Appendix — Frank Lyon Co. v. United States
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Supreme Court of the United States
OcToBeR TERM, 1976
No. 76-624
Frank Lyon Company, Appellant,
v.
Unitep States or AMERICA, Appellee.
ON PETITION FOR CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE EIGHTH CIRCUIT
VOLUME I
(Pages 1-312)
PETITION FOR WRIT OF CERTIORARI FILED NOVEMBER 3, 1976
CERTIORARI GRANTED FEBRUARY 22, 1977
IN THE
Supreme Court of the United States
Octoser Term, 1976
No. 76-624
Frank Lyon Company, Appellants
Ve
Unirep States or America, Appellee
Petition for Writ of Certiorari Filed November 3, 1976
Certiorari Granted February 22, 1977
INDEX
Page
Compiaint, filed September 27, 1973 ................ 6
Answers, filed November 26, 1973 ...............5.. 8
Stipulation, filed September 16, 1974 ................ 9
Supplemental Stipulation, filed December 23, 1974 ... 14
Transcript of Proceedings, November 26, 1974 ...... 17
Supplementary Findings of Fact and Conclusions of
Re, es a ED gn cccsccvceceesesocsce 299
Proposed Findings of Fact and Conclusions of Law... 301
Judgment, filed June 11, 1975 ........... 0.0000 ees 311
Notice of Appeal, filed August 11, 1975
il Index Continued
Page
Plaintiffs’ Exhibit 1: Letter dated August 26, 1967
from Kdward M. Penick, President of Worthen
Bank & Trust Company to 0. O. Wyrick, Vice
President of Federal Reserve Bank of St. Louis.. 313
Plaintiffs’ Exhibit 2: Letter dated September 1, 1967
from Edward M. Penick to O. O. Wyrick ........ 322
Plaintiffs’ Exhibit 3: Letter dated September 12, 1967
from Edward M. Penick to 0. O. Wyrick ........ 324
Plaintiffs’ Exhibit 4: Letter dated September 13, 1967
from O. O. Wyrick to Edward M,. Penick ........ 326
Plaintiffs’ Exhibit 5: Letter dated September 1, 1967
from Edward M. Penick to H. C. Adams, Commis-
sioner of State Bank Department .............. 328
Plaintiffs’ Exhibit 6: Letter dated September 5, 1967
from H. C. Adams to Edward M. Penick ........ 236
Plaintiffs’ Exhibit 7: Letter dated September 12, 1967
from Edward M. Penick to H. C. Adams ........ 338
Plaintiffs’ Exhibit 8: Letter dated September 13, 1967
from H. C. Adams to Edward M. Penick ........ 339
Plaintiffs’ Exhibit 9: Sale and Leaseback proposal
dated September 28, 1967 to Goldman, Sachs & Co. 340
Plaintiffs’ Exhibit 10: Revised Sale and Leaseback
proposal dated October 27, 1967 of Stephens, Inc. 344
Plaintiffs’ Exhibit 11: Letter dated October 30, 1967
from Frank Lyon to Worthen ................0. 346
Plaintiffs’ Exhibit 12; Comparison of financing plans
of Frank Lyon, Stephens, Ine. and Goldman,
Bache & Oe. ..0sc0c0e0encs eeu su ueeeeeee 348
Plaintiffs’ Exhibit 13: Specification for Sale-Lease-
—_ of Worthen Bank Building dated October 31,
ao
Plaintiffs’ Exhibit 14: Letter dated November 1, 1967
from Frank Lyon to Worthen containing Lyon’s
proposal numer Bo. .o0sccsceeeusens eee 352
Plaintiffs’ Exhibit 15: Comparison of financing plans
Gated November & 2660 2... sccccscccencbun 355
Index Continued ili
Page
Plaintiffs’ Exhibit 16: Letter dated Noevinber 30, 1967
from Alan W. Peters, Vice President of First Na- _
tional City Bank to Edward M. Penick .......-- 356
Plaintiffs’ Exhibit 17: Letter dated December 18, 1967
from Richard W. Baker, Jr., Vice President of
New York Life Insurance Company to Frank _
Lyon Company .......--.eeeeeeeeeeeeeerreeees 358
Plaintiffs’ Exhibit 18: Ground Lease dated May 1,
1968 between Worthen Bank & Trust Company, as
Lessor, and Frank Lyon Company, as Lessee.... 366
Plaintiffs’ Exhibit 19: Building Lease dated May 1,
1968 between Frank Lyon Company, as Lessor, _
and Worthen Bank & Trust Company, as Lessee. 376
Plaintiffs’ Exhibit 20: Note Purchase Agreement dated
May 1, 1968 between Frank Lyon Company and
New York Life Insurance Company ........---- 443
Plaintiffs’ Exhibit 21: Building Loan Agreement dated
May 14, 1968 between Frank Lyon Company and -
First National City Bank ........-..5-00seeees 462
Plaintiffs’ Exhibit 22: Building Loan Mortgage Note
for $7,000,000 dated — 14, 1968 from Frank
Lyon Company to First National City Bank .... 488
Plaintiffs’ Exhibit 23: Building Loan Mortgage dated
May 14, 1968 from Frank Lyon Company and
Worthen Bank & Trust Company to First Na-
tional City Bank ..........65-- ccc ceeeeeeeeeees 490
Plaintiffs’ Exhibit 24: Assignment dated May 14, 1968
from Frank Lyon Company to First National City
en acc eee ees ccrccececccoces 503
Plaintiffs’ Exhibit 25: Sales Agreement dated May 19,
1968 between Frank Lyon Company, as purchaser, :
and Worthen Bank & Trust Company, as seller .. 508
Plaintiffs’ Exhibit 26: Secured Note dated December
1, 1969 for $7,140,000 from Frank Lyon Company
to New York Life Insurance Company ......... 523
iv Index Continued
Page
Plaintiffs’ Exhibit 27: First Deed of Trust dated De-
cember 1, 1969 from Frank Lyon Company and
Worthen Bank & Trust Company to Darrell D.
Dover and New York Life Insurance Company... 527
Plaintiffs’ Exhibit 28: Assignment dated December 1,
1969 from Frank Lyon Company to New York Life
Insurance Company
Plaintiffs’ Exhibit 29: Consent and Agreement dated
December 1, 1969 of Worthen Bank & Trust Com-
pany to New York Life Insurance Company .... 575
Plaintiffs’ Exhibit 32: Specimen bank statement of
Frank Lyon’s account at First National City Bank
with specimen checks and credit ticket attached.. 584
Plaintiffs’ Exhibit 33: Comparative consolidated bal-
ance sheets of Frank Lyon Company and subsidi-
aries as of December 31, 1969 and 1968 ......... 587
Plaintiffs’ Exhibit 34: Comparative consolidated state-
ment of income years ended December 31, 1969
and 1968 of Frank Lyon Company and sub-
I ts RES 589
Plaintiffs’ Exhibit 35: Guaranty dated May 14, 1968
from Edward M. Penick, President of Worthen
Bank & Trust Company to First National City
ee OF OE TE acc dcceseseusetéctcicee 591
Plaintiffs’ Exhibit 36: Computation of tax loss on
Worthen Building of Frank Lyon Company for
years 1969 through 1993; years 2007 through 2019
and years 2033 through 2044 .................. 595
Plaintiffs’ Exhibit 37: Letter dated August 22, 1967
from O. O. Wyrick, Vice President of Federal
Reserve Bank of St. Louis to Edward M. Penick,
President of Worthen Bank and Trust Company
of Little Rock, Arkansas ...................... 597
Plaintiffs’ Exhibit 38: Summary of Conservation with
Mr. O. O. Wyrick dated September 6, 1967 ....... 599
Plaintiffs’ Exhibit 39: Letter dated September 20,
1967 from Mr. Theodore M. Siouris, A General]
Partner to E. M. Penick, President of Worthen
Bank & Trust Company in reference to Sale-
Leaseback Financing of New Bank Headquarters 601
Index Continued v
Page
Plaintiffs’ Exhibit 40: Letter dated April 16, 1968
from Edward Penick, President of Worthen Bank
and Trust Company to Mr. H. C. Adams, State
Bank Commissioner, Little Rock, Arkansas ...... 609
Plaintiffs’ Exhibit 41: Letter dated April 16, 1968
— Edward Penick, President of Worthen Bank
and Trust Company to Mr. O. O. Wyrick, Vice
President of Federal Reserve Bank of St. Louis.. 613
Plaintiffs’ Exhibit 42: Letter dated April 19, 1968
oo O. O. Wyrick, Vice President of Federal Re-
serve Bank of St. Louis to Mr. Edward M. Penick,
President, Worthen Bank and Trust Company... 618
Plaintiffs’ Exhibit 43: Letter dated April 22, 1968
from James Penick, Jr., Executive Vice President
of Worthen Bank and Trust Company to Mr. O. O.
Wyrick, Vice President, Federal Reserve Bank of
ME, BOD cccccccccsecccccceescessccesenasaces 620
Plaintiffs’ Exhibit 44: Letter dated April 23, 1968
from ©. 0. Wyrick, Viee President, Federal Re-
serve Bank of St. Louis to Mr. James Penick, Jr.,
Executive Vice President, Worthen Bank & Trust
COUMGET cc cccccccccccccccssccecece jeabewenes 622
Plaintiffs’ Exhibit 45: Comparison of annual rent with
total of depreciation and interest for first 10 years
of Worthen Bank Building ..................-. 623
Plaintiffs’ Exhibit 46: Worthen Bank & Trust Co.
"Rent Schedule on Worthen Building 1944 ...... 624
Plaintiffs’ Exhibit 47: Safeway Lease .............. 625
Plaintiffs’ Exhibit 48: Inter-office communication dated
May 13, 1969 from B. H. Dean, Jr. to James A.
Rowland for Mr. W. H. Dodge regarding Safe-
WEG TABI cc ccccccvcccccccsccccccccceccsecees 641
Plaintiffs’ Exhibit 49: Letter dated July 28, 1971 from
James B. Bolen, Jr. to T. H. Mayer and Nicholas
M. Mayer enclosing Safeway Lease .............
Plaintiffs’ Exhibit 50: Letter dated April 12, 1968
from Frank Lyon Company to Ed Penick, Presi-
dent, Worthen Bank and Trust Company ....... 686
vi Index Continued
Page
Plaintiffs’ Exhibit 51: Letter dated April 26, 1974 from
Rudy Landry, Investment Officer of Cabot, Cabot
& Forbes Equity Trust to Mr. Frank Lyon, Chair-
man of the Board, Frank Lyon Company ......
Plaintiffs’ Exhibit 52: Explanation of Items of Frank
EI AE
Defendants’ Exhibit 1: Equity interest in land and
buildings of Worthen Bank & Trust Co. .........
Defendants’ Exhibit 2: Cash Flow, Frank Lyon Co.-
Worthen Building ............................
Defendants’ Exhibit 3: Loss from Renial Operation,
Frank Lyon Co.-Worthen Building .............
Defendants’ Exhibit 4: Gain on Sale 1980 if 1980 Op-
tion is Exercised, Frank Lyon (Co.-Worthen
I aie eS Le
Defendants’ Exhibit 5: Tax Consequences vs. Eco-
nomic Gain if 1980 Option is Exercised, Frank
Lyon Co.-Worthen Building
ee
Defendants’ Exhibit 6: Tax Benefit—if Option Exer-
cised November 30, 1980, Taking 1969 Tax Reform
Act into Account, Frank Lyon Co.-Worthen
Building
Defendants’ Exhibit 7: Schedule of Direct Reduction
Loan, Frank Lyon Company, Loan from New
York Life (Schedule December 16 1969)
Defendants’ Exhibit 11: Letter dated November 28,
1969 from Frank T. McGehee, Assistant Vice
President of Worthen Bank and Trust Company
to New York Life Insurance Company
"ereeceeeeeeeeeeeereeee eee eeeeeeee ee ese
“eee eevee
,
Defendants’ Exhibit 12: Letter dated November 25,
1969 from Members American Institute of Certi-
fied Public Accountants of Gotham. Wyman &
Howland to New York Life Insurance Company. .
Defendants’ Exhibit 13: Letter dated September 2
a
1966 from Richard F. Gates, Vice President to Mr.
Harry E. Meek, Attorney, Little Rock
687
689
691
692
693
696
697
701
705
707
Index Continued
vil
Page
Defendants’ Exhibit 14: Letter dated October 13, 1966
with enclosures from Harry E. Meek, Attorney
to Worthen Bank & Trust Company .....-.....-
» 9 yw hihi y tte > September 8,
Defendants’ Exhibit 15: Letter dated : ;
1967 from C. J. Giroir, Jr., Attorney to Worthen
Bank and Trust Company ............-000e00e:
)xhibi ): , ication
Defendants’ Exhibit 16: Inter-office communicat
dated August 11, 1967 from Richard F. Gates to
Edward M. Penick regarding financing of bank
building (pp. 1 and 2, and 8-10) ..........-+-55:
708
734
Frank Lyon Company
Vv.
Tue Unitrep “.rates or AMERICA
Date Filings—Proceedings
9-27-73—Complaint filed. Summons issued and handed
marshal for service.
10-9-73—Mar. det. on service on summons, by serving Jane
Thompson, Secretary, on 10-1-73, and by certified
letter to the Attorney General’s Office, 9-27-73.
11-26-73—Answer filed. C/S.
8-13-74—Order setting pre-trial conference on Wed., Sept
18, 1974, 11:00 a.m.
9-16-74—Stipulation filed by both parties.
9.20-74—Pre-Trial Order by J. Eisele ordering this case
set for trial to the Court at 9:30 a.m. Tuesday, No-
vember 26, 1974; Deft. USA filed a demand for jury
trial; it now desires to waive trial by jurv; the case
is therefore transferred to the non-jury docket; Pitf.
has filed a pretrial brief with the Court. Deft. should
provide the Court with citations of authority upon
which it is relying; All discovery must be completed
not later than November 8, 1974; No discovery will
be permitted thereafter except to prevent mauifest
injustice; The Court will read the stipulation and all
exhibits before trial, with reference to deft’s exhibits
there is no agreement that they are accurate or that
they would represent the tax advantage to the Pltf.
if his position were adopted, however, deft. will not
be required to present the testimony of an agent who
prepared them.
10-22-74—Deposition of Edward M. Penick filed by Court
Reporter, taken Tuesday, September 17, 1974.
10-24-74——Deposition of Frank Lyon taken Sept. 12, 1974,
Little Rock.
2
10-24-74— Deposition of E. Ralph Cotham taken 9-12-74,
Little Rock.
11-15-74—Deposition of C. V. Barnes taken 11-4-74, Little
Rock.
11-26-74—Trial to Court before Judge Eisele, 9:32 a.m.-
6:00 p.m. continued.
11-27-74—Trial resumed 9:00 a.m.-5:07 p.m. After comple-
tion of testimony, Court stated some findings from
bench: Frank Lyon is owner of building; it is highly
improbable that Worthen will exercise option at end
of 11th year or any other option period; there is no
loan here, even if finally should determine Worthen
owns the building. Simultaneous briefs due December
20; each party may respord by January 7, 1975.
12-3-74—Marshal’s Return of Service on Frank Lyon,
personally 11-26-74.
12-6-74—Marshal’s Return of Service on Edward M.
Penick, personally 11-22-74.
12-20-74—Deft’s. Supplemental Memorandum of Fact and
Law.
12.23-74—Supplemental Stipulation by parties.
1-7-75—Reply Brief—Deft.
5-21-75—Memorandum Letter Opinion, J. Eisele.
5-27-75—Excerpted Testimony file’ by Reporter Fant (fr
11-27-74).
5-27-75—Excerpted Remarks filed by Reporrer Fant (fr
11-27-74)
6-3-75—Original transcript of remarks made by the Court
at close of trial led by Scott P. Crampton, Asst. Atty.
Gen’l.
6-11-75—Supplementary Findings of Fact and Conclusions
of Law filed by Judge Eisele.
3
6-11-75—Judgment pursuant to findings of fact and con-
clusions of law filed by Judge Eisele, entering judg-
ment in favor of plaintiff in the following amounts
with interest from dates indicated:
$32,624.32 with interest thereon from March 15,
1969;
$231,871.26 with interest thereon from March 15,
1970;
$43,790.84 with interest thereon from April 19,
1973.
8-5-75--Orig. & 1 copy of Vols. I & IT of transcript of
trial filed by Reporter Fanr.
8-11-75—Notice of Appeal for judgment of 6-11-75 by U.S.
Dist. Court to U.S. Court of Appeals for the 8th Cir-
cuit: Certified copy of N/A & 2 cert. copies of docket
entries to 8th Cir.; copies to U.S. Atty., appellant—
J. Gaston Williamson, atty. for appellee—& to Caro-
lyn Fant, Court Reporter.
GENERAL DOCKET
Unrrep Srates Covert or AppraLs
For tHe Eicutn Crrcvir
Appeal from Eastern District of Arkansas
Case No. 75-1615
Frank Lyon Compaxy, Appellee,
Vs.
Tue Unrrep States or Amenica, Appellant.
Date Filings—Proceedings Filed
1975
Aug. 13—Docketed appeal
Aug. 13—Cert. copies Notice of Appeal, Docket Entries of
D.Ct. (1)
4
)
Aug. 18—-Appearance appellee 2)
9
Aug. 19—Appearance appellant (3)
Aug. 25—Appearance appellant (4)
Sept. 19—Motion appellant for extension of time to file
appendix and brief (5)
Sept. 19—Order: Appellant may have thru October 22 to
serve and file appendix and opening brief (6)
Oct. 24—Appendix (vol. 1 & 2) w/service (7)
Oct. 24—Brief appellant w/service (8)
Oct. 24—F our copies exhibit volume
Oct. 23—Appearance appellant (9)
Nov. 25—Order: Appellee may have thru December 4 to
serve and file brief (10)
Dee. 3—Brief appellee (11)
Dee. 3—Affidavit of service w/brief appellee (12)
Dec. 8—Submitted to screening panel
Dee. 19—Mo applnt for ext to file reply brief (13)
Dee. 23—Order: Appellant granted to January 2 to serve
and file reply brief (14)
1976
Jan. 5—Reply brief appellant w/ser (15)
Jan. 21—Transferred to February session
Feb. 13—Appearance for appellee (16)
Feb. 13—Argued and submitted to Judges Bricht. Henley,
Regan. Gary Allen, Dept. of Justice for appellant; C. J.
