identified spills associated with transformer failures and fires. Unicom chose not
to follow up on any of these and other findings.
In addition, two ComEd engineers visited all of the stations before June
2000. Their review, however, was not as thorough as Stone & Webster's and

- 21 involved only short site visits and interviews. ComEd engineers did not find any
problems with any of the stations.
2.

Appraisal of Replacement Properties

Deloitte prepared appraisal reports for all three replacement properties as
well as for the fossil fuel power plants sold by Unicom under the EME agreement.
The reports provided current valuations of the replacement properties, as well as
valuation opinions as to the plants' residual values and remaining useful lives, and
the likelihood of the prospective lessees' being economically compelled to
exercise their cancellation or purchase options. In preparing the reports, Deloitte
sought to address specific requirements set forth in Internal Revenue Service (IRS)
published guidance on leasing transactions, such as the requirements articulated in

Rev. Proc. 75-21, 1975-1 C.B. 715, and Rev. Proc. 75-28, 1975-1 C.B. 752.
By letter dated December 29, 1999, Winston & Strawn provided Deloitte
with a list of "appraisal conclusions we anticipate will be necessary to support our
tax opinion issued in connection with any leasing transaction entered into by
ComEd [Unicom's subsidiary]." That list was later reproduced almost verbatim in
Deloitte appraisal reports. The following table shows side by side some of the

- 22 conclusions from the Winston & Strawn letter and conclusions appearing in the
Deloitte appraisal reports.6
Winston & Strawn Letter

Spruce Appraisal Report (Deloitte)

6) as of the Closing Date, it is
reasonable to expect that the fair
market value of the Leased Property
will substantially exceed the applicable
Early Termination Amount at all times
during the Lease Term;

6. As of the Closing Date, it is
reasonable to expect that the fair
market value of the Facility will
substantially exceed the applicable
Early Termination Amount at all times
during the Lease Term;

7) the Purchase Option Price is no less
than 105% of the estimated "fair
market value" of the Leased Property
as of the expiration of the Lease term,
taking into account inflation and any
reasonably anticipated improvements
or modifications to the Leased
Property and after subtracting from
such value any cost to the Lessor of
acquiring possession of the Leased
Property at the end of the Lease Term;

7. The Cancellation Option Price is no
less than 105% of the estimated "fair
market value" of the Facility as of the
expiration of the Lease Term, taking
into account inflation and any
reasonably anticipated improvements
or modifications to the Facility and
after subtracting from such value any
cost to the Lessor of acquiring
possession of the Facility at the end of
the Lease Term;

8) as of the Closing Date, the Leased
Property's remaining economic useful
life is __ years, and therefore the
Leased Property will have a remaining
economic useful life at the expiration
of the maximum Service Agreement
Term equal to at least 20 percent of its

8. As of the Closing Date, the
Facility's remaining economic useful
life is expected to be 52 years, and
therefore the Facility is expected to
have a remaining economic useful life
at the expiration of the maximum
Service Agreement Term equal to at

6The Scherer, Wansley, and Spruce appraisal reports prepared by Deloitte
contain mostly similar boilerplate in the conclusions, with slight differences
attributable to the specific terms of the transactions and fair market value figures.
We use the appraisal for the Spruce station as an example to illustrate the effect of
the Winston & Strawn letter on the conclusions reached by Deloitte.

- 23 remaining useful life as of the Closing
Date;

least 20 percent of its remaining useful
life as of the Closing Date;

9) the Leased Property will have a "fair
market value" at the expiration of the
maximum Service Agreement Term
(determined without regard to inflation
or deflation or any future
improvements) that is equal to at least
20 percent of the current "fair market
value" of the Leased Property and after
subtracting from such value any cost to
the Lessor of acquiring possession of
the Leased Property at the end of the
Lease Term;

9. The Facility will have a fair market
value at the expiration of the Lease
Term of 38.4 percent of Closing Date
fair market value (determined without
regard to inflation or deflation or any
future improvements) and a fair market
value at the expiration of the maximum
Service Agreement Term of20.0
percent of Closing Date fair market
value (determined without regard to
inflation or deflation or any future
improvements). Both uninflated
residual values are at least 20 percent
of the current fair market value of the
Facility and after subtracting from
such value any cost to the Lessor of
acquiring possession of the Facility at
the end of the Lease Term;

12) neither the physical attributes of
the Leased Property, the financial
standards of the Qualified Operator or
Qualified Bidder, the applicable return
provisions or other terms and
conditions of the Lease, Operating
Agreement or Power Purchase
Agreement, nor any other identifiable
factor known to the Appraiser after
due inquiry, will create a material
inducement to Lessee to exercise the
Purchase Option with respect to the
Leased Property;

13. Neither the physical attributes of
the Facility, the financial standards of
the Qualified Operator or Qualified
Bidder, the applicable return
provisions or other terms and
conditions of the Lease, Operating
Agreement or Power Toll Processing
Agreement, nor any other identifiable
factor known to the Appraiser after
due inquiry, will create a material
inducement to Lessee to exercise the
Cancellation Option with respect to the
Facility;

13) based on the comparative costs of
the reasonably anticipated alternatives

14. Based on the comparative costs of
the reasonably anticipated alternatives

- 24 expected to be available to Lessee at
the expiration of the Lease Term,
Lessee will not be under any economic
compulsion to exercise the Purchase
Option;

expected to be available to Lessee at
the expiration of the Lease Term,
Lessee will not be under any economic
compulsion to exercise the
Cancellation Option;

17) the fixed net return required under
the Service Agreement Option is less
than 90% of the expected "fair market
value" of such payments so that the
Service Agreement Option does not
create an economic compulsion for the
Lessee to exercise the Purchase Option
and it is expected that the Lessor will
not exercise the Service Agreement
Option;

18. The fixed net return required
under the Service Agreement Option is
less than 95 percent of the expected
"fair rental value" so that the Service
Agreement Option does not create an
economic compulsion for the Lessee to
exercise the Cancellation Option and it
is expected that the Lessor will not
exercise the Service Agreement
Option;

Winston & Strawn provided continuous and substantial feedback to Deloitte
on the drafts of the appraisal reports. Although Winston & Strawn did not give
Deloitte directions as to the specific fair market value for each replacement
property, Deloitte knew from its previous work on appraising Unicom's plants
sold under the EME agreement how much gain Unicom was looking to defer.
With respect to all three replacement properties, Deloitte discussed the
results obtained under three standard valuation approaches: cost of replacement
approach, market approach, and discounted cashflow approach. Deloitte
concluded that the discounted cashflow analysis represented the most reliable

- 25 approach to determining the current fair market value of the assets in the test
transactions in all of the cases.7
To arrive at the fair market values of the replacement plants at the end of the
sublease terms, Deloitte used the maximum Federal statutory corporate income tax
rate of 35% and a State corporate income tax rate of 9% (total of 40.85%) even
though the plants were in Texas, which did not have a State corporate income tax,
and in Georgia, which had a 6% State corporate income tax rate." Deloitte used
the same discount rate of 10% for all three plants and assumed inflation of 2.5%
per annum. Deloitte did not perform any sensitivity analysis.
For the Spruce station, Deloitte assumed the plant capacity factor to be

90.3% in 2000, declining to 58.7% in 2032 and to 49.6% in 2052. For the
Wansley station, Deloitte assumed the plant capacity factor of 66.5% in 2000,

declining to 39.2% in 2028 and to 32.6% in 2044. For the Scherer station,
Deloitte assumed the plant capacity factor to be 66.5% in 2000, declining to 39.9%

7We note, however, that Deloitte relied mostly on the cost approach to
determine the fair market value of the assets at the end of the leaseback term.
8At the time of Deloitte's appraisal, Texas had a corporate franchise tax
equal to the greater of 0.25% of a corporation's net taxable capital or 4.5% of its
net taxable earned surplus. Tex. Tax Code Ann. sec. 171.002 (West 2000). In
addition to its corporate income tax, Georgia levied a graduated corporate net
worth tax, ranging from $10 to $5,000. Ga. Code Ann. sec. 48-13-73 (2013).

- 26 by 2030. Deloitte did not analyze in its appraisal reports how a change in a
capacity factor might influence the future fair market value of the assets at issue.
After performing the analysis, Deloitte concluded that CPS and MEAG
would not be economically compelled to exercise their cancellation or purchase
options at the end of their respective subleases. If based on the Deloitte analysis,
the fair market value of all the replacement properties at the end of the leaseback
term would be less than the cancellation or purchase option price. In arriving at
this conclusion, Deloitte did not consider noneconomic factors or any
arrangements between the parties setting aside the money for the option payment
at the beginning of the lease.
3.

Financial and Economic Analysis

Ruth Ann Gillis, Unicom's chief financial officer in 1999-2000, coordinated
the financial and economic due diligence on the Spruce, Wansley, and Scherer
transactions. Ms. Gillis reviewed both the creditworthiness of CPS and MEAG
and the quality of the leased stations. At the end of the due diligence process, Ms.
Gillis felt comfortable recommending that the board of directors enter into the
transactions.
PwC acted as a financial adviser in connection with the like-kind exchange
and the sale-leaseback transactions. PwC's engagement included the following

- 27 services: (i) assessing Unicom's specific needs from economic, tax, accounting,
commercial, and regulatory standpoints in connection with the proposed like-kind
exchange; (ii) developing a strategy matching target replacement property with the
relinquished property; (iii) identifying target replacement property owned by both
tax-exempt lessees and taxable lessees; (iv) arranging for a tax and accounting
analysis regarding the like-kind exchange; (v) providing economic analyses and
pricing models and issuing reports regarding accounting treatment for the life of
the like-kind exchange; and (vi) issuing an opinion regarding the application of
accounting principles to the like-kind exchange. Subsequently, PwC also acted as
the designated tax shelter organizer on behalf of Exelon and registered the
transactions with the IRS as a confidential tax shelter.
Petitioner retained First Chicago Leasing Corp. (FCLC), a wholly owned
subsidiary of Banc One Capital Corp. (Banc One), to serve as a supplemental
investment adviser to the Unicom Group. FCLC provided Unicom with financial
and risk analysis of, and advice relating to, the like-kind exchange. FCLC
considered all material credit risks as having been adequately addressed through
the transaction structure and financial enhancements such that the transactions at
issue possessed above-average safety from a credit risk perspective with respect to
payment of scheduled rent, purchase options, or early termination damage claims,

- 28 thus protecting Unicom's investment return. FCLC advised that CPS and MEAG

were generally very credit-worthy, strong, investment-grade entities and would
remain primarily liable for all rent and purchase option obligations. FCLC also
concluded that Unicom would not suffer losses due to failure on the part of CPS
and MEAG to pay rent, sums due for purchase options, or liquidated damages at
the appropriate times.
With respect to the risk of bankruptcy of CPS or MEAG, FCLC concluded
that "the potential adverse effects of the real estate classification in a bankruptcy
are being borne in these transactions by the credit support parties and not
Unicom." FCLC further concluded that Unicom could rely on being able to get a
full payout in cash if a bankruptcy of a lessee occurred. FCLC did not evaluate
the risks related to the service contract period after the expiration of the sublease

to CPS or MEAG.
Marsh USA, Inc., advised Unicom on standard insurance practices for the
U.S. utility industry and the appropriate terms for property damage and
commercial liability insurance in the Spruce, Wansley, and Scherer transactions.
4.