Giroir, Jr. for appellee; concluded by Mr. Allen.
Reeorded
May 26—Opinion by Judge Bright (Published) (17)
J
May 26—Judgment: Judgment of district court is reversed
and remanded to district court for proceedings con
sistent with opinion (18)
June 4—Appellee’s bill of costs (19)
June 4—Appearance for appellee (20)
June 4—Mo appellee for ext to file pet for reh/reh en
bane (21)
June 4—Order: Appellee may have thru June 18 to file
petition for rehearing (22)
June 17—Petition of appellee for rehearing en bane and
rehearing (23)
Aug. 6—Order: Petition of appellee for rehearing en bane
is denied (24)
Aug. 6—Order: This court directs that our opinion be modi
hed; petition for rehearing of Frank Lyon Co. is denied
(Printed, Published) (25)
Aug. 16—Mandate issued
Aug. 19—-Receipt for mandate 26)
Nov. 8—Notice of filing of petition for writ of certiorari
in Supreme Court as Case No. 76-624 (as of 11/3 76)
27)
1977
Mar. 3—Order of Supreme Court in Case No. 76-624 grant
ing certiorari 25)
6
IN THE UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF ARKANSAS
WESTERN DIVISION
(Caption Omitted in Printing)
Complaint
(Filed September 27, 1973)
The plaintiff, Frank Lyon Company, for its cause of
action against the defendant, United States of America,
states:
1. Plaintiff is, and at all times mentioned in this com-
plaint was, a corporation organized and existing under the
laws of the State of Arkansas with its principal place of
business in Little Rock, Pulaski County, Arkansas.
2. This is an action for the recovery of internal revenue
taxes, with interest thereon, erroneously and illegaily as-
sessed and collected. Jurisdiction is conferred upon this
Court by Title 28, United States Code, Sec. 1346(a)(1), as
amended.
3. Plaintiff filed its income tax return for the calendar
year 1969 with the Internal Revenue Service Center, in
Austin, Texas, and paid the tax reported due thereon.
Following an examination of said return, the Commis-
sioner of Internal Revenue assessed an income tax defi-
ciency against plaintiff for 1969 as follows:
Tax Deficiency Interest Total Assessment
$261,063.34 $48,339.63 $309,402.37
Plaintiff paid said deficiency assessment to the Internal
Revenue Service Center, in Austin, Texas, on April 19,
1973.
7
4. Of the total deficiency assessment for 1969, $24,466.98,
together with interest in the amount of $4,548.79, was at-
tributable to adjustments not contested by the taxpayer.
The remaining deficiency assessment was attributable to
the Commissioner’s erroneous determinations that plain-
tiff was not the owner of the Worthen Bank Building in
Little Rock, Arkansas, and was not entitled to deduct cer-
tain expenses attributable to said building as set forth in
plaintiff’s claim for refund, a copy of which is attached
hereto as Exhibit ‘‘A’’ and incorporated herein by
reference.
9. On July 20, 1973, plaintiff filed with the Internal
Revenue Service Center, in Austin, Texas, a claim for
refund (Exhibit ‘*A’’) of income tax for 1969 in the
amount of $236,596.36, plus interest paid thereon in the
amount of $43,790.84, no part of which has been repaid
to plaintiff. As grounds for recovery, some of which are
stated in the alternative, plaintiff incorporates herein by
reference the averments contained in its claim for refund
for 1969,
6. By certified letter dated August 22, 1973 from the
Internal Revenue Service Center in Ausiia, Texas, plain-
tiff received statutory notice that its claim for refund for
‘1969 had been disallowed in fuil. A copy of said letter
is attached hereto as Exhibit ‘‘B’’.
Wiererore, plaintiff prays for judgment against de-
fendant for income taxes overpaid for 1969 in the amount
of $236,596.36, plus interest assessed thereon in the amount
of $43,790.84, for a total of $280,387.20, together with its
costs and interest as provided by law, and for all other
relief to which plaintiff is entitled.
/s/ J. Gastoxn WititamMson
J. Gaston Williamson
720 West Third Street
Little Rock, Arkansas 72201
Attorney for Plaintiff
IN THE UNITED STATFS DISTRICT COURT
EASTERN DISTRICT OF ARKANSAS
WESTERN DIVISION
(Caption Omitted in Printing)
Answer
[Filed November 26, 1973]
The defendant, United States of America, by its attorney,
W. H. Dillahunty, United States Attorney for the Eastern
District of Arkansas, for its answer to the complaint here-
in admits, denies, and alleges as follows:
1. Admits the allegations contained in paragraph 1.
2. Admits the allegations contained in paragraph 2, ex-
—
cept denies that any tax or interest was erroneously and
illegally assessed and collected.
3. Admits the allegations contained in paragraph 3, ex-
cept alleges that the total deficiency assessment was $509,-
102.97, rather than the amount alleged in the complaint
and further alleges that the Internal Revenue Service re-
ceived payment of this amount on April 20, 1973, rather
than the date alleged.
4. Is presently without knowledge or information suffi-
cient to form a belief as to the truth of the allegations
contained in paragraph 4, except denies that any deter-
mination of the Commissioner was erroneous and further
denies each and every allegation contained in the claim
for refund unless specifically admitted herein, except ad-
mits that a copy of the claim for refund was attached to
the complaint as E:xhioit A.
». Admits the allegations contained in paragraph 5, ex-
cept alleges that plaintiff’s claim for refund was received
on July 24, 1973, rather than the date alleged in the com-
plaint and denies each and every allegation contained in
the claim for refund unless specifically admitted herein.
6. Admits the allegations contained in paragraph 6
Whererore, defendant pravs for judgment in
allowing the defendant its costs, and for such othe
lef as this Court may deem just and proper
W. H. Dirtamuyry
United States Attorney
By:
Assistant United States Att
Demanpd For Jury Trial
Defendant demands a trial by jury of all issues of!
arising out of this action
IN THE UNITED STA RICT Ct
EASTERN DISTRICT « ANSAS
WESTERN DIVISION
(Caption Omitted in Printing)
Stipulation
[ Filed September 16, 1974]
; |
if . hereby stipulated my and hHerween ait part OS
that for the purpose of this case the follow act
he taken As true, subject tr Tiive ric ; ot ‘ ti) Dat}
ob pen
grounds ot materiality O] relevance: prov
that either party may intro luce other and fu
net inconsistent with the facts herein st pula
|. This is an action for the recovery of
nue taxes, with interest thereon. .Juriscdiet
upon this Court by Title s, Lnited States
lj46(a)(1) as amended
’ cy
to the admission of such facts in evidences
hae,
irtie evi
ted
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12
PX 16. Letter dated November 30, 1967 from Alan W.
Peters, Vice President of First National City Bank to
Kdward M. Penick.
PX 17. Letter dated December 18, 1967 from Richard
W. Baker, Jr., Viee President of New York Life Insurance
Cownpany to Frank Lyon Company.
PX 18. Ground Lease dated May 1, 1968 between Wor-
then Bank & Trust Company, as Lessor, and Frank Lyon
Company, as Lessee.
PX 19. Building Lease dated May 1, 1968 between Frank
Lyon Company, as Lessor, and Worthen Bank & Trust
Company, as Lessee.
PX 20. Note Purchase Agreement dated May 1, 1968 he-
tween Frank Lyon Company and New York Life Insurance
Company.
PX 21. Building Loan Agreement dated May 14, 1968
between Frank Lyon Company and First National City
Bank.
PX 22. Note for $7,000,000 dated May 14, 1968 from
Frank Lyon Company to First National City Bank.
PX 23. Building Loan Mortgage dated May 14, 1968
from Frank Lyon Company and Worthen Bank & Trust
Company to First National City Bank.
PX 24. Assignment dated May 14, 1968 from Frank
Lyon Company to First National City Bank.
PX 25. Sales Agreement dated May 19, 1968 between
Frank Lyon Company, as purchaser, and Worthen Bank
Trust Company, as seller.
PX 26. Note dated December 1, 1969 for $7,140,000.00
from Frank Lyon Company to New York Life Insurance
Company.
PX 27. First Deed of Trust dated December 1, 1969 from
Frank Lyon Company and Worthen Bank Trust Company
to New York Life Insurance Company.
PX 28. Assignment dated December 1, 1969 from Frank
Lyon Company to New York Life Insurance Company.
13
PX 29. Consent and Agreement dated December 1, 1969
of Worthen Bank Trust Company to New York Life In-
surance Company.
PX 30. Specimen letter dated September 11, 1969 from
Worthen to plaintiff requesting partial payment toward
purchase price of building.
PX 31. Specimen letter dated September 15, 1969 from
plaint./f to First National City Bank requesting disburse-
ment under interim loan.
PX 32. Specimen bank statement of plaintiff's account
at First National City Bank with specimen and checks and
credit ticket attached,
PX 33. Comparative consolidated balance sheets of
Frank Lyon Company and subsidiaries as of December
O1, 1968 and 1969,
PX 34. Comparative consolidated statement of income
for calendar vears 1968 and 1969,
». Attached hereto are copies of the following documents
which may be introduced by defendant during the trial
of this case in lieu of the original copies of said documents:
DX 1. Schedule reflecting equity interest in land and
buildings of Worthen Bank Trust Company 1969.
DX 2. Schedule reflecting cash flow to Frank Lyon Com-
pany on Worthen Bank Building lease.
DX 3. Schedule reflecting Frank Lyon Company loss frora
rental operation of Worthen Bank Building.
DX 4. Schedule reflecting gain on sale of Worthern
Building by Frank Lyon Company if 1980 option is exer-
cised.
DX 5. Schedule reflecting tax consequences versus eco-
nomic gain of Frank Lyon Company from sale of Wor-
thern Bank Building if 1980 option exercised.
6. Either party may introduce additional exhibits if
copies thereof are furnished to opposing counsel and a
list thereof furnished to the Court at least 15 days before
the trial of this case.
14
/s/ J. G. WiLiiaMson
J. G. Williamson
720 West Third Street
Little Rock, Arkansas 72201
Attorneu for Plaintiff
W. H. Dittanunry
United States Attorney
By: /s/ Euvcene C. Sayre
Eugene C. Sayre
Attorney, Tax Division
Department of Justice
Si? Federal Offive Bldg...
1100 Commerce Street
Dallas, Texas 75202
Exhibits contained in a separate Exhibit Volume
|
IN THE UNITED STATES DISTRICT COURT FOR THE
EASTERN DISTRICT OF ARKANSAS
WESTERN DIVISION
Supplemental Stipulation
[Filed December 23, 1974]
It is hereby stipulated by and between the parties hereto
that for the purposes of this case the following facts may
be taken as true:
1. Due to an oversight by the accountant who prepared
plaintiff’s income tax return for 1969, no portion of the
following items of expense paid in 1969 and attributable
to the Worthen Building were deducted on plaintiff's
federai income tax for 1969:
Date
Paid ’avyee and Deseription Amount
11-31-69 Ist. Nat’l. City Bk., int. on
interim loan $49,583.33
12- 3-69 SW Bell Tel. Co., interim loan 1.60
15
12- 8-69 Beach Abstract Co., title ins.
interim loan 3,405.50
12- 9-69 Parkin Prtg., printing Bldg. Loan
Agreement 216.77
12-23-69 House, Holmes & Jewell, atty. fee
NYL loan 2 830.45
12-23-69 Cotham, Wyman & Howland, fee re
interim loan 1,750.00
12-31-69 Rose Law Firm, atty. fee NYL loan 4,000.00
2. The total interest paid by plaintiff on the interim
loan from First National City Bank and the calendar vear
in which it was paid or accrued was as follows:
Paid or acerued in 1968 $ 40,411.90
Paid or accrued in 1969 413,070.97
Total $452,483.87
3. The travel and telephone expenses paid by plaintiff
attributable to the Worthen Building and dedueted on
plaintiff’s 1969 return were paid or accrued in the follow
ing calendar years:
Paid or accrued in 1968 $ 792.80
Paid or accrued in 1969 226.72
$1,019.53
4. The legal and accounting fees and title insurance
expense attributable to the Worthen Building, the vear
such items were paid or accrued and the proper allocation
of such items between the First National City Bank
(‘*FNCB’’) interim loan, the New York Life Insurance
Company (‘*‘NYL’’) permanent loan and the acquisition
of the building (Sales Agreement) by plaintiff are as
follows:
1968
ENCB NYL
Loan Loan Building
Shearman & Sterling,
legal fees $ 7,000.00
House, Holmes & Jewell,
legal fees $ 8,548.34
16
Rose Law Firm,
legal fees 5,340.81 10,681.63 $1,780.27
Cotham, Wyman &
Howland, acct. fees 1,475.00
Little Rock Abstract Co.,
title ins. 5,092.50
Beach Abstract Co., '
title ins. 4,927.50
Total $23,835.81 $19,229.97 $1,780.27
1969
FNCB NYL
Loan Loan Building
House, Holmes & Jewell, =
legal fees $ 2830.45
Rose Law Firm,
legal fees 4,000.00
Cotham, Wyman &
Howland, acct. fees $ 2,000.00 1,750.00
Little Rock Abstract Co.,
title ins. 120.00
Beach Abstract Co.,
title ins. 3,405.50
Total $ 2,120.00 $11,985.95 — o—
— —— —_
-_——_——
/s/ J. G. Wiuisamson
J. G. Williamson
720 West Third Street
Little Rock, Arkansas 72201
Attorney for Plaintiff
W. H. Dutauunry
United States Attorney
By: /s/ Evoene C. Sayre
Eugene C. Sayre
Attorney, Tax Division
Department of Justice
8E2 Federal Office Bidg.,
1100 Commerce Street
Dallas, Texas 75202
17
IN THE UNITED STATES DISTRICT COURT
FOR THE FASTERN DISTRICT OF ARKANSAS
(Caption Omitted In Printing)
Transcript of Proceedings
(November 26, 1974)
[erroneously dated November 26, 1975]
[42]
Thereupon,
Ralph Cotham, Jr.
having been called as a witness by and on behalf of plain-
tiff, and having been first duly sworn, was examined and
iestified as follows:
The Court: Take the stand.
Mr. Giroir: Your Honor, before beginning examination,
we do want to submit PX 36 as an exhibit. I have furnished
Mr. Sayre a copy of it. It is a computation of the tax loss
to Frank Lyon Company for the year 1969 through 2044 in
respect [43] to the Northern Bank Building.
The Court: Now this is an exhibit that has not beew re-
ceived?
Mr. Giroir: That's correct.
The Court: Have you showed it to Mr. Sayre?
Mr. Sayre: Yes, Your Honor, I have just received it and
at this time I have no objection to its introduction.
The Court: Very well.
Mr. Sayre: I believe it is what it purports to be, that
being a computation of a 75 year—
i8
The Court: lc is received.
Mr. Sayre: Based upon the fact no options are exercised;
is that correct?
Mr. Girori: That’s correct.
The Court: Do you have an extra copy?
Mr. Giroir: Yes, I do.
The Court: All right.
(The document referred to was marked for identifica-
tion as Plaintiff’s Exhibit No. 36 and was received in evi-
denee. )
Direct EXAMINATION
By Mr. Giroir:
Q. Mr. Cotham, state your name. A. Ralph Cotham, Jr.
[44] Q. What is your residence address A. 1600 North
Jackson, Little Rock, Arkansas.
Q. What is your oceupation? A. Currently I am em-
ployed as vice-president of finance for Frank Lyon Com-
pany.
Q. How long have you been employed by the Frank Lyon
Company? <A. Since 1966.
Q. What is your present office of Frank Lyon Company?
A. Presently | am vice-president of finance.
Q). Ilow long have you been vice-president of finance?
A. Since the first of the vear.
(). What office did you hold prior to that time? A. Prior
to that timejl was secretary-treasurer.
Q. Did you hold the job of secretary-treasurer from
1966? <A. No. In ’66 I came as assistant secretary-trea-
surer and then became treasurer of the corporation and
then became secretary-treasurer of the corporation, and
I am still the secretary of the corporation but also vice-
president of finance.
Q. You have been involved in the company’s financial
affairs since your first A. That’s correct.
19
Q. What is your education? [45] A. I attended the
little Rock public schools, was graduated from Little Rock
Central High School, enrolled at the College of Arts and
Sciences at Vanderbilt University, was graduated there
with a B.A. degree and enrolled in the school of law and
received an L.L.B. degree. I was employed first by a public
accounting firm. I took some undergraduate courses at
UALR and took and sat for and passed the CPA exam,
and I am also a certified public accountant.
Q. Are you a licensed attorney? <A. Yes, sir, I am.
Q What associations or socicties are vou a member of ?
A. T am a member of the American Bar Association, the
Arkansas Bar Association, the American Institute of Certi-
fied Publie Accountants, the Arkansas Society of Certified
Public Aecountants. And as vou pointed out, T am also
licensed to practice law before the Arkansas Supreme Court
us well as the Eastern District of Arkansas federal court.
Q. Mr. Cotham, would you tell us what the business of
Frank L.von Company was in 1967? A. In 1967, Frank
Lyon Company was a wholesale distributor of home fur-
nishings, primarily RCA electronic products. This included
TV sets, stereos, Whirlpool products, whieh inelvded re-
frigerators, freezors, washers, air conditioners, and a little
hit of furniture. The primary thing was [46] distributing
RCA and Whilrlpool products.