Legal and Tax Analysis

Winston & Strawn analyzed the qualification of the replacement properties
against the relevant tax tests for like-kind exchanges, helped negotiate the

- 29 transactions with CPS and MEAG, drafted the various transaction documents, and
analyzed the tax consequences thereof. Winston & Strawn also analyzed the
relevant leasing authorities and legal risks associated with the Spruce, Wansley,
and Scherer transactions. Winston & Strawn worked with local legal counsel in
Illinois, Georgia, and Texas to assist with regulatory, corporate, real estate and
title, and engineering and surveying issues with respect to the Spruce, Wansley,
and Scherer stations.
Winston & Strawn was closely involved in the due diligence process,
including marking up the engagement agreement with Deloitte and, as previously
discussed, providing Deloitte with a list of desirable conclusions and comments on
the appraisal report drafts.
Winston & Strawn provided two tax opinion packages containing opinion
letters and supporting memoranda to Unicom, dated as of the closing of the saleleaseback transactions, on the Federal income tax treatment of the transactions.
The opinion package for the exchange of the Collins station for Spruce totaled 357
pages, while the opinion package for the exchange of the Powerton station for
Wansley and Scherer was 392 pages. Winston & Strawn's primary tax opinions
concluded the following.

- 30 (a) The exchange of Unicom's fossil fuel power generating facilities in
Illinois with the lessees' fossil fuel power generating facilities "should be treated
as a valid exchange of like kind or like class property under section 1031 of the
Code."
(b) Each of the Spruce, Wansley, and Scherer leases "will be treated as a
true lease for federal income tax purposes pursuant to which UII [Unicom] will
directly or indirectly receive the taxable income and deductions associated with
the ownership of" the Spruce, Wansley, and Scherer stations, respectively.
(c) Substantially all of the section 467 rental payments "will be treated" as
loans to Unicom "rather than as current rental income."
(d) The Spruce, Wansley, and Scherer leases "will transfer ownership" of
the Spruce, Wansley, and Scherer stations to Unicom for Federal income tax
purposes.
Although Winston & Strawn provided generally favorable opinions, it
separately warned Unicom that there are certain risks related to Federal tax law,
including recent guidance by the Internal Revenue Service on lease-in/lease-out
(LILO) transactions and the possibility that the proposed transaction might be
subsequently classified as a corporate tax shelter.

- 31 Unicom retained Vinson & Elkins LLP to provide legal advice and opinion
as to Texas law relevant to the Spruce transaction. Unicom retained Holland &
Knight LLP to provide legal advice and opinion as to Georgia law relevant to the
Scherer and Wansley transactions.
With respect to the review by Unicom's own employees of the analysis and
conclusions provided in the Winston & Strawn legal opinions, Mr. Roling testified
that he did not get beyond the first seven of several hundred pages of the opinion,9
and Unicom's internal tax personnel also did not review the legal analysis in the
draft opinions. Mr. Berdelle, however, testified that he did read the Winston &
Strawn tax opinions in their entirety.

C.

Board Approval

At the March 9, 2000, Unicom board meeting, John Rowe, Chief Executive
Officer and Chairman of ComEd and Unicom, introduced a discussion of the
proposed like-kind exchange, and Mr. Berdelle presented information to the board

°Mr. Roling testified that he read seven pages of an opinion, but it is not
apparent to which opinion he referred. The record shows that Winston & Strawn
provided two tax opinion packages, in addition to drafts throughout the
preparatory stages of the transactions. However, in certain places, the record
indicates that an employee of petitioner reviewed an "opinion", in the singular.
Here and elsewhere in our Opinion, we use the singular and the plural forms of the
word as appropriate to reflect whichever grammatical number the record
establishes on that particular point.

- 32 on the like-kind exchange and the sale-leaseback proposal as it had developed
since the December 1999 board meeting. On March 28, 2000, the board received
a memorandum explaining the nature of the transactions and a credit and
investment analysis, as well as expected economic results.
On April 4, 2000, Mr. Berdelle presented the proposed like-kind exchange
to the board in more detail, and representatives of the Winston & Strawn team and
Mr. Jenkins from PwC responded to the board's questions about the credit risks,
the tax risks, and the financial returns associated with the transaction. Mr. Rowe,
Mr. Berdelle, and Ms. Gillis all recommended that the board approve the like-kind
exchange, and the board followed their advice.
At the time the transactions were approved, some results of the due
diligence, including legal opinions, valuation reports, and engineering due
diligence reports, were not yet available in their final form. It is unknown whether
the board reviewed the draft reports and opinions, but the board memorandum
dated March 28, 2000, discussed some tax and legal risks.¹°

¹°Specifically, appendix D discussed the risks related to the MEAG
transaction, and appendix E discussed the risks related to the CPS transaction. On
the risks related to a MEAG bankruptcy, the conclusion was that the risk was
mitigated by MEAG's inability to become a debtor under current Georgia law. On
the risks related to a CPS bankruptcy, it was considered to be an "unlikely event"
mitigated by the credit enhancement.

- 33 Test Transactions

I.

Spruce
A.

CPS and Its Decision To Enter Into the Spruce Transaction

CPS is a municipal gas and electric utility owned by the City of San
Antonio, Texas, that sells gas and electricity to its customers. CPS' mission
statement obligates CPS to provide low-cost, reliable gas and electricity service to
its customers. As an entity owned by a municipality, CPS is tax exempt.
In the late 1990s CPS' electric system served a territory consisting of
substantially all of Bexar County, Texas, and small portions of seven adjacent
counties. The CPS system was within the Electric Reliability Council of Texas
(ERCOT) region, which was entirely within the State of Texas and served about
85% of Texas' electrical load. ERCOT includes approximately 500 power plants.
ERCOT is not connected to the national grid, and, as a result, Texas power
producers are not subject to FERC regulations.
CPS owned 15 electric generating units and a 28% interest in the South
Texas Project's two nuclear generating units. The Spruce station's generating
capacity was approximately 12.3% of the generating capacity of CPS' electric
system. The electricity prices for CPS' customers in 1999 were the lowest among
the 20 largest cities in the United States and the lowest among major Texas cities.

- 34 CPS' board of trustees has five members: one director is always the mayor
of the City of San Antonio, and the other four each represent one quadrant of the
city. As a part of the City of San Antonio, CPS has its financial statements
included in the annual financial reports of the City of San Antonio. The City of
San Antonio shares in CPS' revenues, and the percentage of gross revenues to be
paid over or credited to the City of San Antonio each fiscal year by CPS is
determined (within the 14% limitation) by the governing body of the City of San
Antonio.

CPS had been presented with other similar transaction opportunities before
Unicom's proposal, but CPS rejected these prior proposals for various reasons.
After receiving the proposal from Unicom and reviewing valuations and the
transaction documentation, the CPS board determined that the transaction did not
violate CPS' bond covenants and gave its approval for the transaction in 2000.
The City Council of San Antonio also approved the Spruce transaction. A January
27, 2000, CPS presentation to the San Antonio City Council Executive Board
described the Spruce transaction as a "sale of tax benefits to a taxable entity." In
making the decision, CPS did not obtain an appraisal of its own and relied on the
appraisal prepared by Deloitte for Unicom.

- 35 In order to proceed with the Spruce transaction, the City of San Antonio
brought suit in Texas State court to obtain a declaratory judgment on the continued
validity of certain covenants in its outstanding public securities issued for the
purpose of financing the construction and improvement of its electric and gas
systems, which included the Spruce station. The City of San Antonio represented
in the petition that the encumbrance would be limited to the value of the private
company's (Unicom's) "future right to obtain a possessory leasehold interest in the
[f]acility (a) after the 30-year lease back to the City has expired and (b) if the City
elects not to exercise its right to cancel the [headlease] after the 30-year lease back
to the City has expired." In the initial draft of the petition, the City also
represented that it intended to exercise the cancellation option. However, this
statement was later deleted at the suggestion of Winston & Strawn and PwC, who
reviewed the petition on behalf of Unicom and provided comments.
The City of San Antonio represented in its petition that it retained fee
ownership in the Spruce station and retained possession and rights to operate it
during the leaseback term. The City of San Antonio also represented that all the
rent would be prepaid six months after the closing date on the leaseback
transaction and that the City of San Antonio would make an investment that upon

maturity would provide the amounts necessary to pay for the cancellation option.

- 36 The City estimated that the net present value of the rights which Unicom would
acquire in the future was approximately $40 million.
B.

Key Terms of the Spruce Lease and Sublease

1.