Q. How many officers did Frank Lyon Company have at
that time? A. There were four branches. One is located
in Springfield, Missouri; one in Fort Smith, Arkansas: and
one in Shreveport, Lousiana; and then, of course, the
home office is here in Little Rock.
(). And was the company involved in basically the same
business at all these offices? A. We were not involved in
furniture in Springfield or in Fort Smith. We were not in-
volved in selling RCA produets in Shreveport.
Q. But each of them were home appliances? A. All of
them were home appliances, wholesale distributor.
ee
20
Q. Could you have opened additienal offices in that busi-
ness’? <A. No, sir, we could not.
(. Why not? <A. Our contracts with the factory speci-
fied primary areas of the responsibility, and we are re-
quired under our contract with both RCA and Whirlpool to
have offices within our primary 2reas of marketing respon-
sibility.
Q. Did you think you had saturated your market re-
sponsibility area? [47] A. Yes, although we were still
striving to improve our market share a little bit. We do
get market penetration figures which are industry-wide,
which show the total number of TV sets that are sold as an
example. We know what percentage are RCA and what
percentage Zenith and what percentage Sylvania, and what
percentage are Panasonic and Sony, et cetera.
Q. Is the Frank Lyon Company now involved in other
active businesses—that is, other than the wholesale dis-
tributorship of furniture and appliances? A. Yes. In 1968
and 1969 the Frank Lyon Company purchased controlling
interest of the Coca Cola Bottling Company of Arkansas
and also the ‘twin City Bank.
Q. Did vou say those were acquired in 1968? A. “69—
68 and ’69. The bang was acquired in 1968, The Coca
Cola Company was acquired in ’69.
Q. Now, as—
The Court: Is that Coca Cola—
The Witness: Bottling Company of Arkansas.
By Mr. Giroir:
Q. You say ‘‘the bank.’’ Would you describe the hank
in which you have an investment? A. This is the Twin
City Bank of North Little Rock, Arkansas. It is currently
constructing an eight-story building across the river. At
the time we purchased it, it had total assets of around
$15 million. Under the excellent leadership [48] of Mr.
Terry Renaud, who is president and chairman of the board,
it now has total assets of around $85 million.
21
The Court: You mean since 1968?
The Witness: Yes, sir.
By Mr. Giroir:
Q. The Coea Cola Company, would you describe its
operation? A Coca Cola Bottling Company is a bottler
of soft drink beverages. It buys syrup from the Coca Cola
Company, as well as from the Dr. Pepper Company, mixes
it under the strict guidelines so the trademark is not in-
fringed, puts it in bottles or cans and sells it both in vend
ing machines such as the one on the floor here, as well as
the supermarkets for the ultimate resale to consumers.
Q. What is its trade area? A. Its trade area is approxi-
imately one-third of the State of Arkansas. We do not have
Pine Bluff. We have Little Rock, Searcy, go all the way up
to Harrison, Arkansas; Little Rock and aorth. excluding
Fort Smith and West Memphis and Jonesboro.
Q. To disgress for a minute, when you made these acqui-
sitions, did you buy stock in each instance? A. Yes. we
did.
The Court: Are they now wholly-owned subsidiaries or
partially?
149] The Witness: Your Honor, the Coca Cola Bottling
Company of Arkansas is a wholly-owned subsidiary. Twin
City Bank, 92 percent of the stock is owned. The other
shares are owned by either officers or directors of Twin
City Bank.
‘
By Mr. Giroir:
Q. Basically qualifying shares? A. With the exception
of Mr. T. E. Renaud’s share ownership which is five per-
cent of the outstanding.
Q. Your purchase of the stock of Twin City Bank, was
that paid for in cash? A. Yes, it was. However, we bor-
rowed funds from Republic National Bank.
‘yp
—
Q. Your purchase of the stock of Coca Cola Bottling
Company, was that paid for in cash? A, No, Mr. Giroir,
it was not. It was the desire of the selling stockholders to
maximize really their tax benefit and they required a down
payment of 29 percent in cash and wanted corporate notes
for a four-year period in annual payments of principal.
So we paid 29 percent of it down.
(). Roughly, how much did that 29 percent amount to?
A. It was over a million dollars.
(). And then the balance? A. And then the balance was
paid for in four annual equal installments on August the
21st of each year, and that would be ’70, ’71, ’72 and ’73.
(50) Q. When, as an officer of Frank Lyon Company, did
you first learn of the company’s interest in purchasing the
Worthen Building? A. Mr. Lyons, the chairman of the
board, asked me to stay a few minutes after our October
1967 board meeting and asked me what I thought of per-
haps the company’s owning the Worthen Bank Building.
Of eourse, | hadn’t given it much thought at all. I told
him I would be glad to look into it and he urged me to do
so as fast as possible and asked me to get back with him
the first thing the next morning and report to him on my
preliminary findings. °
Q. At that point, what information did you have in re-
spect to the investment? <A. Only what he had given me,
which was that the building was going to cost around $7.5
million, that we should not be too concerned with the
permanent financing because Worthen Bank had already
made some inquiries of some potential mortgage holders;
an investor acceptable to both Worthen and, in this in-
stance, New York Life would be able to take advantage of
these initial contacts.
Q. What was your report to Mr. Lyon the next morning?
A. It was an oral report. I correlated it to the objective
really that the board of directors had adopted and said
that I thought the possibility was worth exploring, but to
really give or to give a thorough analysis that we needed
[51] more information.
23
(). bid you get more information? A. Yes, | did.
Q. How did you get it’? A. I think at that time Mr. Lyon
was going to attend a meeting at Worthen Bank and I be-
lieve spoke with Mr. Penick about the possibility of Frank
Lyon Companies becoming a candidate for ownership of the
building, and after their discussions then Mr. Lyon asked
me to eall Mr. Dick Gates who was at the time—was vice-
president of Worthen Bank and was responsible for coordi.
nating and analyzing from Worthen’s point of view the
various proposals they had received from other potential
investors. I did so and he gave me a little more detailed in
formation.
Q. Did you consult with any advisors in connection with
vour ultimate report to Mr. Lyon? A. No, sir, I did not.
Q. What was your ultimate réport to Mr. Lyon’? A. That
I thought we ought to make a bid to own the building
Q. At that point, was your recommendation at all pre:di
cated upon the existence of permanent financing by Ni
York Life? A. Yes, it was, and | was really surprised in
talking with Mr. Dick Gates how much they were really
selling an [52] economic unit or offering to investors the
economic unit, and they had made several contacts and ygune
into a great deal of detail with the financing officers of \ew
York Life Insurance Company concerning New York |.ife
Insurance Company placing a mortgage on the entire build-
ing.
Q. Hlow did the existence of this at least tentative commit
ment for permanent financing affect your problem or your
undertaking to make a proposal on the building? A. Quite
frankly, it made it a whole lot easier. When you are going
to make a seven or eight million dollar investment, the first
question that always comes into my mind is where are you
going to get the money. In this instance, Worthen Bank
had already had contact to in part satisfy this question or
answer this question.
Q. How did it affect what rental you were willing to re-
ceive? A. Well, in real estate investments at this time the
24
minimum requirement we would have is sufficient rental in-
come to amortize the debt service. When you know what the
annual debt service is going to be that gives a floor, which
in our particular instance we were somewhat reluctant to
go much below that.
Q. Did the Frank Lyon Company make a proposal to
Worthen Bank? A. Yes, they did, Mr. Giroir.
{53} Q. Do you have a copy of that proposal? A. I
don’t have it with me. It’s in the stipulation of the facts.
Q. I believe that’s stipulation number 11 or PX No. 11.
A. PX 11.
Q. Would you read that proposa.! A. This is a letter
dated October 30, 1967 from Mr. Frank Lyon, Chairman of
the board of Frank Lyon Company, to Mr. Ed Penick,
president of Worthen Bank and Trust Company.
‘Dear Ed: In our prior conversations I have stated a
definite interest in Frank Lyon Company's owning the new
Worthen Building. We propose to purchase the building
from you for $7.5 million under a sale and leaseback ar-
rangement and to borrow the money from New York Life
Insurance Company on a note secured by a first mortgage
on the building, a conditional assignment of your lease and
the general credit of Frank Lyon Company.
The lease will require you to pay all expenses necessary
to operate and maintain the building including all repairs,
taxes and required insurance.”’
Q. Do you want to continue? A. ‘‘The annual rental pay-
ment will be $50,000.00 less than the amount of morteage
payments for the first ten years, will be equal to our mort-
gage payments for the duration of the [54] original mort-
gage and will be $600,000.00 per year for the remainder of
the lease.
Worthen will have the option to purchase the building
after 15 years for $1.7 million cash, plus the assumption of
the original mortgage. Worthen will also have options to
25
repurchase the building after 20, 25, 30, 35 and 40 years on
a basis acceptable to Worthen Bank.
This letter merely outlines our proposal, We are flexible
and want to negotiate an arrangement which is fair and
equitable to both parties. Sincerely, Frank Lyon Company,
Frank Lyon, chairman of the board.’’
©. Did you consider this to be a definitive offer to pur
chase the building? A. It certainly contained most of the
essential terms that we thought Worthen was looking to
Honestly, we were trying to get our foot in the door. It
was quite obvious from what Mr. Dick Gates told me that
other investors had made firm proposals and were under
consideration, and that Worthen Bank was going to make
a decision immediately. So we were, as I said, really trying
to get our feet in the door.
Q. What was the response from Worthen Bank to your
proposal? A. They came back and said they were—liked
the terms, but there were other investors that had also
submitted very attractive bids to them and they sugge-ted
that perhaps [55! Frank Lyon Company and Stephens,
Inc. form a partnership te own the building jointly.
Q. What was your response to that? A. We didn’t think
much of that idea.
(). Why not? A. Well, severa) reasons. We did not want
to split any of the benefits of ownership with a third party.
We knew there was going to be some hard negotiations
between ourselves and Worthen Bank to kind of put the
meat on this skeleton. We thought we could do it better with
ourselves and Worthen Bank instead of trying to involve
a third party in it. We had no prior experience of any busi
ness dealings or partnership arrangements with Stephens
and this would be kind of new waters for us to tread into.
Q. So did I understand that you declined to enter into a
joint venture? A. Very violently, yes. We declined.
Q. What was Worthen response to your declining to joint
venture the ownership? A. Either one or two days there-
after, they contacted us again and said that rather than the
26
joint ownership they would like to submit to the narrow
field of bidders on the building specifications for a sale and
leaseback. This was a two-page typed document. They gave
it to us and asked for an immediate response as to whether
or not these terms would be [56] acceptable or if we wanted
to modify them in any way to be sure to specify what that
would be.
{). Is that specification the document that appears as PX
No. 123? A. Yes, it is, Mr. Giroir.
{). Without going into great detail, in what material re-
spects did the specifications deviate from your original pro-
posal? A. Well, the big deviation came in the option price
after 15 years. We had proposed to sell them the building
for $1.7 million plus assuming the wnpaid halance of the
mortgage. in paragraph five they trimmed that back sub-
stantially.
We had also proposed rentals.
Q. When you say ‘‘substantially’’—— A. They trimmed
it hack to only a million dollars including—to a million
dollars.
Q. That was a $700,000 reduction. A. They almost cut
it in half.
Q. In what other respects did the specification deviate
from your preposal? A. We had proposed net rental in-
come to Frank Lyon Company of $600,000.00. They trimmed
this by $400,000.00 during the first initial five year term,
made it only $200,000.00 and then cut it $50,000.00 for each
five succeeding years.
[57] Are you speaking now of the renewal period follow-
ing the 25 years? A. That 's correct.
Q. So they reduced your net rental income during the re-
newal period by approximately two-thirds? A. Yes. From
$600,000.00 to $200,000.00.
Q. At this point did you have any knowledge of what other
investors were pruposing to Worthen? A. None whatso-
ever. Mr. Dick Gates was very, very careful not to disclose
any of the terms which any of the—information that any
27
of the other potential investors had given to him, and he
assured me our conversations would be held confidential
and he would not share the information which I had passed
on to him with any of the ot ier investors.
Q. Obviously, as we will find o1.t later, you accepted these
specifications with some modification. Why did you ccede
to the reduction in the option price? A. Well, in looking at
the economic realities, we were very unsure of Worthen’s
ability to exercise at that particular time so, therefore, we
discounted that factor a bit.
Q. Did you consider the option prices proposed in the
specifications to relate rcughly to what the fair market value
of the building would be on the date of exercise? A. Yes,
we did.
Q. As to the renewal, the reduction in vour proposal [58]
for rental during the renewal period, why did you accede
to tnat reduction? A. Well, we wanted very much to own
the Worthen Bank Building and it was obvious after hav-
ing received the specifications for sale and leaseback that
it was not prepared only for Frank Lyon Company and,
in fact, we knew there were ot .er interested investors. We
would like to have gotten our $600,000.00, but it didn’t look
like We were going to be able to negotiate that and accepted
a smaller return than we would have otherwise liked.
Q. Did you consider the rental during the renewal period
to be fair and equitable in relation to the value of the build-
ing at that point? A. Yes, we did.
Q. Ultimately, did you respond to the specifications sub-
mitted by Worthen Bank? A. We responded by letter from
Mr. Frank Lyon to Mr. Ed Penick.
Q. Is that the letter which appears as PX No. 14? A. Yes,
it is.
Q. Would you read that, please? A. Yes, This is a letter
dated November 1, 1967 from Frank Lyon to Mr. Ed Penick,
president, Worthen Bank and Trust Company.
‘‘Dear Ed: We have reviewed your proposal submitted
[59] to us yesterday. Unequivocally we would like to accept
28
it. However, we do not feel that this proposal is best for
Worthen Bank. Therefore, we accept your proposal with
one major change. Your lease payments for the first five
years will be reduced by $21,000.00 annually. On the en-
closed sheet we have listed the points contained in your
specifications for an easy comparison of our amended pro-
posal with your proposal.
Ed, as you already know, we want very much to be of
service to Worthen Bank. Yours truly, Frank Lyon Com-
pany, Frank Lyon, chairman of the board.’’
Q. And what was Worthen’s response to that letter? A.
They notified us that they had accepted this second proposal.
Q. Now in the specification that was submitted by Wor-
then, it reflected that interim financing would be made avail-
able by First National City Bank? <A. That is correct. The
specific sentence contained in Plaintiff’s Exhibit 13 states:
‘Interim financing during construction is tobe supplied
by the First National City Bank of New York at the
prime rate of interest.’’
Q. Were you then, after your proposal was accepted, fur-
nished any type of commitment letter from First National
City Bank in respect to interim financing? A. Well, we
knew the initial contact had been made. We went ahead and
submitted five year financial statements to [60] First Na-
tional City Bank. We gave them a brief resume on the his-
tory of Frank Lyon Company as well as personal resumes
on both Frank Lyon and C. W. Abrams, who at that time
was and still is president of the corporation.
Q. Did you receive any communications from First Na-
tional City? A. We were notified that we—that they would
be glad to loan Frank Lyon Company the interim financing
due to our ownership of the building.
Q. Did you also receive a commitment letter from New
York Life Insurance Company? A. Yes, we did. We had
to furnish New York Life Insurance Company basically the
same information: namely, five-year audited financial state-
ments, a brief statement of history of the company as well
29
as personal resumes on the chief officers. And on December
18th, they did write a commitment letter to Frank Lyon
Company whereby they offered to loan Frank Lyon Com-
pany under certain terms and conditions $7,140,000.00. I
think that’s Plaintiff’s Exhibit 17.
Q. Plaintiff’s Exhibit No. 17.
Tue Court: First National City Bank is Exhibit 16?
Mr. Sayre: That is correct, Your Honor. Plaintiff’s Ex-
hibit No. 16 is City Bank’s commitment.
By Mr. Giroir:
Q. After you received these commitment letters, were
[61] there negotiations between Frank Lyon on the one
hand, Worthen on the other hand as to the terms of the
lease? A. Indeed there were.
Q. Who represented Worthen Bank in those negotiations?
A. Dick Gates was the officer which represented Worthen.
They were represented by Mr. Dick Williams of Wright,
Lindsey and Jennings law firm. He is their legal counsel.
Q. Were there also negotiations between Frank Lyon
Company and First National City Bank? A. Yes, there
were.
Q. Who represented First National City Bank? A. Mr.
Bob Milod, assistant vice-president of First National City
Bank. His legal counsel was Mr. John Durkee of Sherman
and Sterling, a law firm in New York City.
(). Were there also negotiations and discussions between
Frank Lyon Company and New York Life Insurance Com-
pany? A, Yes, they were.
(). Who represented New York Life Insurance Company
in those negotiations? A. New York Life’s house counsel
or general counsel, Mr. Charles Smith of New York City
was the officer for the New York Life Insurance Company.
Their local counsel was Mr. Darrell Dover, a partner in
Hfouse, Holmes and Jewell of this city.
{62} Q. Over what period of time did the various negotia-
tions between the four parties transpire? A. Really from
30
November or December of 1967 through the first part of
May, 1968.
Q. What took so long? A. It’s a very complicated trans-
action and a lot of details to be worked out.
Q. Approximately how many agreements were entered
into between the various parties? A. Fifteen or twenty.
Q. In the negotiations, with whom was First National
City Bank negotiating in respect to the payment of its note?
A. Frank Lyon Company.
Q. And with whom was New York Life negotiating in
respect to the payment of its note? A. Frank Lyon Com-
pany.
Q. Did Worthen Kank representatives sit in on any of
these negotiations? A. Sometimes they did, but only when
it concerned additional security that the lenders were re-
questing.
(). In respect te the lease between Worthen Bank and
Frank Lyon Company, did First Nationa] City Bank or
New York Life have any interest in the terms of that lease?
A. New York Life did because, as the commitment letter
points out, one of the securities they wanted from Frank
Lyon [63] Company was a conditional assignment of that
lease. So, of course, they had an interest in what the lease
said.