Lease and Sublease

On June 2, 2000, the City of San Antonio, acting by and through CPS,
entered into a sale-leaseback transaction with Unicom, through UII and its wholly
owned subsidiaries, Spruce Equity Holdings, L.P., and Spruce Holdings Trust,
with respect to the Spruce station. In essence, the money transferred by Unicom to
CPS was to be split in three funds: the first fund would be returned to Unicom as
a prepayment of sublease by CPS, the second fund would be set aside for
investment that would secure the payment of the cancellation option should CPS
decide not to reacquire the Spruce station at the end of the sublease, and the third
fund would be retained by CPS and could be used for its current needs.
a.

Spruce Headlease Agreement

Pursuant to the headlease agreement for the Spruce transaction (Spruce
headlease), CPS leased the Spruce station to Unicom for a term of 65 years,
starting June 2, 2000, and terminating on June 2, 2065 (Spruce headlease term),
unless terminated earlier. The Spruce headlease term exceeded the Spruce
station's estimated remaining useful life of 52 years, as determined in the Deloitte

- 37 appraisal report dated June 2, 2000 (Spruce appraisal). Since the headlease term
exceeded the plant's remaining useful life, the transaction could qualify as a sale,

making it a SILO, not a LILO.
Under the Spruce headlease, Unicom agreed to pay $725 million to CPS on
the closing date, June 2, 2000 (Spruce headlease rent). This amount was equal to
the estimated fair market value of the Spruce station on the closing date according
to the Spruce appraisal prepared by Deloitte. The appraised fair market value
served as the basis for determining Unicom's investment in the transaction, and
the parties did not further negotiate the investment amount. Deloitte estimated
that as of the end of the Spruce sublease in 2032 the fair market value of the
Spruce station would be $626 million if based on the discounted cashflow analysis
($609.6 million if based on the cost approach).
b.

Spruce Sublease Agreement

Under the Spruce sublease agreement (Spruce sublease), CPS leased back
from Unicom all of Unicom's right, title, and interest in the Spruce station under

the Spruce headlease. The sublease term commenced on June 2, 2000, and was
scheduled to terminate on March 2, 2032, for a term of 31.75 years.
Under the Spruce sublease, CPS was obligated to prepay rent to Unicom for
the entire sublease term in the amount of $557,329,539 on November 30, 2000

- 38 (Spruce base rent). The Spruce base rent accrued and was allocated annually pro
rata, commencing on the first day of the sublease term. If the Spruce sublease
terminated early, Unicom was required to return to CPS any unaccrued base rent.
The Spruce sublease was a net lease, requiring CPS to pay all costs and
expenses in connection with the Spruce station. In addition, CPS was required to
maintain insurance on the Spruce station under the terms of the sublease.

2.

Default

The parties to the Spruce transaction agreed that the Spruce headlease could
not be terminated or extinguished by any circumstances of any character or for any
reason, with certain limited exceptions including CPS' defaulting under the Spruce
sublease terms.
The Spruce sublease provided for early termination if CPS were to default
under the terms of the sublease. The events of default included, among other
provisions, failure to pay the Spruce base rent, failure of any material
representation or warranty made by CPS, or failure to properly maintain the
Spruce station. In case there was significant damage to the Spruce station so as to
render the station beyond repair, CPS could elect to either replace the Spruce
station or terminate the Spruce sublease.

- 39 In any of these scenarios, Unicom had a number of remedies against CPS,
including collecting the stipulated loss value of the Spruce sublease, and taking
possession of the Spruce station to operate, sell, or sublease it to somebody else.
The stipulated loss value was predetermined on the closing date and based on the
Deloitte Spruce appraisal and was meant to ensure Unicom's return on the
mvestment.

3.

Property Rights and Obligations

Under the Spruce headlease, Unicom had the right to use, operate, and
possess the Spruce station without interference from CPS. Unicom did not have
any obligations to CPS in respect of maintenance, operation, or insurance of the
Spruce station under the headlease. Upon the Spruce headlease expiration,
Unicom could return the Spruce station to CPS. Unicom was not obligated to
make any representations or warranties with respect to the Spruce station except
that it was free and clear of liens in case CPS decided to exercise its cancellation
option at the end of the Spruce sublease term.
The Spruce sublease was a triple-net lease, meaning that CPS was
responsible for all the costs and expenses, foreseen or unforeseen, in connection
with the Spruce station, including costs of operation, maintenance, insurance,
improvements and other expenses. The Spruce sublease contained a covenant of

- 40 quiet enjoyment in favor of CPS unless it defaulted under the sublease. CPS
could, at its own expense, use, operate, service, repair, and maintain the property
as long as it complied with the industry standards and applicable laws and did not
have a material adverse effect on the Spruce station, did not result in risk of
criminal liability, and did not involve any material risk of loss, forfeiture, or sale
of the Spruce station. CPS was solely responsible for environmental compliance
and any necessary remedial measures. CPS was also responsible for obtaining and
maintaining property and liability insurance coverage meeting certain
requirements set out in the Spruce sublease agreement.
Unicom's rights under the Spruce sublease were very limited. Unicom had
the right to inspect the Spruce station no more than once a year. CPS was required
to seek Unicom's consent with respect to proposed improvements, corporate
consolidations, subleases, and assignments.
CPS had limited rights to encumber the property throughout the Spruce

sublease term, and could not create any liens on the property after the Spruce
sublease term expiration. Unicom, on the other hand, could incur liens on the
property after the termination of the Spruce sublease, provided that CPS did not
exercise its cancellation option.

- 41 CPS took the Spruce station from Unicom on an as-is basis. However, at
the end of the Spruce sublease term CPS was required to return the Spruce station
in good working order and meeting the predetermined minimum operational

standards. For example, the Spruce Station was required to have an annual ratio of
the actual net generation to the normal claimed capacity operating for 8,760
hours/year of at least 82.0%. The Spruce station was required to have the ratio of
available generation to maximum generation of at least 89% and have an annual
ratio of the heat energy output of not more than 10,950 Btu/kWh. These
conditions applied to the return of the Spruce station at the end of the Spruce
sublease term in 2032 as well.
If CPS decided to return the station to Unicom at the end of the sublease,
CPS was required to arrange at its own expense for any necessary permits for
Unicom to operate the Spruce station and for engineering and environmental
inspections, as well as to arrange for Unicom fuel supply contracts and
transmission agreements, together with other agreements necessary to operate the
station. Failure to comply with these requirements would trigger a CPS default
under the agreement, and Unicom could pursue its contractual remedies.

-424.

Cashflows

Unicom paid $725 million to CPS under the Spruce headlease on June 2,
2000. Of that amount, CPS retained a lump sum of approximately $88 million, of
which the City of San Antonio received about $12.3 million.
On the same date, CPS entered into the collateralized payment undertaking
agreement (CPUA) with AIG Financial Products (Jersey), Limited (AIG-FP).

Under the CPUA, CPS would pay AIG-FP a fee of $88,995,790 (undertaking fee).
In exchange, AIG-FP would use the proceeds from the undertaking fee to make
payments to Unicom, for the benefit of CPS, at the end of the Spruce sublease
term in the amounts and on the dates specified in the CPUA. In essence, the
payments matched both in timing and amount the amounts CPS would owe to
Unicom upon CPS' exercise of the fixed purchase option (cancellation option)
available to CPS at the end of the Spruce sublease term. The cancellation option
allowed CPS to terminate the Spruce headlease at the end of the Spruce sublease
term and completely regain the ownership of the station."

" CPS' payment to AIG-FP of the undertaking fee was absolute,
unconditional, irrevocable, and not refundable to CPS under any circumstances,
including CPS' bankruptcy. CPS did not have any rights or interest in any portion
of the undertaking fee, and the fee could not be subject to any lien, claim, or
remedy by CPS or its creditors. After the payment, the undertaking fee ceased to
be an asset of CPS and became an asset of AIG-FP.

- 43 The CPUA required AIG-FP to deliver the cash received as the undertaking
fee to Wilmington Trust Co. to be held as collateral pledged primarily to Unicom
until CPS paid its obligations under the various transaction agreements. In the
event of an early termination of the Spruce sublease, Unicom would receive a
"termination amount" under the terms of the CPUA from the undertaking fee

proceeds.
As additional protection of Unicom's interest in the amounts set aside under
the CPUA, American International Group, Inc. (AIG), guaranteed the obligations
of AIG-FP under the CPUA. CPS also obtained a financial guaranty insurance
policy from Financial Security Assurance (FSA). Specifically, the policy provided
certain protections to CPS in case of its bankruptcy or in the event of CPS' default
or early termination of the sublease.
Further, from the Spruce headlease rent, CPS transferred the following
amounts to secure the Spruce sublease base rent due on November 30, 2000:
(1) about $327.3 million to Wilmington Trust Co. as custodian of an
account that would be pledged to Unicom;
(2) about $50 million to an account pledged to AIG Financial Products
Corp. to support CPS' obligations under the letter of credit reimbursement

agreement;

- 44 (3) about $162 million to an account pledged to FSA to support CPS's
obligations under the insurance and indemnity agreement to the Spruce sublease.¹²
C.

End of Sublease Term

1.

CPS's Cancellation Option

At the end of the Spruce sublease term, March 2, 2032, CPS would have the
option of terminating the Spruce sublease and causing Unicom to terminate the
Spruce headlease (cancellation option) for the price of $733,849,606. Because the
entire amount of the cancellation option payment was financed through the CPUA,
CPS would not have to contribute or borrow any additional cash. According to the
appraisal prepared by Deloitte, the fair market value of the Spruce station on the
cancellation option exercise date in 2032 would be around $626 million if based
on a discounted cashflow analysis and around $609.6 million if based on a cost
approach.
If CPS chose not to exercise the cancellation option, it would trigger
provisions of the Spruce sublease describing conditions for returning the Spruce
station to Unicom. Among other things, CPS would have to ensure that the station
meet operational standards, arrange for various inspections, obtain operating
¹²Although the total amount set aside was roughly $539 million, some of the
money was invested by the custodians in low-risk securities to provide sufficient
income to cover the entire $557 million Spruce base rent.

- 45 permits for Unicom, and arrange for Unicom to enter into fuel supply contracts,
transmission agreements, and other contracts with third parties necessary to
operate the Spruce station. Failure to comply with these requirements would
trigger a default and the right of Unicom to seek contractual remedies, as
discussed below.
2.