Q. Over this approximately six months period, there were
obviousiy many negotiating sessions. Where did those oc-
eur? A. Most of them took place in Little Rock, Arkansas.
(Quite a few of them, however, did take place in New York
City. I reeall either three or four times when I personally
went to New York to either meet with representatives of
First National City Bank or New York Life to discuss ma-
terial terms in these documents.
(). Did the representatives of New York Life or City Bank
attend any of the negotiating sessions in Little Rock? A.
They attended one or two, but in the main, the negotiations
which were held in Little Rock were participated in by the
parties who reside in Little Rock.
31
Q. Inasmuch as you were depending upon receipt of per-
manent financing from New York Life Insurance Company,
whose form or whose format dictated the structure of the
transaction? A. The format of New York Life Insurance
Company.
Q. Let us turn for the moment to the various agreements
that were signed. As between Worthen Bank and Frank
Lyon Company, what agreements were execited? [64] A.
I believe there were three agreements. There was a ground
lease whereby we leased from Worthen Bank ground which
they owned, about a half city block on Capitol between Lou-
isiana and Center Streets, a building lease—the ground
lease, by the way, is a term of 75 years—a building lease
with a term of 65 years for the tower and the other exten-
sions of the building, the lobby and the four or five floors
over that. That has got four purchase options in it. It also
has options to renew the lease for rental so Worthen can,
at their option, extend the terms to 65 years if they wish.
Q. Was there any other agreement between Worthen Bank
and Frank Lyon? A. Yes, there was a sales agreement in
which we agreed to buy from them and they agreed to sell
to us the Worthen Bank Building.
Q. Turning first to the sales agreement, what was the
purchase price specified in the sales agreement? A. Seven
million, six hundred forty thousand dollars.
Q. How was that figure determined? <A. It was outlined
really in the specifications for sale and leaseback.
Q. Did it have any bearing or relationship to the antici-
pated cost of the building? A. Certainly it did because in
all of my conversations with Mr. Dick Gates he used the
figure of around $7.5 million [65] or between seven million
or maybe a little more as far as the total cost of the build-
ing. That’s what they thought it was going to cost.
Q. When you say ‘‘they thought,’’ did they have a con-
struction contract? A. I later learned they did have a con-
struction contract at a cost plus basis.
Q. With no maximum figure? A. That was my under-
standing.
32
Q. Had that contract already been entered into at the time
that you entered into the sales agreement? A. Yes, it had.
Q. Then in the sales agreement, did you buy the building
as is: at that stage of completion and complete it yourself?
A. No. It was very important from Worthen’s standpoint
they maintain a direct relationship with the contractor and
the architect and the other consultants they had in the build-
ing. It was going to be called the Worthen Building and,
quite rightly so, they took a great deal of pride in it and
did not want to go through an intermediary in dealing with
these parties they had already contracted with.
Q. Did you buy it as it was constructed? A. Yes, we did.
Title passed to Frank Lyon Company as they were put in
place in the building. I later learned [66] there was another
reason. Dick Williams or Dick Gates told me in the meeting
at that particular time under Arkansas law state banks were
exempt from the sales and use tax provisions of the state
revenue code. As long as Worthen wae buying it and putting
it in the building, they did not have to pay any use tax or
sales tax on the materials.
Q. Did you review the plans and specifications which illus-
trated or showed what the building would be when you
bought it? A. I can’t really read a blueprint, and we had
nice architectural renderings which we saw. Honestly, we
didn’t really care what the building looked like. We knew it
would be a nice building, that it was the desire of Worthen
to make it the most impressive office building in the State
of Arkansas, and had a great deal of confidence in their
abilities and taste to work with ihe architects and contrac-
tors to get it to be that outstanding structure.
Q. Did you require Worthen Bank to undertake to com-
plete its construction? A. Yes, we certainly did. We didn’t
want to pay for a ha'f completed building or 90 percent
completed building. We elicited from them covenants and
warranties that the building would be completed in accord-
ance with the plans and specifications.
Q. Was the building to be situated on land owned by [67]
Worthen Bank? A. Yes, it was.
33
(. You referred to ground lease. A. That’s correct.
(. What was the length of time over which that ground
lease extended? A. Seventy-five years.
Q. What were the lease payments during the first 25
years? A. The sum of $50.00.
Q. What were the lease payments during succeeding
years? A. They begin at a hundred thousand dollars per
year for five years and then escalated by $50,000.00 until
they reach two hundred fifty.
In other words, for the first five-year period it was a
hundred thousand: for the next five-vear peried a hundred
fifty thousand dollars per vear; then two hundred thou-and
per vear for the next five years; then two hundred fifty
thousand per year for the next five years. And it remained
at $250,000.00 for 20 years, and for the last ten-year period
it was ten thousand per vear.
(). Why was the ground rental during the first 25 years
only $50.00? A. Well, we were really viewing this in rela-
tionship with the building lease and talking about the net
economic [68] impact. We could have made it any figure we
wanted to and we would have passed it on to Worthen in
the building lease. It seemed a lot simpler to do it this way.
Q. Do TI understand in the building lease you, in effect,
subleased the ground back to Worthen Bank? A. That’s
correct.
Q. Did you specify a charge in the building lcase for that
sublease of the ground? A. No.
Q. If vou had had a material lease provision or lease pav-
ment under the ground lease, would you have increased the
building lease by roughly the same am unt? A. We cer-
tainly woul have. If the ground lease had been leased to us
at, say, $50,000.00 a year, we would have increased the rent-
als on the Worthen Bank Building by 50.000 a vear.
Q. During the first 25 years of the building lease, approx-
imately what was the annual rental? A. It was approxi-
mately $580,000.00 annually for the first ten or eleven years,
and then it went to approximately 600,000 for the next—
34
up to the 25th year. At that time it dropped to 300,000,
Q. How did the five hundred eighty and six hundred twen-
ty figure relate to the payment that you were required to
pay New York Life? [69] A. They coincide identically with
them.
Q. That is during the first 25 years? A. During the first
& years.
Q. During the renewal period, how does the $300,000.00
annual rental relate to the amount you would owe New York
Life? A. We wouldn’t have owed New York Life anything
after 25 years.
(. Do I understand during renewal period the rental in-
come would be net to Frank Lyon Company? A. Absolute-
ly. It is cash in our pocket.
Q. I’d like to focus for a minute on the relationship be-
tween the ground lease during the 25th to the 75th year as
opposed to the building lea: e if yon assume that Worthen
elected to exercise its renewal. I understand that the build-
ing lease continued for 40 years at a constant rate of $300,-
000.00. Is that correct? A. The rental terms, yes.
Q. The ground lease escalated from a hundred thousand
to $250,000.00. A. True.
Q. From the 25th to the 65th year. A. That’s correct.
.). What net effect or net rental, therefore, was Frank
Lyon to get during the renewal period? [70] A, We would
have received a net rental income of $200,000.00 during the
first five years; a hundred fifty during the second five vear
period; a hundred thousand during the third; 50,000 during
a 25 year period, and then the building lease terminated.
Q. The net rental in the aggregate, therefore, during the
five vears, 25 to 30, would be approximately a million dol-
lars? A. That’s correct.
Q. In the second year it would be in the aggregate of
approximately $750,000.00? A. That’s exactly correct.
Q. Aid so forth down to the last period.
Now at the end of the 65th year, Worthen had no option
to renew its lease; is that correct? A. That is correct.
35
Q. At that time Frank Lyon Company had a continuation
of the written ground lease for a period of ten years. A.
For a period of ten years at an annual rental of $10,000.00
Q. And that $10,000.00 during the year 65 to 75 compares
to $250,000.00 ground rental during the year 60 to 65; is
that correct? A. That’s correct.
Q. Why the drastic reduction from the vear 65 to 75 in
the ground rental? [71] A. We were very, very concerned
about what would happen to our building at the end of the
65 year period and wanted to as a possibility of really
maximizing our return on this real estate investment, ne-
gotiate with someone, hopefully with Worthen to lease the
building over a ten year period at fair market values,
whatever they happened to be at that time.
Q. So that if Worthen continued its building lease at
300,000 a year that would be, in effect, 290,000 per vear
net to vou during that ten year period? A. That’s cor-
rect. A total of $2.9 million.
Q. Was the arrangement as to the 65th to the 75th vear
specified in Worthen’s specification for bids? A. It was
not listed in there, no. This is one of the many points
we negotiated during this six month period between the
time that we first started negotiating and the time that
all the documents were signed.
Q. And in those negotiations, would you paraphrase
what your negotiating position or request was? A. Well,
it was—-since it was our building, we wanted to go ahead
and were very concerned really about what position we
would be in as the owners of the building at the end of
the 65 year period. We felt like it would be to our ad-
vantage to go ahead and have a fixed ground rental °f
10,000 a year during that time which would give us an
additional ten year period to either negotiate additional
rentals from Worthen—[72] as you point out, even if vou
keep it the same, the $300,000.00 level over that ten vear
period of time, that’s net income to the company of $2.9
million. This was really an economic advantage that we
negotiated during the six month period.
36
Q. If Worthen had these options at the end of 11 years
15 years, 20 and 25 years, to buy the building, why were
you concerned in what was going to oceur in the 65 and
75th year? A. The option only ran one way. That was
their choice. I had no idea as to whether they could or
want to exercise. I did know at that time they could not
have exercised or could not have owned the building.
Q. After the 75th year you no longer had an option or
have no option to renew the ground lease. A. That’s cor-
rect.
Q. What, occurs in respect to the building at that point?
A. I was also very concerned about this so received an
opinion from Mr. Bill Nash of the Rose law firm as to the
ownership. He told me that the building still is the prop-
erty of the Frank Lyon Company.
Q. Se you would still be entitled to receive rental in-
come or to sell or otherwise deal with the building after
the expiration of 75 years? A. That is absolutely cor-
rect. The building does not [73] revert to the land owner
unless the lease so specifies and this does not.
Q. In view of the options, why were you concerned with
what would happen at the end of 75 years? <A. At the
time the documents were being negotiated, Worthen Bank
could not own the building. I knew of no reason why they
would be able to own the building. And, secondly, if they
could, it would only cut one way, :
”
Mr. Sayre: I object to that line of testimony. He hasn’t
shown any particular knowledge as to what the workings
of the Worthen Bank and their reasons and their abilities,
I think it would he proper to elicit it from a represeatative
of Worthen Bank and not Frank Lyon Company.
The Court: Well, the agents of the Frank Lyon Company
had certain attitudes of Worthen’s ability which bear upon
the intention of the parties, and the objection will be over-
ruled, whether they were correct or not.
37
By Mr. Giroir:
Q. Turning to the financing documents—
The Court: Just a moment. You say at the end of the
75 years, the lease—you would still own the building?
The Witness: This was the legal opinion we received
from the Rose law firm. Yes, Your Honor.
By Mr. Giroir:
Q. Turning to the financing documents as between Frank
[74] Lyon Company and New York Life Insurance (om-
pany, what agreement did you enter into? A. We entered
into a note purchase agreement.
Q. What other agreements? A. We, of course, executed
& $7,140,000.00 promissory note.
Q. What other agreement? Was there an assignment of
a lease? A. There was an assignment of a lease, a con-
ditional assignment of the lease to New York Life In-
surance Company. |
Q. Let me ask you: The agreement we have mentioned
a minute ago: the sales agreement, the ground lease, build-
ing lease, and the agreements you are talking about now:
the note purchase agreement, the notes and the assign-
ment of lease and the other agreements we will refer to
in a minute, were these all executed simultaneously? A,
The—most of them were. I don’t believe all of them were
executed simultaneously. They are dated, however. You
are referring also to which specific agreement? A. To
each of the agreements. 4
Q. I’m not sure what the date of the sales agreement is.
{ could check it.
Q. In point of time, were they roughly signed at the same
time? A. Yes. They were negotiated during this six
month [75] period, and at the end they were all finalized
and executed by the parties to those particular agreements.
Q. In respect to the note purchase agreement between
New York Life on the one hand and Frank Lyon on the
other hand, what was the import or the thrust of that
agreement? A. Well, the note purchase agreement was
New York Life’s agreement to lend to Frank Lyon Com-
pany $7,140,000.00 subject to certain terms and conditions.
We had to go ahead and sign a $7,140,000.00 note. We had
to assign to them a building lease which, in fact, met their
approval. We also warranted our five year audited state-
ments which we previously furnished them. And we were
also required to furnish throughout the term of the note
audited financial statements on Frank Lyon Company.
Q. Was Worthen Bank a party to the note purchase
agreement? A. No, sir, they were not.
Q. Was Worthen Bank a party to your promissory note
to New York Life? A. They certainly were not.
Q. Did they guarantee that note? A. No. In no way
did they guarantee the payment of that note.
Q. Is it your understanding that in the event of your
default on that note that Worthen would be required to
pay the [76] note? A. That is not my understanding.
Q. Does the note contain provisions for acceleration of
your obligation in the event of your default? A. In the
event of our default it does.
Q. Would those accelerated provisions accelerate Worth-
en’s obligations under the lease agreement? A. No.
Q. Did Worthen Bank enter into any agreement to in-
duce New York Life to enter into the sales agreement with
you? A. Not in the sales agreement, no. Into the note
purchase agreement I believe they did execute a consent
and agreement, yes.
Q. In that consent and agreement, what did they con-
sent and agree tof A. They consented to the assignment
of the lease. They also consented to go ahead and suberdi-
nate their interest in the parking deck and their interest
in the ground to the deed of trust, which we would execute
with New York Life.
Q. Did they also agree to cause the building to be con-
structed in accordance with plans and specifications? A.
Yes, they did.
Q. As to the interim financing, what agreements did
Frank Lyon enter into the First National City Bank? A.
We signed a $7 million promissory note.
[77] Q. Was there any other agreement or undertaking
between First National City Bank and Frank Lyon Com-
pany’? A. Yes, there was a building loan mortgage in
which we mortgaged our building to First National City
Bank. There was also a building loan mortgage agreement
which contained some other covenants and warranties of
Frank Lyon Company. Then there was a guaranty of con-
struction and completion which Worthen Bank signed in
favor of First National City Bank, in which they affirma-
tively covenanted to cause the building to be constructed.
Q. Just as a point of curiosity, the purchase price under
the sales agreement for the building was $7,640,000.00. A.
That's correct.
Q. The permanent loan was $7,140,000.00. A. That’s
correct.
Q. And yet the interim loan was only $7 million. A.
That's correct.
Q. Why the discrepancy between the interim loan and
the permanent loan? A. Well, at that particular time,
we did have some excess funds which we did not mind in-
flowing in the construction of the building, so took funds
from the working capital rather than increase the amount
of the interim loan.
Q. So immediately prior to drawing on the permanent
loan, what aggregate dollar amount of investment of your
own [78] capitai, of your own dollars, did you have in
the building? A. We had $7,640,000.00 invested in the
building. We had borrowed from First National City Bank
$7 million, so in real estate parlance our equity at that
point was $640,000.00.
Q. When you drew on the permanent loan, what amount
did you receive? A. Well, we borrowed as the note shows
$7,140,000.00 from New York Life.
40
Q. And you applied how much to repay your building
loan agreement to First National City? A. Seven million
dollars.
Q. And what did you do with the balance? A. Put it
in our bank account. Used it to pay salaries and buy more
inventory.
Q. Did Worthen Bank enter into any guaranty agree-
ment whereby it guaranteed payment of your interim con-
struction? A. Not to my knowledge they didn’t.
&. Did they sign the note? Did they endorse it? A. They
neither signed nor endorsed the note. Frank Lyon Com-
pany is the only maker in the $7 million note to First
National City Bank and is the only maker in the $7,140,-
000.00 note in favor of New York Life.
Q. Did they undertake to do anything in the event that
the permanent loan for some reason was not closed? A. I
believe in the consent and agreement they covenanted
[79] to sit down and work out with First National City
Bank a lease acceptable to them which would then be as-
signed to First National City Bank.
Q. But that was only in the event the permanent loan
did not-——A. That’s correct.
Q. Again, this was the loan—your commitment to pur-
chase the building, was it predicated upon receipt of a
permanent loan? A. No, it was not.
Q. In the building loan agreement, did you enter into
any guarantee as to construction of completion to First
National City Pank? A. Let me refer to the building loan
agreement, if I may.
Yes, we do, and on page three of Plaintiff’s Exhibit 21
we do express our covenant to cause to be erected on the
land the Worthen Building in accordance with the con-
struction contract, et cetera. Yes, we did.
Q. The options which were contained in the lease agree-
ment between Worthen Bank as lessee and Frank Lyon
as lessor matured at the eleventh, fifteenth, twentieth and
twenty-fifth vear.
41
Q. These are with the options to purchase? A. Yes.
[80] Q. Were there any other options running in favor
of Worthen Bank to purchase the building? A. Yes. In
the event of the insolvency of Frank Lyon Company, they
had the option to go ahead and purchase the building at
the appraised value.
Q. At what price? A. At the appraised value.
Q. Do you recall why that provision was included in the
sales agreement? A. Well, Worthen did want the right
if Frank Lyon Company went into default to be able to
buy the building and perhaps resell it to another investor
that was not insolvent.
Q. But it would have that right during the first 25 vears
at five year intervals? A. No. There were only four spe-
cifie dates at which they would have it, and if we went
insolvent on any other date those particular option periods
would not help them any.
Q. And the purchase price under that option was what?
A. Appraised value.
Q. How was that to be determined? A. By getting two
appraisers and taking the price and dividing it by two.
Q. We are now to the point where you have entered into
all the agreements with Worthen to buy the building, with
[81] lenders to lend you the funds. Mechanically how did
you obtain funds from First National City during con-
struction?
The Court: Let me interrupt there since we are turning
now and I note the time. I suggest we may want to recess
for lunch. Let me ask a few questions.