Unicom's Options

If CPS chose not to exercise the cancellation option at the end of the
sublease term, Unicom would have three choices. First, Unicom could require
CPS to arrange for a "qualified operator" to enter into an operating agreement with
Unicom. Second, Unicom could require CPS to arrange for a "qualified bidder" to
enter mto a service agreement. If Unicom did not provide CPS with written notice
of which option it decided to exercise, Unicom would be deemed to have
exercised both the operating agreement and the service agreement options.
Finally, Unicom could take possession of the Spruce station and could operate it
and sell its energy production without exercising the operating agreement or
service option.
If Unicom exercised the service agreement or operating agreement option
and CPS failed to implement the service agreement or operating agreement option
by the end of the Spruce sublease, such failure would constitute an event of default

- 46 and trigger the right of Unicom to pursue appropriate remedies. However, under
certain circumstances CPS would have another opportunity to exercise the
cancellation option at the same price.
a.

Operating Agreement

Under the operating agreement option, CPS was required to find a qualified
operator for the Spruce station. CPS could not be the qualified operator. A
qualified operator would have to, among other requirements, have its senior longterm debt rated no lower than Aa2 by Moody's and AA by S&P or have a
comparable rating by another rating agency acceptable to Unicom or be deemed
similarly creditworthy in the sole opinion of Unicom. Alternatively, a qualified
operator could obtain a guaranty of its obligations under the operating agreement
by any person with its senior unsecured long-term debt rated no lower than Aa2 by
Moody's and AA by S&P, or have a comparable rating by another rating agency
acceptable to Unicom.
The operating agreement option contemplated that the electric output of the
Spruce station would be sold to third parties under the power toll processing
agreements, discussed in the next section.
Deloitte included in its appraisal a list of potential power purchasers and
operators. The only entity with an acceptable credit rating was General Electric

- 47 Corp., meaning that most potential qualified operators would have to make
guaranty arrangements.

3.

Service Agreement

If CPS did not elect to exercise its cancellation option and Unicom elected
to exercise the service agreement option, CPS was required to arrange for the
submission of one or more bids from qualified bidders to enter into the power toll
processing agreement with Unicom for a term of 9.58 years. Unicom expected the
power toll processing agreement to be substantially in the form attached to the
Spruce sublease agreement. CPS was also required to arrange for the qualified
bidder to satisfy all of the conditions precedent to entering into the power toll
processing agreement on or before the expiration date for the Spruce sublease.
A qualified bidder would have to have--or have its obligations under the
power toll processing agreement guaranteed by any person that had--senior
unsecured long-term debt obligations rated no lower than Aa2 by Moody's and
AA by S&P or have a comparable rating for its senior unsecured long-term debt
obligations by another rating agency acceptable to Unicom. If a bidder or a
guarantor did not have debt with such a rating, Unicom could determine whether
the bidder or guarantor satisfied the creditworthiness requirements at its sole
discretion.

- 48 The power purchase bids would have to provide Unicom with net power
revenue in the amounts and at the times set forth in the Spruce sublease. Unicom
could reject any bid if it concluded that the bid would require the Spruce station to
be operated inconsistently with the standards and operational practices and
policies of operators of similar facilities in similar circumstances. In that event,
CPS would be entitled to arrange for one or more alternative bids. If CPS were
unable to find a qualified bidder or Unicom rejected all bidders on or before the
Spruce sublease expiration date, CPS would have to exercise the cancellation
option.

II.

Scherer and Wansley
A.

MEAG and Its Decision To Enter the Scherer and Wansley
Transactions

MEAG was created by the State of Georgia to own and operate electric
generation and transmission facilities and supply bulk wholesale electric power to
its 49 member municipalities, 48 cities, and one county in Georgia. MEAG's
mission is to deliver low-cost power to its participants and, with respect to its own
generation plants, operate them at the lowest cost. MEAG sells power to its cities
at cost and any profit it earns has to inure to the benefit of its cities.

- 49 MEAG is a member of a power marketing agency called the Energy
Authority, which optimizes MEAG's resources and identifies the most economical
method for MEAG to supply power to its members. These options could entail
selling output to the market from one of the power plants MEAG owns and then
buying lower-cost power from a third party, or selling some of MEAG's extra
capacity during colder months to Florida, North Carolina, or Alabama.
MEAG's portfolio of assets consists primarily of investments in power
plants, including undivided ownership interests in the Scherer and Wansley
stations.¹³ Typically, MEAG issues debt to finance the construction of a power
plant, capitalizing the interest during the construction, and then bills cities
monthly for the debt service, the operating expenses, and the fuel expenses.
MEAG is a governmental entity and is tax exempt. State law restricts
MEAG's investments primarily to U.S. Treasuries, repurchase agreements backed
by treasuries and agencies, and money market funds that have treasuries and
agencies. In 1999 MEAG opened an account with $435 million that was intended
to grow with interest until 2008 when MEAG thought deregulation would occur,
but the power market in Georgia was never deregulated.
¹³Georgia Power Co., Oglethorpe Power Corp., and the City of Dalton are
the coowners of the Scherer and Wansley Stations. Georgia Power Corp. operates
the Scherer and Wansley Stations.

- 50 James Fuller was MEAG's treasurer at the time the Wansley and Scherer
transactions were negotiated and closed. Mr. Fuller led MEAG in the negotiations
with petitioner and the other third parties involved in the transactions. During the
negotiations, Mr. Fuller reviewed the transaction documents and the terms relating
to the fixed price purchase option. Mr. Fuller also reviewed the Deloitte appraisal,
but MEAG did not do an appraisal of its own. MEAG originally acquired the
Wansley and Scherer stations at cost.
Before entering into the Scherer and Wansley transactions, MEAG obtained
certain consents from the coowners of the stations, Georgia Power Co., Oglethorpe
Power Corp., and the City of Dalton. MEAG also retained R.W. Beck to evaluate
the impact of the sale of these plants on MEAG's participants to comply with the
provisions of the bond indentures issued to finance the Wansley and Scherer
stations.
B.

Key Terms of the Scherer Transaction

Plant Robert W. Scherer Unit Nos. 1 and 2 (Scherer station) is on a 12,000acre site near Forsythe, Georgia, and includes a powerhouse containing Units 1
through 4, various ash ponds, a water pond, a coal storage yard, a 550-kilovolt
substation, and a man-made lake. Only Units 1 and 2 of the Scherer station were
part of the leasing transactions with Unicom. The leased property did not include

- 51 the coal stockpile, inventories, intangibles, and unit trains owned by MEAG at the
sites. Units 1 and 2 of the Scherer station are conventional coal-fired units
equipped with a single boiler and turbine generator, commissioned in 1982 and
1984, respectively.
1.

Lease and Sublease

On June 9, 2000, Unicom, acting through Scherer Holdings 1, LLC, and
UII, entered into a sale-leaseback transaction with MEAG involving an undivided
interest in the Scherer station (Scherer transaction).
a.

Headlease

Pursuant to the headlease agreement for the Scherer transaction (Scherer
headlease), MEAG leased to Unicom (i) a 10.0% undivided interest in the Unit 1
site, the Unit 2 site and the unit common facilities site, and a 5.0% undivided
interest in the Plant Scherer Common Facilities Site, (ii) a 10.0% undivided
interest in Unit , Unit 2, and the unit common facilities, and (iii) a 5.0% undivided

interest in the Plant 27 Scherer Common Facilities (collectively, Scherer station)
for a term of 61.75 years, starting June 9, 2000 and terminating on September 9,
2061 (Scherer headlease term), unless terminated earlier. The Scherer headlease
term exceeded the Scherer station's estimated remaining useful life of 49 years, as

- 52 determined in an appraisal report on the Scherer Station dated June 9, 2000,
prepared by Deloitte (Scherer appraisal).
Under the Scherer headlease, Unicom agreed to pay MEAG $201,986,755
on the closing date, June 9, 2000 (Scherer headlease rent). The Scherer headlease
rent equaled the estimated fair market value of the Scherer station as of June 9,
2000, as determined by Deloitte in the Scherer appraisal. The parties did not
further negotiate the fair market value of the station, and Mr. Fuller could not
recall whether MEAG had obtained written advice on the valuation of the Scherer
station from anyone other than Deloitte.
MEAG had the right to inspect the Scherer station site throughout the
duration of the headlease. Unicom did not have any obligations to MEAG as to
maintenance, operation, or insurance of the interests conveyed under the
headlease.
b.

Sublease

On the same date, June 9, 2000, Unicom and MEAG entered into an
agreement to lease back the Scherer station (Scherer sublease). MEAG leased
back from Unicom all of Unicom's right, title, and interest in the Scherer station
under the Scherer headlease. The sublease term commenced on June 9, 2000, and

- 53 was scheduled to terminate on September 9, 2030, for a total term of 30.25 years
(Scherer sublease term).
MEAG had an absolute and unconditional obligation to prepay Scherer
sublease rent of $157,414,216 to Unicom on December 7, 2000. Similar to the
Spruce transaction, the Scherer sublease was a triple net lease, meaning that
MEAG was solely responsible for any expenses associated with the sublease. The
parties allocated all the risks related to the Scherer sublease to MEAG. MEAG
was also responsible for maintaining property and liability insurance which met
the requirements set forth in the Scherer sublease.
2.

Default

Similarly to the Spruce transaction, MEAG and CPS could not declare a
default under the headlease. The Scherer sublease, however, had provisions
outlining what events would constitute a default by MEAG. Such events included,
among others, MEAG's failure to pay the Scherer sublease rent on time, failure of
material representation or warranty, or failure to properly maintain the Scherer
station. MEAG had an opportunity to cure such defaults.
In addition, the Scherer sublease also specified certain "Events of Loss", in
case of which MEAG could elect to either rebuild or replace the specific unit in
question or to terminate the sublease with respect to that unit.