I am not sure I understand the situation about building
the building and Worthen had a contract directly with—
The Witness: With Matson Bellow, a joint venture.
The Court: And it was a cost plus contract?
The Witness: That’s correct.
42
The Court: And they had an obligation under these docu-
ments to complete it in accordance with the plans and
specifications?
The Witness: Yes.
The Court: Did it have any—would it have had any
effect upon the transaction had the cost gone to nine mil-
lion?
The Witness: Well, Worthen Bank would have still been
obligated to go ahead and complete the building at what-
ever cost. If it cost them nine million they would have had
to have completed building.
The Court: And it would not affect the agreement here?
The Witness: That's right. We still bought the building
for $7,640,000.00.
[82] The Court: What, if you know, was the reason for
the apparent altruism expressed in the November 1 letter
about, in effect, reducing what you were regarding unilat-
erally: the $21,000.00? You are saying this whole agree-
ment is not really the best for Worthen and ‘‘we accept
your proposal with one major change. Your lease pay-
ment for the first five years will be reduced by $21,000.00
annually.’’
The Witness: We knew there were other very, very
interested investors and we were most anxious to own the
building. They had asked us when they gave us the specifi-
cations for the sale and leaseback to respond in that gen-
eral format or if there were any modifications to let them
know on the letter form. We were thinking that another
bidder migh‘ just say, ‘‘ Yes, I will take the building under
the terms and conditions outlined in the specifications for
sale and leaseback.’? We wanted to underbid them.
The Court: In other words, you wanted to accept it plus?
The Witness: That’s correct. And we just didn’t——
43
The Court: What thought, if any, if you recall, went into
the decision to offer to reduce it by $21,000.00 as opposed
to some other figure?
The Witness: We were kicking around the idea of redue-
ing it by about a hundred thousand and we thought maybe
someone else did that, so we just bettered them $5,000.00,
making [83] it $21,000.00 for five years or a hundred five
thousand.
The Court: T see.
Just one other question before we recess. The financing
on the Twin City came from what bank?
The Witness: Republic National Bank of Dallas, Texas.
The Court: All right. How are we going? Are we losing
ground?
Mr. Williamson: I think we are going a little slowly be-
cause of the length of time in the opening statements and,
consequently, to be sure to get through in two days I
suggest you be a little light on the lunch hour.
The Court: Why don’t we be in recess for one hour,
Court will be in recess. We are going to have to make it
until 1:15 because I have an appointment at 1:00.
Court will be in recess until 1:15,
(Whereupon, at 12:00 noon, the above-entitled proceed-
ings were in recess, to reconvene at 1:15 p.m., the after-
noon of the same day.)
. . . . * 7 . . . .
[84] By Mr. Giroir:
Q. Ralph, when we terminated a minute ago we were
discussing the sales contract and the fact that you bought a
building that was under construction—that is, that
Worthen Bank had under construction on a cost plus con-
tract. A. Correct.
44
Q. Now I asked you earlier how you arrived at the
¢7,640,000 purchase price. Would you state your answer
to that again?’ A. That was the best estimate at the time
of the actual cost to complete the building.
Q. When you say ‘‘the building,’’ what do you refer to?
A. The part of the building that you typically think of as
being a building, eacluding the specialized leasehold im-
provements such as the way one tenant or law firm may
want a [85] library done or the way certain tenants want
certain paneling in the offices and excluding the specialized
banking fixtures: vault doors and other things that a bank
would want to put into any facility that it oceupied.
Q. Did you have any information as to whether Worthen
had gotten estimates on what the cost of the building
would be? A. This was only through oral conversations
with them, and it was their consensus of thinking it would
be $7,640,000.
Q. When you agreed to pay $7,640,000, did you do so
with the realization that they may make a profit on you?
A. Yes. But we felt like that would be a fair purchase price
to pay for that office building and that location.
Q. Did you anticipate that Worthen would have to ex-
pend a substantial amount of its funds for leasehold im-
provements? A. Yes, for the peculiar purposes of any
bank they do require specialized teller equipment and vault
doors and safety deposit boxes that we really were not
interested in owning or do not want to purchase. It was
understood by both parties that Worthen would go ahead
and purchase these and make minor improvements to the
building to make it suitable for Worthen’s peculiar pur-
pose as a banking institution.
Q. The type of things that you would classify as lease-
hold improvements for these purposes, would it include the
paneling on the walls? A. Yes.
[86] Did it include interior partitions? A. Yes.
Q. What other types of items? A. Carpeting on the
floor. I have already mentioned specialized banking equip-
ment. Certainly heavy vault doors.
45
Q. What about consulting or other types of fees paid?
A. Well, certainly anything that had to do with the in-
terior design of the building as far as where you wanted
to use oak paneling or a darker wood would really be up to
the tenant. Painting on the walls, whether it was going to
be white or a bright color.
Q. Did you care what the structural portion of the build-
ing looked like? A. As far as the architectural design, no.
We did care that it was an attractive building and had the
utmost confidence or realized that Worthen wanted it to be
an attractive building and had confidence in the architects
and had seen architectural renderings of the design of the
building. We were not interested in paying $7,640,000 for a
run-down or unattractive piece of real estate.
We did care if it was an attractive building and in that
sense cared what it looked like. The fact that it might
have been colored white instead of maybe some aesthetiec-
ally pleasing design of black and white or bronze glass
didn’t concern us that much.
[87] Q. Turning again to the mechanics by which funds
were disbursed to you from First National City Bank to
fund the construction of the project, how were funds d:liv-
ered to you? A. Frank Lyon Company opened up a regular
demand deposit account at First National City Bank. I
think the initial deposit was something like a hun!red
dollars. After we submitted our written request to First
National City Bank, they would credit our account in t\icir
financial institution with the amount of our requested draw
on the loan.
At that time, after we received notification of this, I
would go ahead and write a regular company check and
deposit it in another account of Worthen’s which was at
Twin City Bank.
Q. An account of Worthen’s? A. Either at Worthen or
at Twin City. We had two accounts. This particular ac-
count was at Twin City Bank.
46
And we would then deposit a check drawn on Frank
Lyon Company’s account with First National City Bank
on our account at Twin City Bank and would transfer the
funds down to North Little Rock in that manner and then
would go ahead, as required, and make disbursements or
reimbursements to Worthen, provided they had satisfied
the requirements.
Q. What requirement did you impose upon Worthen to
justify or to obtain a draw? A. It was laid out in the
sales agreement. We required four things: we required
either an architect or consultant’s [88] certification that
the amount of the materials had really been, in fact, put
in place in the building and had been expanded; we re-
quired an independent C.P.A. firm’s opinion as to the re-
sult of their audit of these particular bills and disburse-
ments to show they had actually been paid and were, in
fact, stated correctly; we required schedules showing what
portions of the building had been completed so we'd have
more detailed access to the information as to what went
into the building; lastly, we required an affidavit from an
officer of Worthen Bank who was the overseer of the con-
struction saying that he was really familiar with these
transactions and made certain warranties and representa-
tions or that Worthen Bank did that the figures were cor-
rect.
Q. Of the documents that you required of Worthen, how
many of those documents or what part of them were re-
quired of you by First National City? A. I think only
two of the four were required of First National City.
Q. Which two were those? A. I think that was the
architect’s certification as to the percentage that was com-
pleted and the C.P.A.’s audit of the figures and funds
actually put into the building—disbursed.
Q. Why did you require the additional documentation?
A. Because we wanted to make sure that they put
$7,640,000 in the building. We wanted to make sure it was
[89] going in there and wanted to get these other war-
47
ranties and representations affirmative] swo
officer of Worthen Bank as additional ve rad rs nd ma
Q. At the time the building was completed, how were
the funds mechanically transferred from New York Life
to you? A. New York Life gave me a check payable to
Frank Lyon Company in the amount of $7,140,000.
Q. Incidentally, where was that closing? A. The clos-
ing was actually in the building—in the completed Worthen
Bank building in Little Rock, Arkansas.
Q. And New York Life delivered a check to Frank Lyon
Company? A. To Frank Lyon Company. I endorsed that
check and deposited it in Frank Lyon Company’s check-
ing account. ,
©. Then what did you do with the deposit or the funds
in Frank Lyon’s checking account? A. That same day I
had given written instructions to an officer of Worthen to
wire the funds through the Federal Reserve System to
First National City Bank in payment for our interim loan.
Q. When you say “wire the funds’? A. Wire
funds. Wire $7 million. .
Q. And the balance of the funds, what happened to it?
A. They just stayed in the checking account.
Q. What documentation do you require of Worthen in
[90] connection with your drawing down the permanent
financing? A. Well, hasicaliy the same—I am sorry. That
we required of Worthen?
Q. Yes. A. With regard to drawing down the perma-
nent financing?
Q. With regard to that? A. The drawing down of the
—_ financing was Frank Lyon Company’s respon-
Q. Right. But did you obtain any assurance for your own
protection from Worthen before you drew the funds down?
A. Okay. We did get affidavits that the building had been
completed in accordance with the plans and specifications
attached and also required as-built plans and specifications.
Q. You testified that you were involved in the decision
at Frank Lyon Company to make this investment.
2 ee, we
48
The Court: Let me back up a moment to the mechanies.
You said you took title to the building piecemeal from
time to time.
The Witness: Yes, Your lIlonor.
The Court: What were the mechanics of that?
The Witness: Well, according to the legal instruments
the title passed to Frank Lyon Company as the building
as the material was actually placed in the building.
The Court: I’m just curious as to the type of instru-
ments. What would it be? That additional space or the
[91] third floor—how did you piecemeal take title?
The Witness: There was a lot of conversation struggling
with that very legal issue. You can get discussion on any
legal issue when you have three or four lawyers involved,
but we did spend a great deal of time discussing that and
finally decided that in the eontext of the sales agreement
that we had, in fact, purchased materials when they were
actually put in place and became a part of the real estate.
The Court: All right.
By Mr. Giroir:
Q. Did we, for our own clarification, describe that as
brick-by-brick? A. That was the phrase we referred to.
We were buying the building brick-by-brick.
©. Would you state the reasons why the Frank Lyon
Company entered into this investment? A. For many
years or for the years immediately preceding the possi-
bility of our entering into the transaction it had been a
stated goal, and perhaps the most important goal of the
company, to obtain some diversification. We realized that
the future of our company really hinged upon our contrac-
tual arrangements with two major suppliers: Whirlpool
and RCA. These contracts could be canceled, really, on 50
days’ notice almost at their whim. We felt it was very im-
49
portant for the continuing existence of the corporation to
diversify into [92] other areas.
Q. Were you at that time enjoying good earnings? A.
Yes, we were.
(). Were there other reasons? A. Yes, there were. Also
at this particular time color TV sets were really in demand
and we were able to sell all of them we could get and were
making quite a bit of money and did have some surplus
funds to invest.
As an aceountant I was also cognizant of the potential
challenge down the road which the service might make
as far as aceumulated earnings, and it was in the best
interest for the company to go ahead and invest those
funds 'n some other investment to protect ourself against
a penaly tax under 531.
(). Were there other reasons? A. Yes. Most all of the
members of the exeeutive committee were familiar with
real estate transactions and had had experiences mvest
ing in real estate. Specifically, | was seeretary-treasurer
of several real estate corporations which paid a mange
ment tee to Frank Lyon Company, reimbursing them for
my time that T spent which had similar investments, such
as the IBM building, Safeway office building, National
Cash Register office building.
The Court: The executive committee of your board of
directors? .
The Witness: Yes that’s correct, Your Honor, It [93]
was at that time Mr. Frank Lyon, Mr. C. W. Abram , and
Mr. Nash Abrams. I believe Mr. Dick Woodmansee also
at that time.
By Mr. Giroir:
Q. Were there other reasons? A. Yes. As financial
officer for the company I realized it is very important to
obtain good relationships with your primary bank, and
Worthen was our primary bank. Personally I felt if we
50
could go ahead and have a long-time mutually profitable
relationship between them this would, in a sense, cause
them to look more favorably upon us for future needs of
credit down the line should anything else come on the
horizon.
Q. Any other reasons? A. Just analyzing the invest-
ment itself, it seemed to be a very profitable investment for
Krank Lyon Company. While, as owner of the building, we
would be able to select various methods of depreciation
under the Internal Revenue Code, either straight line or
one of the accelerated methods, if we elected an aecelerated
method this would be a tax shelter for the early years. In
fact, an analysis showed we would shelter in the aggregate
about $3 million of taxable income during the early years
ana, in effect, save for a time about a million and a half in
income taxes,
Also during this time we had an investment in which we
were continually building up an equity in the building, and
although that was no immediate cash flow, as far as the
[94] difference in the rental income we received and the
amount required to service New York Life debt, at the
end of the 25 years we would have owned and will own the
building free and clear, a building which it cost $7,640,000,
Q. Any other reason? A. Well, yes. Continuing in
the time frame, should Worthen at that time eleet to exer-
cise its option to rent the building, we would receive both
pretax and after tax cash flow. Since we would have no
payments to New York Life or any other lender, we would
receive the rental income and our expenses directly related
to that building would be the ground rent, which I dis-
cussed earlier, and this would be a net cash profit to the
company.
If the building lease continued at Worthen’s option to
renew to the end of the 65 years, we would then be in a
position of having them obligated under the ground lease
for a 10 year period requiring us to pay $2,000 a year. I
don't know what the fair rental value of that building
4
“|
will be in 50 years at the initial time, 65 years from the date
that the agreements were entered inte; but even if you
assume a continuation of the same building rent of $00,
000, this would mean that in each year we would receive
in excess of a quarter of a million dollars. specifienlly
$290,000 for the 10 year period. That's an aggregate of
$2,900,000,
Q. Any other reasons? [95] A. As I think | mentioned
this morning, | was very concerned about what was wenn
to happen after everything was said and dene and some-
what hopeful I'll be alive to see it although Ul be ninety
some odd years old, |
We «id obtain a legal opinion from Mr. Bill Nash of the
Rose law firm that tithe would still remain in Frank Lowon
Company and this would be, then, a very, very valuable
asset of the company at that particular time whieh we
could perhaps sell back to the owner of the ground or take
whatever steps we wanted to do to either continue to rent
itor perhaps otherwise dispose of the asset.
Q. Let me for a moment quantify the types of financial
inducements you felt you had. Let me talk about them with
you in terms of the pure economic rewards and rewsrds
giving consideration to tax benefits.
It seems that the pure economic rewards you referred
to are primarily the renewal of the lease which will pet cou
how much in the aggregate, approximately? A. Tt will
be several million dollars. About over whieh period are
you talking about?
Q. The full 25 to 75 years—your projections. A. May
I refer to my schedule? .
Q. Yes. That's P?X.36, I believe. A. Were you refer
ring to the gross rental income or the net rental income
after we deducted the amount due to the 16) grown
lease?
Q. The net. A. All right. The net will be a hundred
thousand dollars for a five year period which would be
ee
52
I’m sorry—a hundred thousand dollars fer the five year
period, which would be $500,000.
Q. Let’s start backwards. During the last 10 years you
are going to net how much? A. If you assume that we
will continue to rent the building to Worthen for $300,000,
we will net $290,000 per year. For the 10 year period that’s
going to be $2,900,000. ;
Q. And then you’ve got what, four five-year periods?
A. There’s a 20-year period or 25-year period. I think
it is in the ground lease referred to as four five-year pe-
riods and then an additional 20-year period.
Q. And in each of those five-year periods you will net
how much? A. Well, in the——
Q. Is it 250% A. Let me refer to the ground lease, if I
may, which is Plaintiff’s Exhibit 18.
During the time from the 25th year to the 30th year the
building lease calls for rental to be paid to Frank Lyon
Company in the amount of $300,000. We have to pay $100,-
000 per year on the ground. That’s a net of $200,000 for
the five-year [97] period, which would be a million dollars
in hard cash.
For the second five-year period the net is $159,000 times
five is three-quarters of a million dollars or $750,000.
In the third five-year period the net is $100,000 a year
—that’s net income to Frank Lyon Company—times five
is $500,000. And then for a 25-year period there is a net
of $50,000 per year, which would be a million and a
quarter.
Then for the last 10-year period we don’t know what
the building rental will be, but if you assume a $300,000
annual! building rent, it would be $2,900,000 in the aggre-
gate. . .
. So, roughly, $6 million? A. $6 or $7 million, yes.
. And does that, to you, seem like a substantial benefit?
A. It certainly is to me.
53
Q. Now there’s been much conversation this morning in
opening statements about there being no inducement to
make the investment other than the tax benefits during
the 25-year period. Does Frank Lyon individually or the
company have any history of making investments that have
no benefits other than following the termination of the
initial lease? A. They certainly do. There are several
buildings which are owned by corporations where the <ole
function of the corporation is just to own those buildings.
Specifically the IBM building in the Industrial District,
Stover Medical Supply [98] building also located in the
Industrial District, National Cash Register building lo-
cated in the old Safeway Office Building downtown, a retail
store which, incidentally is built on leased ground in
Springfield, Missouri, which was originally leased to Gib-
son Products Company and now leased to Handy Dan
Home Improvement Center.
All these real estate investments are held by and owned
by separate real estate corporations. The stockholders re-
ceive absolutely no tax benefit from them.
In all of them the rental payments are approximately
equal to, although not identically equal to, the amount re-
quired to service the debt. In those cases we either elect a
straight line method of depreciation or sometimes we effect
an accelerated method of depreciation and do go ahead
and create net operating losses that can be carried forward
in that corporation for five years.
Q. Is there any income in those corporations to offset
the net operating loss? A. No. The corporations only own
that particular real estate.
Q. Do the corporations have any value in the real estate
other than the residual value? A. That’s all they have.
Rental income is approximately equal to debt service.
There's a little bit left over to pay Arkansas franchise tax
and a management fee that goes to Frank [99] Lyon Com-
pany for my time that I spend on them.
ot
The whole design is that after the mortgage is paid the
corporation will own free and clear the real estate.
Q. Looking only at the residual value then, are these in-
vestments any different from the Worthen Bank Building?
A. None whatsoever.
Q. Turning then from the non-ecoromic to the tax bene-
fits, did you elect an accelerated method of depreciation?
A. Yes, we did.
Q. What benefit does that result in? A. Well, in the
early years allows deductions in excess of the rental in-
come. In the later years we have excess income if you will,
over and above the deduction. So what we do is save in-
come tax in the early years and pay more income tax in
the later years.
Q. Do you know at what point in time in this lease that
the tax shelter becomes a negative tax shelter? A. Yes.
In 1980 is the last year that we shelter any income. We only
shelter about $25,000 in that vear.
Q. In the period up to 1980 approximately how much in-
come and approximately how much tax do you save in the
aggregate? A. We shelter approximately $3 million dol-
lars in income and, therefore, save a little over one and
a half million dollars in income tax.
Q. During the years from 11 through 25, approximately
[100) how much negative shelter do you have and approxi-
mately how much tax do you incur? A. We would be pay-
ing approximately a million and a half in taxes over the
last 15 years of the lease. In 1993, for example, our tax
liability would be, according to these projections, about
$228,000 in that one year based on this transaction only.
Q. Would that be the highest year? A. No. In 19%4 it’s
$232,000. About a quarter of a million dollars a year.
Q. That’s the highest amount of negative tax shelter?
A. Yes. Now I’m speaking of the income tax we would
actually pay. The negative shelter is closer to half million
dollars. My computations show that in "92 for example, we
will have taxable income of $436,000; in '93 about $477,000
taxable income.
55
Q. That’s income which you are paying taxes on for
which you are not receiving cash flow? A. That’s correct.
Q. In view of that, what would induce you or what did
induce you to elect the accelerated method? A. It’s really
the economic concept of a current dollar being worth more
than a future dollar. There’s a real economic benefit to us
in being able to shelter approximately $3 million of tax-
able income in these first 10 years and, in effect, save ap-
proximately one and a half million dollars of income tax.
{101} Q. Did you do anything specifically with the dol-
lars that you sheltered? A. Yes, we did. I mentioned
earlier that it had been the stated objective of the cor-
poration to go ahead and diversify. Fortunately, very
shortly after this transaction was completed we learned
that both the majority stockholders in Coca Cola Bottling
Company and the Twin City Bank were going—wanted to
sell; and really were in not for structuring our ownership
of the Worthen Bank Building in this way, we would not
have been able to purchase both Twin City Bank and Coca
Cola. We could not have paid for them.
Q. Would you elaborate on that? Exactly how did this
tax saving enable you to pay for Twin City Bank and the
Coca Cola Company investment? A. Well, we were able
to reduce our tax liability in 1969 by approximately $257,-
000. In ’70 we reduced it by approximately $294,000 dollars
and about $212,000 in ’'71.
This means that the corporation was able to retain «ol-
lar amounts of approximately a quarter of a million dollars
a year that otherwise would have yone in the United States
Treasury. We were able to take those dollars and pay
them out to third parties: namely the ex-shareholders of
Twin City Bank and Coca Cola, in order to acquire those
invest ments.
Q. If you had not made these investments, would you
have been able to accumulate cash? [102] A. Yes, we
would have.
a
Q. Did you accumulate sufficient cash to pay the full
payment for these investments? A. No, we did not, It
was necessary in both instances to go ahead and obtain
outside financing to pay the entire purchase price, The
majority stockholders from whom we purchased the ma-
jority of shares in the Twin City Bank wanted a cash set-
tlement. It was bought from the estate of HL. Tupp. They
just wanted cash.
We were able to go ahead, partially through our own
funds and partially through negotiating a loan with Ke-
publie National Bank, acquired the funds. However, in ne-
gotiating the loan with Repubhe National Bank we were
able to use our tax savings in subsequent years te, in
effect, repay that debt and were not required to rely solely
upon Twin City Bank's paying a dividend it Frank Lyon
Company to enable us to service the debt, As a matter of
fact Twin City Bank has never paid a cash dividend since
the time Frank Lyon Company aequired the stock. They
have retained all earnings for their own internal purposes.
Q. Of the initial purchase price for Twin City Bank
stock, do your records reflect how much you paid eash out
of the corporate funds and how much you paid out of the
proceeds of the loan? A. Honestly, most of it was bor:
rowed from Republic [108|) National Bank but with the
idea of keeping the tax savings on this venture to help us
service the debt in future years. That was on a 10 year
loan.
Q. Has it been serviced? A. Yes, it has, Never missed
an interest or principal payment.
Q. With respect to the investment in the Coea Cola Com
pany, how much of your own funds did you use in that
instance? A. It was 29 percent of the purchase price.
The selling stockholders were very insistent on getting thal
amount in cash. We, at that time, had to borrow, | think
it was, a half million dollars from Worthen to make that
cash payment. The selling stockholders also wanted the
balance for the remaining 71 percent over a relatively
n7
short period of time. Specifieally, they wanted it over four
years with interest, of course.
Q. | believe you testified this morning that the ayere
gate down payment for Coke stock was approximately a
million dollars, A. 1 think that's eorreet, .
Y. So you paid A. Yeu,
(). then, 500 out of your corporate funds, borrowed
900 from Worthen, and entered inte note agreements with
other stockholders obligating you to pay approximately
2.000 over what period of time? [104] Al Well, the bal
ance was payable over a four year period, Four equal in
staliments of principal, plus interest.
Q. Have those been paid on time? A. Yes, they have.
Kvery one of them. .
Q). Have those investments been good investments? A.
They have been very good investments for ws.
Q). Approximately how much per year de those invest
ments contribute to the earnings of Frank Lyon Company?
A. We account for those things by reporting our equity
moearn consolidated subsidiaries, This year after taxen
Coen Cola Bottling Company will earn approximately
$750,000, Twin City Bank will earn after taxes Appross
mately $700,000,
Q. Do you think the investment in those companies and
the earnings they have generated justifies you im bemg
penalized with this negative tax shelter? A. ‘They cor
tainly do, because there's no way we could have paid for
and acquired both of those investments um. or the terns
that we did pay for them without a tax shelter,
Q). Now when Frank Lyon Company entered into this
transsetion did it intend to be a mere accomodation
party for Worthen Bank? A. Absolutely not,
Q. Died it intend to be a straw man? A. Absolutely not,
Q. Is Frank Lyon Company's general eredit obligated on
[105] the note to New York Life Insurance Company? A,
It quite clearly is. | also point to the requirement in the
note purchase agreement where we do warrant our finan
58
cul statements for five preceding years and aiso are re-
quired to furnish them audited statements—they want two
copies, incidentally—for every year that the note Is still
unpaid for the 25-year period.
Q. On those financial statements how do you reflect your
ownership of the Frank Lyon Company? A. We show
that as an asset, originally of $7,640,000. Since it is a de-
preciable asset, we reflect it at the original cost, less the
accumulated depreciation. And today it’s on the books for
a little over $6 million.
We also carry, of course, the note payable to New York
Life on our balance sheet as was the note to First National
City Bank until it was paid.
Q. Does Frank Lyon Company have any agreement—
written, oral, implied, or otherwise—with Worthen Bank
under which Worthen Bank agrees or promises to exercise
its option? A. To my knowledge they do not.
Q. Does Frank Lyon Company have any form of agree-
ment with Worthen Bank whereby they agree to pay Frank
Lvon either its $500,000 equity investment or to hold it
harmless from loss on its $7,140,000 note obligation? A.
To my knowledge, no, they do not. Such an agreement
{106} does not exist. | |
Q. At the time of these agreements, was if your inten-
tion of the other parties of Frank Lyon Company to be-
come the owner of the Worthen Building? A. We clearly
intended to be the owner and are the owner of the Worthen
Building.
Q. The obligation which appears on your balance sheet
for $7 million approximately to New York Life now. How
long will that appear on your balance sheet? A. For 25
years. |
Q. Will that have any effect on your corporation opera-
tion? A. It certainly will. One factor all creditors look
at is who else you owe, and the fact that we have borrowed
this amount of money from New York Life Insurance
Company does restrict the additional amount of money we
might borrow from another financial institution.
59
Q. Did either New York Life Insurance Company, First
National City Bank, or any other party in the transac-
tion to your knowledge consider or treat Frank Lyon to be
anything other than the owner of the building? A. No,
sir, they did not.
Mr. Giroir: I have no other questions.
The Court: Are all the agreements between the plain-
tiff and Worthen and the banks with respect to this trans-
action [107} in writing and here before us?
The Witness: Yes, Your Honor, they are.
The Court: There are no other outside oral or other
agreements of any kind?
The Witness: Not to my knowledge.
The Court: Any further questions?
Mr. Giroir: No.
The Court: Mr. Sayre, you may cross examine.
Cross EXAMINATION
By Mr. Sayre:
Q. Mr. Cotham, I have caused to be served on you a
subpoena to bring with you the calculations that you pre-
pared for Frank Lyon Company with regard to this trans-
action and the financial tax position it pat the company
in. Have you brought any of those requested documents
or do you have any? A. Yes. Our entire file is sitting in
the back of the courtroom on that bench in a brown enve-
lope.
Q. Would you please produce or get the file relating to
the calculations that you made?
Mr. Cotham, in going through your files have you located
any original copies of calculations you made concerning
the economic tax position of the company if it entered into
CG ———————————E ee ———————————E—OO
60
this arrangement with Worthen Bank? A. Mr. Sayre,
after the negotiations were completed and the documents
signed, I went through and did clean out the [108] files.
I have, however, reconstructed the benefits that we looked
at at the time, and these schedules do—Plaintiff’s Exhibit
36 corresponds to my best recollection to exactly what we
looked at at the same time we were looking into going
into this proposition.
Q. And you were planning to use—the company was
planning to use the double declining balance method of
depreciation? A. Yes, we were.
Q. Was the idea to shelter income from the appliance
business’? A. Yes.
Q. The depreciation deduction is actually a paper trans-
action. There is no cash pay for that amount, is there? A.
Cash is paid when you purchase the building or purchase
the assets.
Q. And how much did Frank Lyon put in in all cash?
A. $7,640,000.
Q. Of its own money? A. Of its own money.
Q. Without borrowing any? A. No, not without bor-
rowing.
Q. How much did it borrow? A. From First National
City Bank we borrowed $7 million. So on November 30
of °69 we had put $7,640,000 in the building. [109] We had
borrowed $7 million from First National City Bank and
in real estate parlance had an equity of $640,000 in the
building.
Q. So in net effect Frank Lyon Company put $500,000
from its own cash from retained earnings into the Worthen
Bank Building? A. No, we put $7,640,000.
Q. Of your retained earnings? Not counting borrowings.
How much retained earnings did Frank Lyon Company
rut into the Worthen Bank arrangement? A. I’m not sure
exactly how you are using ‘‘ retained earnings’’.
Q. Wasn't there a cash expenditure from the company’s
retained earnings of $500,000, a borrowing from New York
Life of $7,140,000 to pay the entire amount of the trans-
61
action with Worthen Bank: is that correct? A. Again,
we put $7,640,000 in the bank. We did borrow from New
York Life $7,140,000. In real estate parlance our equity
in the building was $500,000. I don’t know how you cor-
relate the exact dollars as far as coming from retained
earnings or—
Q. It cost the company in cash out of its earnings $500,
000; is that correct? A. No.
Q. What did it cost from the company’s earnings to
[110] construct the building or pay for the building? A.
I’m not sure how you get from net earnings to net assets.
I’m not trying to be cute or unresponsive to your question.
Q. A specification sheet, which is Plaintiff’s Exhibit 13.
there is a statement that the investor is expected to put
up $500,000, Is that what Frank Lyon Company put up?
A. I assume you’re talking about paragraph number one
on Plaintiff’s Exhibit 13.
Q. That’s correct. A. Yes. As I testified, that was the
equity.
Q. My question was: The equity came from cash or
money that Frank Lyon Company already had and was
not from outside borrowings that it put in; is that cor-
rect?
The Court: You really asked whether it was from re.
tained earnings.
By Mr. Sayre:
Q. If it came from current expenditures or retained
earnings. It was cash that the company had; is that cor-
rect? A. Immediately before the New York Life loan
was closed, our equity was $640,000.
Q. After the New York Life loan was closed. A. We
had borrowed $7,140,000 from New York Life. We had
purchased the assets for $7,640,000,
©. And that left the company putting into the venture
{111} $500,000; is that correct? A. As I testified, that is
our equity in the investment.
62
Q. Then it came either from current earnings or retained
earnings; is that correct? A. On borrowings or sale of
other assets or liquidation of accounts receivable.
Mr. Sayre: Would you make this as Defendant’s Ex-
hibit 18.
(The document referred to was marked for identification
as Defendant’s exhibit 18.)
By Mr. Sayre:
Q. I hand you what’s been marked as Defendant’s ex-
hibit 18 and ask if you can identify that, please. A. Yes,
I can. This is a photostatic copy of the general ledger of
Frank Lyon Company at 12-31-69.
Mr. Sayre: Your Honor, I would offer into evidence De-
fendaut’s exhibit No. 18.
The Court: Any objection?
Mr. Williamson: That was Defendant’s exhibit 18?
Mr. Sayre: Yes, sir.
Mr. Williamson: I thought it had been offered. No ob-
jection, Your Honor.
The Court: Defendant’s exhibit 18 is received.
(The document previously marked [112] for identifi-
cation as Defendant’s exhibit 18 was received in evidence.)
By Mr. Sayre:
Q. And you say about the time you closed with City
Bank—excuse me—closed with New York Life paid off
City Bank, that wasin— A. On November 30, 1969.
Q. And during August of 1969 did Frank Lyon Company
borrow an amount of $500,000 from the Worthen Bank?
A. Yes, on August the 21st, 1969, we did.
Q. And that is reflected on the second page of Exhibit
18 as a $500,000 credit? A. That’s correct.
63
Q. It doesn’t show any payments made on the loan in the
year 1969. Were principal payments made in 1969? A.
No, it was a one-year note.
Q. Was it paid at the end of the year? A. No, we asked
Worthen to renew it.
Q. Have they renewed it? A. Yes, they have.
Q. And they have renewed it every year since; is that
correct? <A. Yes.
Q. At the request of Frank Lyon Company? A. At the
request of Frank Lyon Company.
[113] Q. Now your other debts as shown on this general
ledger sheet, there are payments made on a loan to First
National Bank of Little Rock and to accrued life insur-
ance. Also another loan to Worthen Bank on which there
are payments of $12,500. May I ask why there’s been no
payments on this $500,000 loan. A. It depends entirely
on the terms of the note. The note you have referred to to
the First National Bank and the other note to Worthen
Bank were five-year notes requiring quarterly principal
reductions of, in the case of Worthen Bank $12,500 a quar-
ter; in the case of First National, $11,875 with a balloon
at the end of five years.
Q. So tlis was a different type of note from the normal
note that you entered into? A. Different from those two
preceding notes, yes.
Q. This note was made some two months before the
closing—two or three months before the closing—and to
date there has been no payment of principal on that $500,-
000? <A. That’s right.
Q. And the $500,000 is the amount of equity that the
Frank Lyon Company had in the building—excuse me, in
the Worthen Bank Building as of the date of closing? A.
After the permanent loan was closed, yes.
Q. Now if you will look at Plaintiff's exhibit 13, which
is the specification sheet—
The Court: Let’s don’t go by that. Your commitment
[114] was made in October of whet vear?
64
The Witness: 67 Your Honor.
The Court: All right. Now at what time did anyone in
your company to your knowledge become aware of or in-
terested in any possibility in connection with the acquisi-
tion of the Coca Cola stock?
The Witness: It was in late July or the first of August
of 1969.
The Court: ’69?
The Witness: Yes, sir.
The Court: And the acquisition was actually made in
"697
The Witness: It was on August 21st, 1969.
The Court: And you borrowed from Worthen a half
million dollars?
The Witness: Correct.
The Court: On a one-year note which has been renewed
from time to time thereafter?
The Witness: Yes, Your Honor.
The Court: Now was there any relationship of the Coca
Cola acquisition to this transaction?
The Witness: None whatsoever.
The Court: Was there ever any other agreement, hid-
den or otherwise, or representation by Worthen that back
in October of 1967 that, ‘‘If you will do this now we are
going to be very [115] lenient with you or will provide
capital for your future acquisitions,’’ or was there any
such understanding at all?
The Witness: Not to my knowledge.
The Court: Let me ask you Mr. Sayre. I want to follow
the testimony and be sure I am aware of the significance
of each bit of it that you bring out. What is the Govern-
ment’s position in connection with the half million dollar
loan by Worthen which has been renewed from time to
time, which apparently was used by plaintiff in connection
with the acquisition of the Coca Cola stock. What relation-
ship does that have to this transaction?
Mr. Sayre: May I ask the witness one question to clarify.
By Mr. Sayre:
(). Has there been any other loans? I believe I asked
you to bring records of all loans. Are there any other loans
to Worthen outstanding during that period of time other
than those shown on the exhibit? A. These were the
ones outstanding at that time.
The Court: What exhibit are you referring to?
The Witness: Defendant's Exhibit 18, Your Honor.
By Mr. Sayre:
Q. And has there been any other loan from Worthen
Bank that has been deferred in this manner as this $500,
000 loan has? A. We have complied with all the terms of
each loan. [116] The one to First National Bank and the
one to Worthen were originally $500,000 loans. They were
five-vear loans requiring quarterly reductions of princi-
pal. That was not—this was a one-year loan.