- 54 In the event of default, Unicom had the following contractual remedies: (1)
enforce performance by MEAG at MEAG's cost or recover damages for a breach;
(2) terminate the Scherer sublease and demand that MEAG return possession of
the subleased assets to Unicom; or (3) demand that MEAG pay any supplemental
sublease rent due plus the stipulated loss value, and, upon such payment, transfer
all of its right, title, and interest in the leased assets back to MEAG. If Unicom
chose to proceed with the second or third option, it was required to return
unaccrued rent in the form of an early termination amount, as determined on

schedule 2 of the Scherer sublease agreement. If Unicom chose to proceed with
the second option, MEAG would still have an option to purchase the undivided
interest in the Scherer station at a price equal to the higher of stipulated loss value
as of the date of sublease termination due to a default or the then fair market sale
value.
If an event of loss occurred and MEAG chose not to rebuild or replace a
specific unit, MEAG would have to pay Unicom a stipulated loss value, as set
forth in schedule 2 to the Scherer sublease agreement. Unicom would then have to
pay to MEAG an early termination amount, which would reflect any unaccrued
rent as of the date of the event of loss.

- 55 3.

Property Rights and Obligations

Unlike the Spruce transaction, where Unicom received a 100% interest in
the Spruce station, the Scherer headlease transferred only a partial interest in the
Scherer station to Unicom. Unicom received a right of quiet enjoyment under the
headlease. This, however, did not result in Unicom's authority to operate the
Scherer station.¹4 Unicom had the right to use the ground interest to construct,
install, operate, use, repair, and relocate and remove facilities and structures on or
under the Scherer site. Unicom, however, in general did not have any obligations
to MEAG with respect to maintenance, operation, or insurance of the Scherer
station interest under the headlease.
Upon the expiration of the Spruce headlease, Unicom was to return its
interest to MEAG on the "as is" and "with all faults" basis. MEAG had the right
to inspect the property after the expiration of the leaseback term. Unicom was
responsible for a percentage of certain taxes and assessments with respect to the
ground interest described in the Scherer headlease agreement from the date the
leaseback to MEAG ended and until the end of the headlease. Both MEAG and

¹#Operation of the Scherer station was governed by the agreement among
MEAG, Georgia Power Co., Oglethorpe Power Corp., and the City of Dalton. At
the time Unicom and MEAG entered into the sale-leaseback arrangements,
Georgia Power Co. operated both the Scherer and Wansley stations.

- 56 Unicom agreed to limit their ability to incur liens with respect to the Scherer
station interest transferred by the Scherer headlease.
Under the Scherer sublease, MEAG received the same interest in the
Scherer station it transferred to Unicom under the Scherer headlease. Overall, the
rights of MEAG under the sublease were similar to the rights of CPS under the
Spruce sublease. MEAG's rights with respect to subleasing its interest during the
sublease term were broader than those of CPS: MEAG did not need separate
approval for a sublease if it met certain requirements. Unicom had the right to
inspect the premises during the sublease once a year and the right to consent to the
assignment by MEAG of its rights under the Scherer sublease.
Under the Scherer sublease, MEAG took the Scherer station interest from
Unicom on an as-is basis. If MEAG or other tenants in common of the Scherer
station did not exercise the purchase option at the end of the Scherer sublease or if
MEAG was required to return the Scherer station interest to Unicom after a
default, MEAG was required to meet certain conditions, including having the
Scherer station meet certain operational standards and be free from major defects,
in good working order, and in a good state of repair. Unicom was entitled to
receive, and MEAG agreed to deliver, the Scherer station with at least a 62%
capacity factor based on 8,760 hours of operation per year and net energy output

- 57 of 87.5%. In addition, MEAG was required to be in compliance with other
agreements governing ownership and operation of the Scherer station and have no
outstanding amounts due under those contracts.
If MEAG were required to return the Scherer station interest to Unicom, and

Unicom chose the service agreement option, MEAG was to arrange at its own
expense for any necessary permits for Unicom or a qualified bidder under the
service agreement to operate the Scherer station. MEAG was also required to
arrange for an environmental inspection, as well as to arrange for Unicom fuel
supply contracts and transmission agreements, together with any other agreements
necessary to operate the station. Failure to comply with the prerequisites to
returning the Scherer station interest would trigger for MEAG, under certain

circumstances, the requirement to pay to Unicom an amount equal to the
diminution in the fair market sale value of the interest caused by MEAG's failure
to comply with the return conditions.
4.

Cashflows and Collateral Agreements

Unicom and MEAG chose to structure the cashflows for the Scherer and
Wansley transactions differently from those for the Spruce transaction. In part this
was so because of MEAG's limited authority to invest in securities.

- 58 Pursuant to the Scherer headlease, on June 9, 2000, Unicom paid the
Scherer headlease rent of $201,986,755 to MEAG.
On June 9, 2000, MEAG entered into the Government securities pledge
agreement (Scherer pledge agreement) with Ambac Credit Products, LLC (Ambac
Credit), and State Street, as agent and intermediary. Pursuant to the Scherer
pledge agreement, MEAG would pay from the Scherer headlease rent
$152,228,894 to State Street to purchase Government securities on the closing
date of the Scherer transaction. The pledge agreement required MEAG to pledge
these Government securities to Ambac Credit first and Unicom second to secure
MEAG's obligation under the Scherer sublease to make the Scherer base rent
payment on December 7, 2000.
State Street also paid Ambac Credit $1,544,674 on the closing date of the
Scherer 1 transaction on behalf of MEAG. In exchange, Ambac Credit agreed to
make certain payments on behalf of MEAG pursuant to a credit swap agreement
between Ambac Credit and UII (UII swap agreement). The payment also covered
the financial guaranty insurance policy issued by Ambac Assurance Corp., No.

SF0353BE, dated June 9, 2000 (Scherer FGIP).
Under the UII swap agreement, Ambac Credit was obligated to pay UII the
excess of the stipulated loss value over all payments UII received with respect to

- 59 the stipulated loss value or purchase option price from other sources, plus the early
termination amount. In exchange, UII would be required to surrender its right,

title, and interest under the Wansley transaction to Ambac Credit, the swap
provider.
Under the Scherer FGIP, Ambac Assurance Corp. unconditionally and
irrevocably guaranteed the payments by the swap provider under the UII swap
agreement. The payment obligation under the UII swap agreement is triggered by
the occurrence of any of several events, including MEAG's failure to pay the base
rent or the stipulated loss value, certain misrepresentations by MEAG, MEAG's
insolvency or bankruptcy, and MEAG's failure to perform or observe the
covenants and obligations under the Wansley transaction documents.
On June 9, 2000, MEAG entered into a credit swap agreement with Ambac
Credit (MEAG swap agreement). Ambac Credit paid MEAG $372,890, and
MEAG agreed to make the payments described in the MEAG swap agreement.
MEAG's payment obligations under the MEAG swap agreement are the same as
those described under the UII swap agreement. State Street paid $1,000,934 of
various transaction expenses on the closing date of the Scherer transaction on

behalf of MEAG.

- 60 On June 9, 2000, MEAG also transferred $47,576,143 to various collateral
accounts for investment in short-term collateralized flex repurchase agreements.
The collateral accounts served as collateral for MEAG's purchase option
obligation under the Scherer sublease.
The effect of the transactions discussed above was to set aside funds from
the Scherer headlease rent to fund MEAG's obligations to pay the Scherer rent and
the purchase option under the Scherer sublease.
5.

End of Sublease Term

Similarly to the Spruce transaction, at the end of the sublease term MEAG
or one of its cotenants in common could exercise the purchase option to regain all
the rights to the Scherer station. If that did not happen, Unicom could exercise its
rights under the operating agreement or service agreement option, or could choose
to purchase and sell its share of the Scherer output on the market.¹5
a.

MEAG's Purchase Option

At the end of the Scherer sublease term, September 9, 2030, MEAG has the
option of terminating the Scherer sublease and causing Unicom to terminate the
Scherer headlease for the price of $179,284,424 (Scherer purchase option). If

¹sAs discussed supra note 14, Unicom's authority to operate the Scherer
station was limited, so we do not consider it as a viable possibility in our analysis.

- 61 MEAG chooses not to exercise the Scherer purchase option, one or more of
MEAG's cotenants in common will then have the right to acquire Unicom's
interest in the Scherer station.¹6 To exercise the Scherer purchase option, MEAG
will have to give written notice to Unicom no later than January 15, 2029.
If neither MEAG nor its cotenants in common decide to exercise the Scherer
purchase option, MEAG will have to comply with all of the requirements for
returning the Scherer station interest to Unicom as described above.
b.

Unicom's Options
i.

Operating Agreement Option

Under the terms of the Scherer sublease, if neither MEAG nor its cotenants
exercise their purchase options, Unicom can exercise the operating agreement
option. This option will not be available to Unicom if, at the time of exercise,
MEAG is not an operator of the Scherer station under the agreements governing
MEAG's relationships with cotenants and management and operation of the
Scherer station.
If MEAG is an operator of the Scherer station, Unicom can then require
MEAG to arrange for a qualified third party to enter into an operating agreement
¹°Georgia Power Co., Oglethorpe Power Corp., and the City of Dalton all
had the right to exercise the purchase option for the undivided interest in the
Scherer station if MEAG chose not to.

- 62 with Unicom to operate the Scherer station. The electric output of the Scherer
station would be sold to third parties under power purchase agreements while the
station was operated and maintained on behalf of Unicom by the qualified
operator.
A qualified operator would, among other requirements, have, or have its
obligations guaranteed by a guarantor who has, a rating not lower than Aa2 by
Moody's and AA by S&P, or be deemed similarly creditworthy by Unicom and be
otherwise reasonably acceptable to Unicom. Failure by MEAG to implement its
obligations under the operation agreement option would lead to MEAG's default
under the Scherer sublease. Under certain circumstances, MEAG and its cotenants
would get another opportunity to exercise the purchase option. If they decided not
to do so, Unicom would have to use other remedies available to it under the
Scherer sublease.
ii.

Service Agreement Option

If MEAG or its cotenants chose not to exercise the purchase option and
MEAG was not an operator of the Scherer station at that time, the only option
available to Unicom would be to exercise its rights under the service agreement
option.