Q. Why was thir handled differently and why has no
payment been made? A. Because the very heavy debt
payments we had to make to the ex-stockholders of Coca
Cola being paid over a four-year period. We had to pay
in principal approximately $600,000 a year to them, plus
interest. So we had to pay somewhere between three-
‘marters of a million and a million dollars to them. At
that time we did not want to obligate ourselves to make
any fixed reduction of that note, and in talking with the
officers of Worthen we thought the best way to handle it
was, ‘‘They can loan it to us for a year. We will take a
look and see what our cash position is. We may pay it
in full or renew it or pay it in part.”’
The Court: What has been the practice? Just paid the
yearly interest?
The Witness: Yes, sir.
The Court: Have the renewals been on the same inter-
est’
The Witness: Prime has gone up since then.
The Court: Is that prime?
The Witness: I think it was a half over prime. I’m
sorry, Your Honor. I’m thinking of the other half million
[117] dollar note.
No, this one, I believe, because Worthen realized it might
be a long-term commitment, I think the interest rate was
around nine percent. I think that the prime was around
six and three-quarters. So it would have been about two
over prime.
By Mr. Sayre:
Q. Mr. Cotham, you said Worthen was aware this might
be a long-term. You said that Coca Cola Company is net-
ting $700,000 a year in income and your tax shelter, I
believe, was substantial in these years. A Yes.
Q. But you only had to pay $600,000 ir. peyment to the
over actually a three-year period or four-year period.
A. Four equal installments of principal.
Q. Of 61 percent? A. Right, the 71 percent.
Q. So what I’m asking you is: Why was this loan handled
differently if you had that kind of cash flow than any
other loan from Worthen Bank? A. The earnings of the
Coca Cola Company have all been retained by that cor-
poration, and they have used those to go ahead and ex-
pand the physical plant and for purposes solely related to
the Coca Cola Bottling Company.
67
Q. Is it a wholly-owned subsidiary? A, Wholly-owned
subsidiary.
[118] Q. Does it file a consolidated return? A. No. it
does not, and there has been no dividend paid. Therefore,
we did not have that cash. The only cash that Frank Lyon
Company had was from the earnings on the sale of the
appliances. This was sheltered by our real estate invest.
ments. However, at this time we had note obligations to
Worthen Bank on the half million dollar note that was
negotiated, I think, in "66, "67 requiring quarterly redue-
tions of $12,500. We had quarterly reductions to First
National Bank of $11,875. We had annual installments of
approximately $600,000 to the “‘X’’ stockholders of the
Coca Cola Bottling Company, and we had principal pay-
ments of around $300,000 a year to Republic National
Bank.
Q. Did Frank Lyon Company, during the years in which
this Coca Cola debt was outstanding, have taxable income
for federal tax purposes—— A. The Coca Cola Company?
Q. No, Frank Lyon—or did it operate as a loss corpo-
ration? A. For 1969 I believe we had a operating loss.
Q. What about the subsequent years? A. I’m not «ure.
‘70 I don’t believe that we did.
Q. You don’t believe that you did what? A. Did have a
net operating loss.
Q. And you have had taxable income since then? [119]
A. Yes.
Q. But you haven't used those funds to retire a debt of
the corporation? A. We have.
Q. But not this particular debt? A. That's correct. not
that particular note.
Mr. Sayre: Your Honor, the purpose of pointing this out
is to show the circumstances were at least in a time frame
close to the time of the closing of this arrangement with
the permanent financing from New York Life and that the
loan has been handled in a manner different from any of
the loans Frank Lyon has made from Worthen Bank.
68
These partics were fairly closely related in their nego-
tiations on this building, and I believe it’s pertinent to
show a different kind of dealing in an amount which is
perhaps coincidentally or perhaps purposely the same
amount as the equity in which Frank Lyon put into the
building.
The Court: I want a little better explanation. It looks as
if you look upon it as some sort of a suspicious circum-
stances, and I want to follow the inferences that are to be
derived from that.
Are you suggesting that it is evidence of a hidden agree-
ment or an additional benefit that would acerue to the
plaintiff if it entered into the bank arrangement?
Mr. Sayre: Yes, sir, I think, Your Honor, it is an [12]
inference of an understanding.
The Court: If, in fact, it was so, how does that
strengthen the Government’s position? Isn't it one of the
problems that they do not charge more in connection with
their offer to act as investor in this case than perhaps
others or the ones they were negotiating with?
Mr. Sayre: It would show that Worthen Bank, it is the
Government’s position, is the true economic owner for tax
purposes of this building and that in essence they had sub-
sidized the investment of Frank Lyon Company by lending
them $500,000 which has not to date had any payment paid
on it and is treated differently from any other loan Frank
Lyon has now or has had with the same lending institution.
The Court: Well, you mean they had at the time they
put up this money, some $500,000—you eall it retained
earnings.
Mr. Sayre: Frank Lyon had an equity and expenditure
of $500,000,
The Court: Now the suggestion is, then, they would not
have put that money in or they needed it in their own
business if they did not have some commitment from the
bank to replace it, in effect, by a loan in the future.
Mr. Sayre: Your Honor, Mr. Cotham has testified the
tax effects or the tax shelter was desired to shelter the
income from tax—unrelated or other income of the corpo-
ration from the IV appliance sales from taxation.
{121} In this manner they could have invested their
$500,000 into the Twin City Bank and put the additional
$500,000 that they put into the bank into the Twin City and
borrow it.
Instead of that, they chose to buy the tax benefit, that
being the depreciation deduction, and then Worthen Bank
has made a loan to Frank Lyon Company which is identical
in amount to the amount which was handed two month-—
over this period of time or the net effect of $500,000 put
into the building by Frank Lyon Company.
The Court: Mr. Cotham, how about the Twin City invest-
ment’ Was that opportunity known to any of the officers
of the plaintiff or yourself at the time that you made the
commitment on this bank building?
The Witness: No, Your Honor, it was not. That only
became available when the president of the Twin (‘ity
Bank, Mr. H. L. Tupp, died and the heirs of his e-tate
decided to liquidate his investment.
The Court: He died when? In "68?
The Witness: I just don’t recall the date of his death,
but I believe it was in the spring of "68.
The Court: And did that transaction have anything to
do wiih this——
Mr. Sayre: Excuse me, Your Honor. I believe I said
Twin City Bank and I believe we are talking about Coca
Cola.
70
The Court: We are talking about both, I guess, if [122
you’re looking at both. Mr. Cotham testified the company
was doing well and looking to diversify and shows this
particular opportunity to look upon it as such and as a
consequence of it created the potential acquisition of still
others.
But these others, at least one of them some two years
later shortly before the closing of the loan, required acdi-
tional money they had to borrow. If it had some relation-
ship, if it was part of the transaction, a hidden part of it,
and if that is what I should be looking for [ want to and
to follow your theory. But the Court just—I am like you:
$500,000, suspicious circumstances. But suspicious of what,
and how am I to follow it through and be sure I get your
point’? From time to time when you are trying it to the
Court I’m going to be asking questions to find out why
you are asking.
By Mr. Sayre:
Q. With regard to the interest rate, is it still earried at
nine percent? A. I believe so, yes.
Q. Which is how much below the prime? A. Well, until
the Brock bill was passed we had a 10 percent usury
limitation and all our notes to the Arkansas banks had
been 1 percent.
Q. And it is still carried below prime? A. Yes. I don’t
recall the exact rate; between nine and ten percent.
{123| Q. It’s your testimony that to your knowledge
there was no understanding of Worthen Bank that it would
make a loan of $500,000 to Frank Lyon Company about the
time of the closing? A. That’s correct. There was no
understanding.
Q. Now with regard to paragraph one of Exhibit 15
which is b under specification, ‘‘equity to be supplied by
investor, $500,000, and annual rate of interest to he
charged thereon, six percent.’’ That’s couched in terms of
a debt. You pay interest on a debt obligation.
71
It’s the Government’s position in this ease that in sub-
stance for tax purposes Frank Lyon Company made a loan
to the Worthen Bank of $500,000. May I ask why or how
it was calculated that six percent would be returned on
that money and also how in Exhibit 14 the Frank Lyon
Company acknowledged that there would be six percent on
the second page? A. To answer your first question, the
sale and leaseback was directed by the officers of Worthen
Bank. I don’t know why they phrased it that way.
In response to your second question, we quote Virtually
verbatim their specification for sale and leaseback they had
handed us approximately two days earlier without altera-
tion except for an offer of the $21,000 that we mentioned
in paragraph two of the lessor.
Q. With regard to that $21,000 actually you said you
made that as an inducement. The actual terms of the agree.
ment [124] between Frank Lyon Company and Worthen
Bank do not reflect that $21,000 saving, do they? A. That's
correct, they do not.
Q. They go back to an amount in excess of $571,000—
$523,000), A. What five eighty-three?
(). Instead of $142,000, it’s a little over $143,000; ix that
correct? A. I don’t recall off-hand without referring to
the note. Whatever the note savs is correct.
Q. Well A. What exhibit is that?
Q. Look at your debt service, which is Defendant's ex
hibit No. 7, and it will show you the amortization schedule.
I think the note is probably Exhibit No. 26 or 27. A. Rivht.
Yes, it does require quarterly installments of $145,551.03.
Q. So there was no saving of $21,000 by the bank hy
agreeing to Frank Lyon’s proposal A. Correct.
Q. —for accepting Frank Lyon’s counter proposal. A.
Correct.
Q. Now you stated you made these caleulations and one
of the intentions was to shelter income by use of the double
[125] declining balance method of depreciation. A. That's
correct.
72
Q. Now was it also one of the considerations that at that
time Section 1250 of the Internal Revenue Code provided
for recapture on accelerated depreciation of buildings? If
a building was held longer than 19 years there would be
no recapture. A. | was aware of that provision, ves.
Q. So the first option date being 11 years would mean if
the transaction stood without being questioned that capital
gain would be realized on the entire amount of the exercise
of the option price, if exercised? A. Correct, but the op-
tion periods were dictated by Worthen.
®. You were aware of the fact? A. I was aware of the
facts, yes.
Q. May I ask why—you said 11 vears is the maximum
shelter that can be achieved. A. Yes.
(). Then it starts to go back the other way? A. Yes.
@. May I ask why the rental payments were designed to
change at 1) vears and increase and did increase some
$8,000? A. This was part of the package that Worthen
Bank had offered to us, Plaintiff’s Exhibit 15.
[126! Q. I believe these figures were not used. The other
figures were used. In your note you read a moment ago,
$145,000 and $153,000 were actually used. Why did Frank
Lyon Company agree to the increase in rent after the end
of 11 years? A. The rental income and the debt service
were to be approximately equal.
Q. They weren’t to be approximately equal; they were
to be exactly equal; is that correct? A. They were equal.
Q. To the penny? A. To the penny—for the first 25
vears,
Q. Now going back to Exhibit No. 13, Worthen Bank
had contracted—had already broken ground in September
of 1967 on the construction of the property; is that cor-
rect? A. Yes.
Q. And Defendant’s Exhibit—I don’t remember the
number right off, but the contracts between the architect
and the bank, between the overseeing consulting engineer
and the bank, and between the construction company and
the bank were all in effect prior to the time that Frank
73
Lyon came into this arrangement; is that correct? A.
That is correct.
Q. And during the entire period of construction of the
bank after Frank Lyon Company came into the pieture in
May of 1969, the bank continued to oversee the operation
at the site [127] and the actual construction of the bank?
A. That is correct.
Q. You did not assume any obligation under the con-
tracts with these building architectural entities? A. Not
with the architect noi with the contractor, that’s correct.
Q. And one of the reasons was because Worthen Bank
wanted to save approximately $125,000 in sales tax that
it could save as the builder of the building: is that correct?
A. That’s what one officer told me, ves.
Q. If vou, being Frank Lyon Company, had purchased
the building or, in effect. vou really didn’t purchase a
building as such; it was under construction at that time
and you said you purchased a little bit as it went up: is
that correct? A. That’s correct.
Q. If Frank Lyon Company had built the building and
leased it back, the amount of sales tax would have been
added into the cost; is that correct? A. Yes.
Q. So there was a savings to Worthen Bank of $125,000
by doing it in this manner; is that richt? A. That’s cor
rect.
Q. Under Exhibit 13, one of the requirements was that
all investment credit and sales tax savings with regard to
the construction of this building be passed throuch to
Worthen Bank; [128] and it was, in fact, passed throuch?
A. Yes, it was.
Q. So all investment credit on the building itself or the
equipment in the building went to Worthen Bank rather
than Frank Lyon Company? A. Yes.
Q. And prior to Frank Lyon Company getting into this
arrangement, there had been numerous trins by Worthen
Bank to New York to visit with First National City Bank
and also with New York Life, and they had commitments
74
for interim and permanent financing before Frank Lyon
Company came into the picture; is that correct? A. I have
no knowledge about any trips they took. I do know they
had made initial contacts.
Q. And they had commitments on the financing subject
to finding an acceptable investor? A. Subject to the
lendor’s—yes, approving the borrower.
@. Now this exhibit savs that the interim financing is to
be supplied by City National Bank of New York at prime
rate, such interest to be paid by Worthen on amounts
actually disbursed.
The Court: Where are you reading from?
Mr. Sayre: The next to last paragraph before the num
bers, Your Honor.
The Court: In which document?
Mr. Sayre: Exhibit 13.
[129] The Court: Oh, I see.
Mr. Sayre: There’s a series of numbered paragraphs,
and it was the one before.
The Court: All right.
By Mr. Sayre:
Q. Now under the proposal of Worthen Bank they
would pay the interim financing interest charge; is that
correct? A. That’s apparently what the specification of
the sale and leaseback provides, ves.
Q. And did they pay the amount? A. No, sir, they did
not. Frank Lyon Company paid the interest.
Q. Frank Lyon Company paid interest and fees to ac-
countants and to attorneys of approximately $500,000 in
connection with the construction of this building; is that
correct? A. Yes, between $450,000 and $500,000, yes.
Q. And you cannot tell the Court why the specifications
state that the investor would put in $500,000 at an annual
rate of interest of six percent or why the company ack-
nowledged that in its agreement? A. We acknowledged it
because we were just trying to repeat verbatim the speci
fications for the sale and leaseback they handed us.
Q. On your calculations have you made calculations to
show what the tax position of Frank Lyon Company would
be if {130} the options were exercised? A. Yes. we did
Q. It would be, at the end of 11 years, approximately
$500,009 in gain; is that correct? A. On the sale there
would be about—I think it was about three and a half mil-
licn dollar gain ou the sale.
The Court: Apparently there were considerable negoti-
ations after the specification and letter ——
The Witness: Yes, Your Hono. there were.
The Court: —in which additional terms were agreed
upon which were reflected by the documents: is that cor-
rect?
The Witness: That is correct.
sv Mr. Sayre:
Q. Now with regard to the construction. you said the
Worthen Bank oversaw the complete construction. I take
it the mechanics would be that on a monthly basis demand
would be made by the contractor—the general contractor
to Worthen Bank for payment, and Worthen Bank would
then make demand upon you to pull down amounts from
City Bank under the financing agreement, and you would
reimburse Worthen Bank for their payment to the con
tractor. A. We would not reimburse Worthen. We ac
tually paid the contractor.
Q. In other words, Worthen paid all the bills for the
construction of the bank and you drew the money from
City Bank [131] and paid it to Worthen? <A. Yes. We
reimbursed Worthen.
Q. Frank Lyon Company did not have anyone to oversee
the construction of the building? A. That’s correct.
76
Q. Now you said that with regard to this rental, it’s
equal to the penny to the debt service owed to New York
Life? A. That’s correct.
Q. And there is, then, no hope of making a cash flow
or an economic profit off this arrangement for the first 25
years; is that correct?) A. From a cash standpoint for the
first 25 years that’s correct, outside of the income tax
consideration; but from 25 to 75 there would be.
Q. But in the original 25 year term which the bank has
four options to repurchase. there is no way that a cash
profit or cash flow can be made by Frank Lyon Company?
A. That’s right. Our economic profit comes from increas-
ing the equity in the building.
Q. Now the equity, you say, in the buildine—the amount
of the option price of Worthen Bank in the building lease
—decreases instead of increases; is that correct? A.
That’s correct.
Q. So that if the building increased in value or apnre-
ciated in value or staved the same and had a market value
of [132] seven and a half or $9 million. or whatever that
value of the total investment in the building was, that at
the end of the 25-year term any appreciation that would
be in that building could be taken away from Frank Lvon
Company by the Worthen Bank’s exercise of the option
for the stated eption price? A. They would purchase the
building for the stated option price.
Q. And, therefore, there would be no equity or appre-
ciated value to Frank Lyon. It would be taken away by the
exercise of the option? A. We would have sold it for
approximately two plus million dollars at the end of the
twentv-fifth vear.
. We are assuming that the value of the building stays
between 7 and $9 million. A. I’m not sure that’s a valid
assumption. Buildings would deteriorate.
Q. Then it’s your assumption that the market value of
the building would be only $2 million in 19—or after 25
years’ A. Perhaps, ves.
Q. Now with regard to the term of the rental under the
building lease, Frank Lyon Company at the end of 25 years
77
would be receiving in excess of $600,000 a year; is that
correet! A. At the end of which period, sir?
Q. At the end of 25 years. A. At the end of 25 years?
[133] Q. You were going into what you were going to get
after 25 years, and that’s all assuming that no option is
exercised by the bank. A. That’s correct. Our original
proposal was we would receive $600,000 a vear.
Q. What I’m asking is: Why would Frank Lvon Com
pany be willing to cut its rent in half? If $600,000 wonld
he the fair rental value in 1994, then the next vear why
would thev be willing to take half and the net amount
greatly reduce some over that period? A. Half a loaf is
better than no loaf. It looked like other investors against
whom we were competing were willing to do it for less,
according to the terms of the Specifieation of Sale and
Leasehack. So the $300,000 rent was just out of the ques
tion. We did have to settle for a smaller amount of rent.
Q. The ground lease on the building site was for $50 for
the initial 25-year term? A. That’s correct.
Q. And that, you exnlained, was because of a net effect
but that was not the fair rental value of that property. A.
No, it was not.
The Court: Mr. Sayre, let me interupt you to give the
court reporter a break. We will be in recess for 15 minutes.
[134] The Court: Mr. Sayre, you may continue.
By Mr .Sayre:
Q. Going back again to the depreciation deduction, that
is not an actual cash expenditure or cash expense. It is a
bookkeeping entry; is that correct? A. The cash disburse
ment has been made when the asset was purchased.
Q. And that’s where we came into this $500,000 versus
$7,640,000,
Now Worthen Bank paid to Frank Lyon Company an
amount identically equal to the debt service so that the
money Frank Lyon received from Worthen Bank was then
78
turned over to New York Life and paid off principal and
interest payment; is that correct?) A. The rent check goes
into our regular bank account and we do write a check in
the same amount to New York Life to pay our debt.
Q. There’s no yearly expenditure for depreciation. It is
a bookkeeping entry theoretically to recover costs of
amounts expended. <A. It’s a non-cash expense in that
vear.
Q. And the cash expenditure that Frank Lyon Com-
pany made was $500,000 in equity, and then for bookkeep-
ing purposes or for tax purposes, or however it’s ae-
counted for on your books, amounts were received as ren-
tal, credit as rental, and [135] deduction taken: is that
correct?) A. Which $500,000 are vou referring to?
Q. The original $500,000 in equity put into the—— A,
Again, we purchased the building for $7,640,000. On that
investment we are receiving rentals of around $580,000 a
year.
Q. For tax benefit purposes, a cash expenditure was
made from Frank Lyon Company’s own funds of $500,000?
A. That was our equity in the building.
Q. And an asset was acquired with a basis of $7,640,000
which was depreciated then by Frank Lyon Company? A.
Yes. They are the owners of the building.
Q. And what is the deprecistion deduction in the first
full vear of 1970? A. It’s about $614,000,
Q. And the interest payment was how much? A. In the
first year it was $478,000
Q. So about a million dollars? A. Total deduction in
the first year, ves.
Q. A million dollar deduction on a $500,000 cash expen
diture from funds? A. Rental income of about $582,000
in that vear.
Q. Excuse me. Then there was a net amount of $400,000?
A. Approximately.
Q. Again you say that Frank Lyon Company bought a
building. [136] The building \ is not completed. It was in
<< $$ §
79
the process of being constructed. It had already been
started by Worthen Bank. A. That’s correct. .
Q. And they paid for all the expenditures for the land,
the parking garage, and the initial million or million and
a half dollars in expenditures for the building hefore
Frank Lyon came into the picture; is that correct? <A.
That's correct.
Q. So actually would you say the basement belongs to
Worthen and you own the rest of it? A. No. We own the
building.
Q. Now on Exhibit 13 on the options on the second page,
how were the amounts determined of 822, a million, a
million-six, and two million one hundred forty-five? A. I
don’t know. This was prepared by Worthen Bank.
Q. Eventually the amounts that were agreed upon were
couched in terms not of an assumption plus this amount
but an assumption—exeuse me, a total dollar figure; is that
correct’ A. Yes, that’s correct.
Q. I believe paragraph 21 or something of Exhibit 19 js
the option.
Now there is a discount factor of $198,280 shown on the
fifteenth year. Was that carried over into the agreement?
A. I don’t recall specifically, but I assume it was.
Q. What does that discount represent? [137] A. I don’t
know.
The Court: What are you talking about?
Mr. Sayre: The second page, Your Honor-—
The Court: I have it.
Mr. Sayre: —where it shows the $1,198.28) minus
$198 281).
The Court: In parenthesis.
By Mr Sayre:
Q. What is the discount determined, and if it was carried
over what does it represent? A. It looks like it was just
80
an amount to round the fifteenth year off to a million
dollars—the figure that was backed into—but that is just
a speculation on my part. As I said, I did not prepare this
specification.
The Court: Do you know what the figures are in the
parenthesis: the eleventh year or fifteenth year?
The Witness: No, Your Honor, I do not.
The Court: All right.
The Witness: The one for the fifteenth year apparently
ties into paragraph six. The amounts are the same as ‘‘B’”’
and **C’’,
By Mr .Sayre:
Q. Let me ask you. On Exhibit 14 you show a repurchase
after the eleventh year. Now you prepared this exihibit?
A. Exhibit 14, yes.
[138] Q. Seeond page. What is the discount of $149,000
there representing? A. We were again copying verbatim
the form they had given us, and it’s just an amount to
round off—it looks like the equity to $800,000.
Q. Let’s go back to—do you have the knowledge if this
figure of $822,000 or approximately $800,000 as shown on
your computation, Exhibit 14, was the amount of the net
amount received not on the assumption but the net amount
to be received under the final agreement! A. I assume it
was. We could tie it out by taking a look at the amortiza-
tion schedule by taking a look to see what the outstanding
balauce of the mortgage would be.
Q. That’s Defendant’s Exhibit 7. A. Yes, sir, that’s
approximately the figure. You’re Defendant’s Exhibit 7
shows that the outstanding balance of the debt is $5,521,000
at that time, and the option price in section 20.1 of the
building lease is $6,325,000, approximately, so that would
be $804,000 cash.
Q. That would be the amount of net equity again or net
equity realized by Frank Lyon out of the transaction; is
81
that correct?’ A. That would be the cash that we would
receive on the sale. They would assume the mortgage and
give us that much in cash. |
[139] The cash put in by Frank Lyon was originally
$500,000 is that correct? A. The equity in the building,
yes, was $500,000,
Q. So there would be an increase to Frank Lyon Com-
pany of a little in excess of $390,000 in cash if the option
were exercised at the end of 11 years? A. Yes,
Q. Now was this calculated prior to the time the instru-
ments were entered into? A. I’m sure it was.’
Q. Does that amount represent approximately six per-
cent interest as referred to in your Exhibit 14. which js
your acceptance, and the bank’s Exhibit 13, which is their
specifications? A. Let’s see. Purchased the building ‘for
$7,640,000 and borrowed seventeen-forty from New York
Life, so our equity was a half million dollars. Three hun-
dred forty divided by a half million is about 6 plus per-
cent, so divided by 11—plus or minus six percent, roughly.
The Court: In other words, the least benefit that Frank
Lyon could make would be, in effect, a six percent on its
money, plus the tax benefit which would accrue during the
period of this time?
The Witness: Yes, Yeur Honor, if Worthen exercised
their option at that time.
[140] The Court: Under any other set of facts they would
receive more benefits?
The Witness: Yes, Your Honor.
By Mr. Savre:
Q. You said that these two entities that Frank Lyon
Company invested in: Twin City Bank and the Coca Cola
Company, were both money makers or profitable corpora-
tions’? A. Yes. But no dividend has been paid by either
one to Frank Lyon Company.
82
Q. But they were viable; profitable corporations that
were acquired by Frank Lyon? A. Yes.
Q. At one time did Frank Lyon Company own or have
a subsidiary that owned a Gibson’s discount store? A.
Yes.
Q. Was it a profitable venture? A. It was for awhile.
Q. And then became a loosing venture? A. Less than
acceptable return.
Q. And it was disposed of? A. We sold it, yes, to the
Jasper Howard Group who had a larger chain of discount
stores.
Q. Now the Worthen Bank transaction was not profit-
able during the initial 25-year term of the lease to the
Frank Lyon Company; is that correct? [141] A. No,
that’s a correct [sic] statement. It was profitable.
Q. During the first 25-year period? A. During the first
25 years.
Q. How was it profitable? A. Because with every prin-
cipal payment on the debt service, we were reducing the
amount we owed on the mortgage and thereby increasing
our equity in the building.
Q. You said one of the reasons that Frank Lyon Com-
pany wanted to get this was to build up an equity in the
building. Again, you admitted that i* Worthen Bank exer-
cises its option, Frank Lyon Company would lose the
equity. A. We would sell it to Worthen.
Q. Under the agreement you would have to sell for the
stated price. A. That’s right.
Q. You have no equity. A. But we would realize a gain
on the sale.
Q. Excuse me. You would realize a gain on the sale?
A. Yes. I thought vou just asked me to compute that it
was around six percent.
Q. About six percent gain on the sale? A. That wou'd
be per year on an annualized rate. It’s really about 60
percent on the equity at the end of the eleventh year.
Q. You said it would be mutually profitable to both [142]
entities—both Worthen Rank and Frank Lyon—to enter
83
into such an arrangement is one of the reasons. Was that
the fact that you were told you would get this loan of
$500,000 or favorable treatment on similar loans? A. No.
As I pointed out, one of the reasons I was anxious to enter
into it was I hoped it would strengthen our relationsaip
with Worthen Bank.
Q. You said it would be profitable in as much as the
double declining balance depreciation deduction would give
you a cash savings of about a million and a half dollars in
the first 11 years. A. That’s correct. It would shelter
about $3 million in income and would save taxes totaling a
million and a half.
Q. And all of these speculations about what would hap-
pen after 25 years and after 65 years and after 75 years
would not ever come about if Worthen Bank exercises the
option to purchase; is that correct—exercises the option
fo purchase or repurchase? <A. Speculating on whether
they would or would not exercise the option, it may or may
not come about.
Q. We are assuming if they exercise the option all that
is wiped out. A. If they don’t, it’s very real.
Q. You stated in the other transaction regarding sub-
sidiarv corporations, I believe, of Frank Lyon Company
are real estate corporations. Are thev subsidiaries of
Frank Lyon? [143] A. No, they are not.
Q. Are they real estate corporations owning property or
stores in which subsidiaries have their operations. A.
Some of them are, yes.
Q. And there is a s-:all cash flow on these? A. Minimal
cash flow.
The Court: Let me interupt a minute. I haven't looked
at the witness list. Are we going to have any experts on
sale and leaseback agreements here to testify?
Mr. Williamson: Yes, Your Honor.
The Court: All right.
a |
84
Mr. Sayre: Your Honor, I think I have reached a point
if you would like to take Mr. Dover out of sequence at this
time, it would be all right.
The Court: It is your pleasure, gentlemen. I can do it
any way you wish.
Why don’t you stand down, Mr. Cotham.
(Witness excused. )
The Court: Mr. Dover, come forward, raise your right
hand, and be sworn.
Darrell Dover
having been called as a witness by and on behalf of Plain-
tiff, and having been first duly sworn, was examined and
testified as follows:
Thereupon,
[144] Drrect ExaMINATION
By Mr. Giroir:
Q. State your name for the record, please. A. Darrell
Dover.
. What is your residence address? A. 22 River Val-
ley.
Q. What is your occupation? <A. Attorney.
Q. With whom are you associated in the practice of law?
A. House, Holmes and Jewell.
Q. That’s a law firm here in Little Rock, Arkansas? A.
Correct, sir.
Q. Did your firm serve as counsel to New York Life
Insurance Company in connection with a permanent loan to
Frank Lyon Company to purchase the building? A. Yes.
Q. When were you employed? A. ’67. Late ’67 or early
68.
Q. Do you recall whether or not a written commitment
had been issued to Frank Lyon Company by New York Life
at that time? A. Yes, sir, it had been.
ad)
Q. Are you personally familiar with any of the negotia-
tions or background leading up to the issuance of that
letter? A. No, sir.
[145] Q. Who was your primary contact or whom did you
associate with in New York Life Insurance? A. Mr.
Smith, Charlie Smith, assisiant—I believe he’s assistant
chief counsel for New York Life.
Q. Did you consider him to be knowledgable in rea! estate
lending matters? <A. Very.
Q. Was he active in connection with structuring of the
transactions? A. Yes, sir. Yes, sir. He played a large part.
Q. In your dealings with the lendor or with the borrower,
Frank Lyon Company, with whom did you have contact?
A. Yourself and Mr. Cotham.
Q. In your dealings with the interim lendor, First Na-
tional City Bank, with whom did you have contact? A.
Mr. Dirkey with a New York law firm.
Q. With Worthen Bank with whom did you have contact?
A. Mr. Dick Williams of the law firm
The Court: Wright, Lindsey and Jennings.
The Witness: Excuse me, Your Honor.
By Mr. Giroir:
Q. Did the negotiations extend over an extensive period
of time? A. Yes, sir, they did. Awhile ago | said I was
employed in either late 1967 or early 1968. The negotia-
tions continued [146] for approximately i... to six months,
Q. What took so long? A. Well, there was ju. t consid-
erable give and take, bargaining, negotiating between par-
ties. I assume these documents are in evidence. There were
volumes of documents and they were negotiated chapter
and verse, paragraph by paragraph, almost word for word.
Q. How would you characterize the negotiations between
the four parties? Were they serious negotiations? A. Cer-
tainly. Certainly very serious.
Q. Were important terms of each of the documents the
subject of conferences and discussions? A. Yes, sir. Yes,
RG
sir. As I say, it was virtually a paragraph by paragraph,
provision by provision negotiation.
. Now in some instances did all the parties participate
in the negotiations? A. Yes, sir.
©. In al! instances did all parties participate in the
negotiations? A. | have searched my recollection. I think
there were certain instances where simply New York Life
and the Lyon Company were represented. Just the two
parties: lendor and borrower.
(). Were any of those instances where New York Life
Insurance Company and Frank Lyon representatives were
involved [147] in the negotiating, were any of those con-
ducted out of town? <A. Yes, sir. My memory is that there
was a trip to New York at which one of those conferences
took place.
Q. Were there instances where negotiations were con-
ducted only by Worthen and Lyon but perhaps in your
presence? <A. Conversations, yes, sir. Discussions.
Q. What was your interest in the lease agreement he-
tween Worthen and Frank Lyon? A. Well, the lease
agreement is a major part of the security for the loan, As
I reeall the transaction, it is structured so that the lease
would survive the foreclosure by New York Life and we'd
be looking to Worthen Bank and Trust Company as the
leasee.
Q. Was there any guarantee by Worthen Bank of Frank
Lyon's note to New York Life? A. No, sir
Q. To whom did New York Life look as the borrower and
primary obligor on the note?’ A. The maker, Frank Lyon
Company.
Q. If there was a default by Frank Lyon Company and
New York Life elected to accelerate the obligation of Frank
Lyon Company, did that also trigger an acceleration or
otherwise disturb Worthen Bank’s lease? A. No, sir. No,
sir. As I say, it was structured—this is from memory but
I think it’s aceurate—it was [148] structured so the lease
would survive an acceleration or foreclosure or what have
you.
87
Q. So in the event that Frank Lyon defaulted you could
be conceivably in litigation with Frank Lyon while at the
same time Worthen Bank went along unaffected. A. Cor-
rect.
Q. Conversely, if Worthen Bank defaulted on the lease,
did that trigger a default on the note? <A. No, sir. No, not
legally. Practically it prebably could have if that resulted
in the Lyon Company not having the funds with which to
pay New York Life.
Q. But that second step would have to occur? A. That
would have to occur. Legally it was not so structured.
Q. I take it, then, your employment, at least in part, was
to give New York Life the opinion that Frank Lyon had a
full face and credit obligation to pay $7,140,000 to New
York Life.
Mr. Sayre: Your Honor, I object to the leading nature of
the question. It is assuming.
The Court: Please don’t lead the witness.
By Mr. Giroir:
Q. What was the purpose of your employment? A. It
was to render an approving opinion to the New York Life
Insurance Company, assuring them that it had a valid
[149] and enforceable obligation of the Lyon Company.
Q. Were you employed to give an opinion as to whether
or not Worthen Bank had an obligation under the note?
A. No, sir. I previously testified it had no such obligation.
The Court: Do you know if your client was concerned
with or took an interest in the net worth of the plaintiff and
its financial reliability?
The Witness: Your Honor——
The Court: That is, the Frank Lyon Company.
The Witness: I’m new to this proceeding. The plaintilf
is Frank Lyon Company?
By Mr. Giroir:
Q. The plaintiff is Frank Lyon Company. A. Yes, sir.
Yes, sir. We were furnished either four or five years finan-
cial statements of the Lyon Company.
Q. Insofar as you were concerned, do the documents re-
flect the intention of the parties? A. Yes, sir. I have our
firm signatures on the opinion to that effect.
The Court: Particularly, did the documents carry out the
instructions as to those intentions given to you by your
client?
The Witness: Yes, Your Honor.
The Court: All right. Anything else?
{150} Mr. Giroir: No further questions.
The Court: You may cross examine.
Cross ExaMINATION
By Mr. Sayre:
Q. Mr. Dover, was the New York Life Insurance Com-
pany also interested in the financial wellbeing and net
worth of the major tenant or the tenant of the building,
the Worthen Bank. A. Surely.
Q. And, in fact, New York Life requires that a yearly
financial statement be submitted by Worthen Bank to New
York Life with regard to this note purchase; is that cor-
rect? A. I think that’s correct.
Q. The arrangement for the financing with New York
Life, the permanent financing and the construction of the
Worthen Bank Building was arranged by the Worthen
Bank intially? A. I have been so told.
Q. You said—
The Court: Do you know if the tentative arrangement
that had been worked out between Worthen and New York
Life were entirel¥ conditional and particularly were they
~f)
conditional upon an investor who was satisfactory to your
clent, or do you know if that was a-miatter of importance
or not discussed or——
The Witness: Judge, that predated my connection with
the case. I feel sure that—this is sort of speculation, but
I feel, yes, sir, the New York Life would have—the investor
[151] would have had to be satisfactory to New York Life.
The Court: Were there any binding contractual agree-
ments binding your client as a result of its associations
with Worthen prior to the time that Frank Lyon Company
entered the picture that you know of?
The Witness: No, sir. No, sir. But I have no real know!
edge of that.
The Court: I’m sorry.
The Witness: I have no real knowledge of what pre-
dated my connection with the case.
The Court: I understand. Of course, you had to take it
as it was given to you.
The Witness: Our firm was purely special counsel. My
understanding was that it had a conditional commi
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