- 63 Under the service agreement option, Unicom could require MEAG to
arrange for the submission of one or more power purchase bids from "qualified
bidders" to enter into power purchase agreements with Unicom.
Similarly to the Spruce transaction, a qualified bidder would have to meet
certain creditworthiness requirements or have its obligations under the power
purchase agreement guaranteed by an entity with sufficient creditworthiness.
MEAG could itself submit a bid as a qualified bidder subject to meeting all the
qualified bidder requirements. The parties contemplated that a qualified bidder
would enter into a power purchase agreement and would purchase the electric
output from the Scherer station for the term of 8.69 years. On the basis of the
Deloitte appraisal, the parties believed that after the end of the power purchase
agreement term, the remaining economic useful life of the assets under the Scherer
headlease would be 10.6 years or 20.53% of the estimated overall useful life
remaining as of the closing date in 2000.
The requirements for the net power revenue under the power purchase
agreement to be received by Unicom were predetermined and set out as schedules
to the Scherer sublease. However, these payments were not guaranteed unless the
plant actually produced power in the required amounts and at certain efficiency
standards.

- 64 Unicom could reject any bids at its sole discretion. If MEAG failed to
provide Unicom with qualified bidders to enter into the power purchase agreement
or if Unicom rejected all such bids, that would constitute an event of default under
the agreement. Under certain circumstances, MEAG would have an additional
opportunity to exercise the purchase option. Otherwise, Unicom could use the
standard remedies available under the provisions governing events of default.
Similar to the Spruce sublease, if Unicom did not give notice as to which
option it elected, it would be deemed to have elected to exercise both the operating
agreement and the service agreement options if both options are available.
MEAG's failure to implement its obligations under both options would constitute
its default under the sublease, which would result in either another chance to
exercise the purchase option or Unicom's entitlement to other contractual
remedies.
C.

Key Terms of the Wansley Transaction

Power Plant Wansley (Wansley station), on a 5,225-acre site near
Carrollton, Georgia, included two conventional power generation units, as well as
a 320-acre ash disposal pond, a 126-acre potable water pond, a 40-acre coal
storage yard, a 15-acre 500-kilovolt substation, and a 606-acre service water pond
that provides cooling water for the plant. At the time of the transaction in 2000,

- 65 Wansley station comprised two self-contained 865 MW coal-fired units. Units 1
and 2 are conventional coal-fired units equipped with a single boiler and turbine
generator, commissioned in 1982 and 1984, respectively. The leased property did
not include the coal stockpile, inventories, intangibles, and unit trains owned by
MEAG at the sites.
1.

Lease and Sublease
a.

Headlease

On June 9, 2000, MEAG entered into the Wansley transaction with Unicom
(through Wansley Holdings 1, LLC and UII) involving an undivided interest in
Plant Hal Wansley Units 1 and 2 (together, Wansley station), as well as certain
common facilities. In the Wansley transaction, MEAG leased a 10%
undivided interest in the Wansley station¹7 to Unicom through its wholly owned
subsidiaries for a term of 56.75 years (Wansley headlease). Deloitte appraised the
undivided interest in the Wansley station as of the closing date of June 9, 2000, at
$172 million. Deloitte determined that the Wansley headlease term of 56.75 years
exceeds the Wansley station's estimated remaining useful life of 45 years.

¹7For the sake of clarity, references in this Opinion to the lease or sublease
of the Wansley station are to be understood as referring to a lease or sublease of
the 10% undivided interest in the Wansley station.

- 66 On June 9, 2000, under the Wansley headlease, Unicom paid $172,185,430
to MEAG for the lease of the Wansley station (Wansley headlease rent).
According to Deloitte, the Wansley headlease rent was approximately equal to the
estimated fair market value of the Wansley station on June 9, 2000. The appraised
fair market value served as the basis for determining Unicom's investment in the
transactions, and the parties did not further negotiate the investment amount.
Deloitte estimated that as of the end of the sublease the fair market value of the
Wansley station would be about $485 million if based on the discounted cashflow
approach and $481 million if based on the cost approach.¹8
b.

Sublease

On June 9, 2000, MEAG and Unicom, through Wansley Holdings 1, LLC,
entered into the sublease agreement, whereby MEAG leased the Wansley Station
back (Wansley sublease) from Unicom for a term of 27.75 years. MEAG leased
back from Unicom all of Unicom's rights, title, and interest in the Wansley station.
The Wansley sublease was scheduled to terminate on March 9, 2028. Under the
terms of the Wansley sublease, MEAG was obligated to pay rent to Unicom of

¹8The Wansley appraisal prepared by Deloitte did not allocate the values
between Wansley 1 and 2.

- 67 $134,087,903, on December 7, 2000, six months after the closing of the Wansley
transaction (Wansley base rent).
The Wansley sublease was a net lease, similar to the Spruce and Scherer
subleases. MEAG was responsible for all costs and expenses associated with the
Wansley station throughout the sublease. In addition, MEAG had to maintain
property and liability insurance on the Wansley station meeting the requirements
set out in the sublease.
2.

Default

Provisions governing events of default and events of loss are substantially
the same in the Wansley and Scherer transactions. The Wansley sublease outlines
different operating standards that the station must meet if it is returned to Unicom

in an event of default, but other conditions are either very similar or the same.
3.

Property Rights

The property rights of Unicom and MEAG under the Wansley transaction
are substantially identical to those in the Scherer transaction and need not be
separately stated here.
4.

Cashflows and Collateral Agreements

MEAG and Unicom used the same structure of cashflows and collateral
agreements for the Wansley transaction as for the Scherer transaction.

- 68 Pursuant to the Wansley headlease, on June 9, 2000, Unicom paid the
Wansley headlease rent of $172,185,430 to MEAG.
On June 9, 2000, MEAG entered into the Government securities pledge
agreement with Ambac Credit and State Street as agent and intermediary. MEAG
paid State Street $129,768,893 from the Wansley headlease rent to purchase
Government securities on that same date. MEAG pledged the Government
securities to Ambac Credit and Unicom to secure MEAG's obligation to pay the
base rent under the Wansley sublease on December 7, 2000. It was projected that
the Government securities would equal the Wansley base rent of $134,087,903.
On June 9, 2000, MEAG provided UII with the UII swap agreement and the
financial guaranty insurance policy issued by Ambac Assurance Corp., No.
SF0356BE, dated June 9, 2000 (Wansley FGIP). On the same date, State Street,
on behalf of MEAG, paid Ambac Credit $1,200,317.76, in consideration of
Ambac Credit's agreement to make the payments described in the UII swap
agreement and in the Wansley FGIP. The obligations of the parties are the same
as under the UII swap agreement and the Wansley FGIP in the Scherer transaction.
On June 9, 2000, MEAG entered into the MEAG swap agreement with
Ambac Credit, and Ambac Credit paid MEAG $287,226 in consideration of
MEAG's agreement to make the payments described in the credit swap between

- 69 MEAG and Ambac Credit. MEAG's payment obligations under the MEAG swap
agreement are the same as those described under the UII swap agreement. On
behalf of MEAG, State Street Bank also paid $860,927 of transaction expenses on
the closing date.
Also on the closing date, MEAG transferred $40,642,518 to collateral
accounts for investment in short term collateralized flex repurchase agreements, as
collateral for the purchase option, with a pledge first to Ambac Credit and second

to UII.
5.

End of Sublease Term

The end of sublease term options for Unicom and MEAG regarding the
Wansley station are substantially the same as those in the Scherer transaction.
MEAG and Georgia Power Co. could exercise the purchase option at the end of
the Wansley sublease. The purchase option price was set at $143,543,915. If they
chose not to do so, Unicom would be able to proceed with the operating agreement
and service agreement options, similar to the provisions in the Scherer
transactions. Alternatively, Unicom could get its share of the Wansley station
output and sell it on the market.

Under the service agreement option, the electric output from the Wansley
station would be purchased by third parties for the term of 8.09 years, and after the

- 70 end of the power purchase agreement term the parties projected the remaining
economic useful life of the Wansley station to be 9.17 years, or 20.38% of the
estimated overall useful life remaining as of the closing date in 2000.

D.

MEAG's Net Present Value Benefit

MEAG was entitled to receive a payment of approximately $110 million for
its participation in the Scherer and Wansley transactions (MEAG NPV benefit).
Mr. Fuller informed MEAG's board of directors in June 2000 that the MEAG
NPV benefit for entering into the transactions would be approximately 11.19% of
the value of each lease in the Wansley station and 12.34% of the value of each
lease in the Scherer station. MEAG placed the NPV benefit into a trust account
with State Street until 2014, at which time MEAG was expected to transfer the
funds to the municipal competitive trust. MEAG's rights to use the NPV benefit
until then were limited under the corresponding agreements because the trust
account was pledged to lower the cost of insurance of the transactions and to
secure the payment of early termination fees.
Post-Closing Events
I.

Construction of Spruce II
At the time that CPS built the Spruce station, CPS had also intended to

build, on an unspecified future date, a second generating plant (Spruce II) on the

- 71 same site as the Spruce station. The Spruce transaction documents reflected the
existence of such plans but in terms that did not convey absolute certainty.
On June 16, 2004, CPS informed Unicom in writing of CPS' intention to

exercise its right to install and use additional facilities on the site of the Spruce
station. CPS intended for this expansion--Spruce II--to share facilities with the
Spruce station, such as a "control room", a "computer room", "coal conveyers", a
"demineralizer", a "limestone silo ball mill", and a "limestone slurry storage tank".
Although CPS would also build other operational facilities strictly for the benefit
of Spruce II's operations, those facilities would be situated on the same land
occupied by the Spruce station.
The letter dated June 16, 2004, from CPS requested prior written approval
of the Spruce II construction from Unicom under the terms of the Spruce
headlease. In evaluating CPS' request, Thomas Miller, Exelon's vice president of
finance, and Randy Specht, from petitioner's engineering group, visited the Spruce
site on December 17, 2004. Messrs. Miller and Specht met with CPS' plant
personnel and toured the facility. In addition to the tour, Mr. Miller requested
written representations from CPS that the Spruce II station would not interfere
with or harm petitioner's interest in the Spruce station. CPS provided such written
representations. Exelon, which at the time became a successor to Unicom by

- 72 virtue of merger, then executed an approval authorizing the construction of the
Spruce II plant. Exelon did not visit the site after the Spruce II project was
completed in 2010 to examine the outcome.
II.

Registration of the Test Transactions as Corporate Tax Shelters
On or about April 5, 2000, before the closing of the test transactions,

Winston & Strawn circulated the initial draft of a designation agreement whereby
PwC as designated organizer agreed to register the Spruce, Scherer, and Wansley
transactions as tax shelters with the IRS in accordance with section 6011 and
applicable regulations. On May 2, 2000, PwC informed the parties involved in the
test transactions that the transactions would be registered as confidential corporate
tax shelters pursuant to section 6111(d) and applicable regulations and provided
the parties with the proposed designation agreement which, upon execution, would
appoint PwC as a designated organizer. On or about June 9, 2000, PwC and the
other parties involved in the Scherer, Wansley, and Spruce transactions entered
into a designation agreement for registration of confidential tax shelters under
section 6111(d).
On or about June 1, 2000, PwC filed with the IRS in Kansas City, Missouri,
Form 8264, Application for Registration of a Tax Shelter (Confidential Corporate

- 73 Tax Shelter), for the Spruce transaction. On June 16, 2000, the IRS assigned tax
shelter registration No. 00167000008 to the Spruce transaction.

On or about July 13, 2000, PwC filed a supplemental Form 8264 with the
IRS in Kansas City, Missouri, for the Spruce, Scherer, and Wansley transactions.
On July 18, 2000, the IRS issued tax shelter registration No. 00167000008 for the
Scherer and Wansley transactions.
Unicom's tax return for its 1999 tax year included an appropriate disclosure
statement under the then-effective regulations for a reportable transaction for UII
on account of the test transactions. It also properly disclosed tax shelter
registration No. 00167000008 on Form 8271, Investor Reporting of Tax Shelter
Registration Number, issued by the IRS in connection with the Spruce, Scherer,
and Wansley transactions. PwC monitored the status of the tax shelter
registrations, including the registration No. 00167000008, for Unicom/UII and the
Spruce, Scherer and Wansley transactions.

III.

MEAG Collateral Substitution
Enhancements in the Scherer and Wansley transactions were structured

differently from those in the Spruce transaction. CPS and Unicom used a CPUA
as credit enhancement to secure the sublease obligations and provide the funds for
the cancellation option exercise to CPS at the end of the sublease. In the Scherer

- 74 and Wansley transactions, MEAG and Unicom used credit swap contracts issued
by Ambac Credit to secure the payment of the purchase option exercise price.
Under the swap contracts, MEAG would pledge high-quality securities primarily
to Ambac Credit and secondarily to UII to pay the termination fees under the
subleases or purchase option price. MEAG detennined how it wanted to invest the
money, with the ultimate goal to have sufficient funds to pay the purchase option
price at the end of the Scherer and Wansley subleases.
Initially MEAG decided to invest the funds in short-term repurchase
agreements, Federal agency discount notes, and a managed portfolio with
Government-backed agency and Treasury securities. These short-term
investments were rolled over and reinvested as they came due. Any ongoing
investment risk, such as changes in interest rates over time, was borne entirely by

MEAG.
In 2001 MEAG first suggested changing its investment portfolio by
investing either in adjustable rate mortgage securities guaranteed by a Federal
agency or Government-sponsored enterprise or in short-term money market funds
rated AAA. Exelon agreed to the substitution. The securities continued to be
pledged to Ambac Credit and Exelon.

- 75 Because the early 2000s ended up being a period of low interest rates, the
funds invested by MEAG grew at a rate insufficient to fully fund the future
purchase options. In 2006 MEAG proposed another substitution to Exelon,
whereby MEAG would replace the existing collateral with a pledge of MEAG's
own newly issued bonds insured by Ambac Credit. In August 2006 Exelon agreed
to MEAG's request. This allowed MEAG to receive the funds it needed for
environmental compliance and certain operational needs. Overall, MEAG
replaced $173 million worth of collateral securities with its own bonds. MEAG
also pledged an extra $81,171,330 of securities to Ambac Credit in 2007. In
essence, MEAG remained obligated under the sublease agreements, and the bonds
securing those sublease obligations were just another form of MEAG payment
obligation.
When Ambac Credit's credit rating declined, MEAG contacted Exelon and
received a waiver of the requirement that the bond insurance company maintain a
certain credit level.
IV.

Postclosing Monitoring
After the closing dates of the Spruce, Wansley, and Scherer transactions, the

lessees were required to provide Unicom with certain financial and operational
information. For example, CPS contacted petitioner regarding the impact of

- 76 higher property insurance rates following the September 11, 2001, attacks. In
addition, as discussed above, Unicom consented to the construction of Spruce II
and the MEAG collateral substitution.
In 2008 employees from Exelon's corporate finance and asset management
groups inspected the Spruce, Wansley, and Scherer stations as part of a
"compliance review" to ensure that the facilities were being operated and
maintained properly. Before the on-site inspections, Exelon's employees reviewed
various operating and financial performance indicators and data, and also
requested applicable documents for the leased stations from CPS and MEAG. The
review did not raise any red flags. Exelon did not conduct compliance reviews in
any other years even though it had the right to visit the sites and request related
documents each year.
V.

Early Termination of the Spruce Transaction
Pursuant to an omnibus termination agreement, on or about February 26,

2014, CPS and Exelon terminated the Spruce transaction. Upon termination of the

Spruce transaction, Exelon received $335 million in exchange for terminating its
interests in the Spruce station. Possession of the Spruce station passed to CPS,
free and clear of any claims or liens by Exelon.

- 77 Tax Returns, Notices of Deficiencies, Trial
I.

Tax Returns

A.

1999 Tax Year

Unicom timely filed the Unicom Group's consolidated Federal income tax
return for the 1999 tax year. On or about April 1, 2004, Exelon, as successor to
Unicom, filed Form 1120X, Amended U.S. Corporation Income Tax Return, for

the Unicom Group's 1999 tax year. On or about August 25, 2004, Exelon filed a
second amended tax return for the Unicom Group's 1999 tax year. On or about
January 9, 2007, Exelon filed a third amended tax return for the Unicom Group's
1999 tax year.
On its 1999 income tax return, Unicom had indicated taxable income of

$2,484,829,531 and filed Form 8824, Like-Kind Exchanges, describing the
transactions at issue here. Unicom had not included in income deferred section
1031 gain of $1,231,927,407 arising out of the test transactions.

B.

2001 Tax Year

On or about September 26, 2002, Exelon, as successor to Unicom, filed its
consolidated Federal income tax return for the 2001 tax year. On or about April 1,
2004, Exelon filed an amended tax return for its 2001 tax year. On or about
January 30, 2007, Exelon filed a second amended tax return for the 2001 tax year.

- 78 On its 2001 income tax return, Exelon reported taxable income of
$1,412,586,105. With respect to the transaction with CPS, Exelon had claimed a
depreciation deduction of $2,968,648 an interest expense deduction of
$38,261,289, and an amortized transaction costs deduction of $183,708. Exelon
reported $40,476,248 of taxable rental income. Exelon had not reported taxable
original issue discount income with respect to the transaction (which respondent
determined claims to be $5,939,981 for the 2001 tax year).
With respect to the transactions with MEAG, Exelon had claimed a
depreciation deduction of $5,447,849 an interest expense deduction of
$46,547,887, and an amortized transaction costs deduction of $231,814. Exelon
reported $50,370,556 of taxable rental income. Exelon had not reported taxable
original issue discount income with respect to the transaction (which respondent
determined claims to be $7,078,805 for the 2001 tax year).
II.

Notices of Deficiency

A.

1999 Tax Year

On September 30, 2013, respondent timely issued a statutory notice of
deficiency to petitioner for its income tax liabilities for the tax year ending
December 31, 1999 (1999 notice of deficiency). Respondent determined a

- 79 deficiency in tax for 1999 of $431,174,592 and a penalty under section 6662(a) of

$86,234,918.
Respondent disallowed petitioner's treatment of the transactions with CPS
and MEAG as section 1031 like-kind exchanges. The 1999 notice of deficiency

stated that deferred section 1031 gain of $1,231,927,407 should be included in
income for tax year 1999, because petitioner "did not acquire and retain significant
and genuine attributes of a traditional owner, including the benefits and burdens of
ownership, of the Replacement Property."
The 1999 notice of deficiency determined a section 6662 accuracy-related
penalty of 20% on the grounds of negligence or disregard of rules and regulations,
or a substantial understatement of income tax.

B.

2001 Tax Year

On September 30, 2013, respondent timely issued a separate statutory notice
of deficiency to petitioner for its income tax liability for the tax year ending
December 31, 2001 (2001 notice of deficiency). Respondent determined a
deficiency in tax for 2001 of $5,534,611 and a penalty under section 6662(a) of

$1,106,922.
The 2001 notice of deficiency disallowed depreciation deductions of

$2,968,648 and $5,447,849 claimed by Exelon for the CPS and MEAG sale-

- 80 leaseback transactions, respectively, because "the taxpayer failed to acquire and
retain significant and genuine attributes of a traditional owner, including the
benefits and burdens of ownership". Respondent disallowed interest expense
deductions of $38,261,289 and $46,547,887, and amortized transaction costs
deductions of $183,708 and $231,814, for the CPS and MEAG transactions,
respectively. Respondent determined that because the transactions with CPS and
MEAG were in substance loans, petitioner should have reported original issue
discount (OID) income of $5,939,981 and $7,078,805 resulting from the deemed
loans to CPS and MEAG, respectively. Furthermore, according to respondent,
because petitioner did not acquire ownership interests in the CPS and MEAG
transactions, it was not required to report rental income of $40,476,248 and
$50,370,556, respectively, from the subleases in 2001.
In the alternative, respondent determined that sale-leaseback transactions
with CPS and MEAG lack economic substance and should be disregarded for
Federal income tax purposes. Accordingly, respondent disallowed petitioner's
deductions of depreciation, interest expense, and transaction costs, and reversed
rental income.

- 81 The 2001 notice of deficiency imposed a 20% accuracy-related penalty
under section 6662 on the grounds of "negligence or disregard of rules and
regulations regarding * * * [petitioner's] tax treatment of the SILO transactions."
In the alternative, respondent determined the section 6662 penalty for 2001
for a substantial understatement of income tax attributable to a tax shelter item of a
corporation. Respondent conceded the issue of a substantial understatement of
income tax under section 6662(a) and (b)(2) for 2001 before trial, so we need not
in this Opinion address this ground for imposition of the section 6662 penalty for

2001.
III.

Trial
Exelon timely filed petitions in both cases on December 13, 2013. The

Court held a three-week special trial session in Chicago, Illinois. During the trial,
the parties presented the testimony of 16 fact witnesses and 10 expert witnesses.
Both parties rely heavily on expert opinions to support their arguments. The
parties' expert witnesses, their qualifications, and their Court-recognized areas of
expertise are listed below. We also briefly summarize the conclusions of the
experts in their respective expert reports.

- 82 A.

Petitioner's Expert Witnesses
1.

Stewart Myers

The Court recognized Stewart Myers as an expert in finance, valuation, and
investments in the energy industry, as well as analysis of complex financial
transactions including leases and real options. Prof. Myers has a Ph.D. in finance
and economics from Stanford, and he is the Robert C. Merton professor of
financial economics at the MIT Sloan School of Management, where
he has taught since 1966.
Prof. Myers' graduate-level textbook, Principles of Corporate Finance (with
Professors Richard Brealey and Franklin Allen) is a highly regarded treatise. He
has also published dozens of articles on corporate finance and financial
economics. He was also a director for Entergy Corp., a large public utility and
merchant power generator based in New Orleans, Louisiana, that also has
generating plants in the eastern and northeastern United States.
In his expert report Prof. Myers discussed the primary factors that affect the
decisions of the parties involved in the test transactions to exercise their respective
options. Prof. Myers testified that, while both MEAG and CPS do not pay income
tax, their tax-exempt status does not affect their valuation of the leased stations.

- 83 Prof. Myers also testified that the accepted financial practice always makes
decisions based on after-tax cashflows and rates of return.
Prof. Myers conducted sensitivity analysis involving several variables such
as inflation and electricity price to determine the range of future market values of
residual interests in the Spruce, Scherer, and Wansley stations and to see how it
would affect the decisions of CPS and MEAG to exercise their
cancellation/purchase options at the end of the sublease terms. He concluded that
both CPS and MEAG would return their respective interests in the subleased
stations to Exelon if the values of these interests at the end of the sublease terms
were less than the purchase option prices. This would also cover the "base"
scenario outlined in the Deloitte appraisal.
We find Prof. Myers' sensitivity analysis helpful because it illustrates that
even a difference of 1%-2% in the inflation rate would dramatically change the
future market value of an interest over a 30-year term. For example, in the case of
the Spruce station, a 4% inflation rate--1.5% higher than the rate assumed by
Deloitte--would result in the future market value of the plant of $971.1 million,
almost $250 million above the exercise price of $723.2 million for the cancellation
option and almost $350 above the fair market value projected by the Deloitte
appraisal. Conversely, a 1% inflation rate--l.5% lower than the rate assumed by

- 84 Deloitte--would result in the future market value of the plant of $394.2 million,
almost $330 million less than the cancellation option exercise price and over $200
million less than the fair market value projected by the Deloitte appraisal.
2.

John Reed

The Court recognized John J. Reed as an expert in transactions involving
energy, industry firms and assets, energy market economic analyses, and
evaluation and financial analysis related to the energy industry. Mr. Reed is a
graduate of the Wharton School of the University of Pennsylvania, where he
received a bachelor of science degree in finance.
Mr. Reed is currently the chairman and CEO of Concentric Energy
Advisors, Inc., a financial advisory and management consulting firm for energy
industry firms. Mr. Reed has over thirty-five years of experience in the energy
industry, including as an executive in energy consulting firms and as chief
economist for Southern California Gas Co., the largest U.S. gas utility. He has
also been involved in the purchase, sale, and valuation of energy-related assets,
including the sales of over 50 fossil fuel power generating facilities.
In his expert report Mr. Reed concluded that, at the time Unicom, CPS, and
MEAG entered into the test transactions, a significant uncertainty existed with
respect to the future value of the Scherer, Spruce, and Wansley stations. Mr. Reed

- 85 concluded that CPS' and MEAG's tax-exempt status would not influence their
analysis of the future market value of the plants.
3.

Karl A. McDermott

The Court recognized Karl A. McDermott as an expert in regulatory
economics, the history of regulation, and capital investment decisionmaking in the
power utility industry in the United States. Prof. McDermott has a Ph.D. in
economics from the University of Illinois at Urbana-Champaign and serves as the
Ameren distinguished professor of business and government at the University of
Illinois Springfield. He has served as a lecturer and teacher for 36 years on topics
regarding public utilities, banking, energy market regulation, gas wholesale
markets, and macroeconomics. He has also published articles on the energy
industry, the ICC, and energy market regulation. Prof. McDermott served as a
commissioner for the ICC from 1992 to 1998, during the period when Illinois
deregulated its energy market.
Prof. McDermott provided the Court with a primer on the U.S. energy
market that also covered the periods both before and after many States (including
Illinois) deregulated. In his expert report Prof. McDermott concluded that
Unicom's investment in leases with CPS and MEAG allowed it to achieve the
same risk and reward profile it had had before the deregulation of generation

- 86 assets in Illinois. Prof. McDermott stated that bankruptcy of CPS or MEAG was a
relatively low probability although such bankruptcies had occurred in other
jurisdictions.
4.

Stuart Gilson

The Court recognized Stuart Gilson as an expert in the financial
consequences of bankruptcy, including decisionmaking and financial
consequences relating to bankruptcy proceedings. Prof. Gilson has a Ph.D. in
finance from the University of Rochester and is a tenured professor in the Finance
Department of Harvard Business School. His academic and consulting
experiences focus on corporate finance, business valuation, credit analysis, and
corporate restructuring and bankruptcy; and he has written several articles and
case studies on those subjects.
In his expert report Prof. Gilson concluded that Unicom faced a risk of loss

arising from a CPS or MEAG bankruptcy.¹9 In the event of a CPS or MEAG
bankruptcy, section 502(b)(6) of the Bankruptcy Code could limit the recovery
available to Unicom to rent for the greater of one year or 15%, not to exceed three

¹°Prof. Gilson assumed that Georgia bankruptcy law would be changed to
allow municipalities to take advantage of chapter 9 of the Bankruptcy Code.
Alternatively, Prof. Gilson assumed that MEAG could have filed for protection
under chapter 11 of the Bankruptcy Code if the bankruptcy court had determined
that MEAG did not qualify as a municipality.

- 87 years, of the remaining term of the sublease. In his analysis Prof. Gilson did not
consider various credit enhancements and contractual provisions available to
Unicom in the case of a CPS or MEAG bankruptcy. Prof. Gilson concluded that
the net financial impact on Unicom of an early sublease rejection would depend on
the fair market value of the facility at the time of rejection. At low fair market
value, Unicom could experience a loss at sublease rejection, but with the fair
market value increase the net financial impact on Unicom would become
increasingly positive.
5.

Mark E. Zmijewski

The Court recognized Mark E. Zmijewski as an expert in the field of
accounting, and particularly accounting for financial analysis of leases. Prof.
Zmijewski is the Leon Carroll Marshall professor of accounting at the University
of Chicago Booth School of Business, where he has served on the faculty since
1984. Prof. Zmijewski has an M.B.A. in accounting and a Ph.D. in accounting
from the State University of New York at Buffalo. Prof. Zmijewski teaches
courses in valuation, mergers and acquisitions, financial analysis, accounting, and
entrepreneurship. He has also published articles on accounting, discounted
cashflow valuations, and securities regulation.

- 88 In his expert report Prof. Zmijewski concluded that the test transactions
were structured as direct financing leases rather than SILOs. Prof. Zmijewski also
concluded that the test transactions are not front loaded under any of the options
available in the lease and are not tax driven.
6.

Ingrid Sarapuu

The Court recognized Ingrid Sarapuu as an expert in lease financing,
leasing, and asset financing. Ms. Sarapuu has an M.B.A. from the University of
Chicago Booth School of Business. She has been a licensed securities principal
with Series 7, 24, 63, and 79 certifications. She also has over 30 years of
executive experience in leveraged leasing and corporate finance in the private
sector. In her expert report Ms. Sarapuu concluded that the test transactions are
consistent with traditional leasing structures. Ms. Sarapuu also opined that
Unicom engaged and appropriately employed various specialists and advisers to
complete the test transactions.
7.

Nancy Heller Hughes

The Court recognized Nancy Heller Hughes as an expert in the valuation of
power facilities. Ms. Hughes has an M.B.A. in finance and accounting from the
University of Chicago Booth School of Business. She is also an accredited senior
appraiser in the public utility discipline (as certified by the American Society of

- 89 Appraisers) and a certified depreciation professional (as certified by the American
Society of Appraisers). She has also performed many appraisal and depreciation
studies for businesses in the energy industry.
Ms. Hughes opined in her expert report that the Deloitte appraisals of
Spruce, Scherer, and Wansley used an appropriate process for the purpose of
producing credible appraisal reports under the Uniform Standards of Professional
Appraisal Practice (USPAP). Ms. Hughes concluded that Deloitte's conclusions
were appropriate, supported in its appraisal reports, and prepared in accordance
with generally accepted appraisal procedures. Ms. Hughes did not offer an
opinion of what the fair market value of the Spruce, Scherer, and Wansley stations
would be at various stages of the test transactions.
B.

Respondent's Expert Witnesses
1.

Douglas J. Skinner

The Court recognized Douglas J. Skinner as an expert in accounting and
financial econo

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A9285ca607bd8bb9c. Public record. Not legal advice.