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Case 1:06-cv-00305-MBH Document 99 Filed 04/07/2008 Page 1 of 140

No. 06-305 T

(Judge Marian Blank Horn)

IN THE UNITED STATES COURT OF FEDERAL CLAIMS



CONSOLIDATED EDISON COMPANY
OF NEW YORK, INC. & SUBSIDIARIES

Plaintiff

Defendant

v.

THE UNITED STATES,



UNITED STATES’ OPENING POST-TRIAL BRIEF



NATHAN J. HOCHMAN
Assistant Attorney General

DAVID GUSTAFSON
STEVEN I. FRAHM
DAVID N. GEIER
JOSEPH A. SERGI
ADAM R. SMART
KAREN M. GROEN

Attorneys
Tax Division
Department of Justice
Washington, D.C. 20044
(202) 616-3448 (telephone)
(202) 307-0054 (facsimile)



Case 1:06-cv-00305-MBH Document 99 Filed 04/07/2008 Page 2 of 140

TABLE OF CONTENTS

TABLE OF CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ii

TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

PROCEDURAL BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

FACTUAL STATEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

I. REGULATORY AND STATUTORY BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

II. DETAILED STRUCTURE OF THE EZH LILO TRANSACTION . . . . . . . . . . . . . . . . . 9

A. Transaction Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1. Lease Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

2. Debt Defeasance Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3. Equity Defeasance Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

4. Sublessee Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

5. Letter of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

B. End-of-sublease options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

1. EZH’s purchase option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

2. CED’s options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

a. Sublease Renewal Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

b. Retention Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

3. Final Basic Rent Payment

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

III. THE PATH TO THE EZH LILO TRANSACTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

A. The History of CED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41



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B. CED’S Consideration of LILO Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

C. Pursuit of the EZH LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

D. The Papering of the EZH LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

E. The Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

F. CED’S Pursuit of Other LILOs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

IV. RISK LEVEL OF THE EZH LILO TRANSACTION . . . . . . . . . . . . . . . . . . . . . . . . . . 83

ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

I. BURDEN OF PROOF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

II. PLAINTIFF IS NOT ENTITLED TO DEDUCTIONS FOR AN ADVANCE HEAD
LEASE PAYMENT AND TRANSACTION COSTS IN 1997 . . . . . . . . . . . . . . . . . . . . . 88

A. The Transaction’s Substance, Not Its Form, Determines Its Tax Treatment . . . 88

B. CED Failed to Acquire a Current Leasehold Interest in the EZH
RoCa3 Facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

C. The Court Should Collapse Reciprocal Rights and Obligations . . . . . . . . . . . . 101

III. PLAINTIFF IS NOT ENTITLED TO AN INTEREST EXPENSE DEDUCTION

RELATED TO THE PURPORTED LOAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

IV. THE TRANSACTION LACKS ECONOMIC SUBSTANCE . . . . . . . . . . . . . . . . . . . . 107

A. The Sham Transaction Doctrine and Economic Substance . . . . . . . . . . . . . . . . 107

B. Plaintiff’s LILO Transaction Lacks Objective Economic Substance . . . . . . . . 113

1.

2.

Plaintiff Did Not Have a Reasonable Expectation of Profit, because the
LILO Transaction Would Generate Huge Negative Cash Flows and
Earnings on a Pre-Tax Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Plaintiff Could Not Expect To Realize Economic Gains Typically
Associated with Leveraged Leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

C. Plaintiff’s Asserted Business Purpose for Entering the LILO Transaction
Is Not Credible . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120



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1.

Without the Tax Benefits Plaintiff would not have Entered
into the EZH LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

2.

Plaintiff’s Purported Business Purpose Lacks Merit . . . . . . . . . . . . . . . 122

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131



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TABLE OF AUTHORITIES

FEDERAL CASES

ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998) . . . . . . . . . . . . . . . . . . . passim

ASA Investerings Partnership v. Commissioner, 201 F.3d 505 (D.C. Cir. 2000) . . . . . . . . . . . 113

Aderholt Specialty Co. v. Commissioner, 50 T.C.M. (CCH) 1101, T.C. Memo (P-H) 1985-491
(1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Alstores Realty Co. v. Commissioner, 46 T.C. 363 (1966) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

American Electric Power Co., Inc. v. United States, 326 F.3d 737 (6th Cir. 2003)

. . . . . . . . . 87

American Electric Power Co., Inc. v. United States, 136 F. Supp. 2d 762 (S.D. Ohio 2001) . . 130

Ballagh v. United States, 331 F.2d 874 (Ct. Cl. 1964) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Basic Inc. v. United States, 549 F.2d 740 (Ct. Cl. 1977) . . . . . . . . . . . . . . . . . . . . . . . . . . 122-123

BB&T Corp. v. United States, 2007 WL 37798 *7-8 (M.D.N.C. 2007) . . . . . . . . . . . . . . . passim

Benedict v. United States, 881 F. Supp. 1532 (D. Utah 1995)

. . . . . . . . . . . . . . . . . . . . . . . . . . 99

Big “D” Development Corp. v. Commissioner, 30 T.C.M. (CCH) 646 (1971) . . . . . . . . . . . . 101

Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006) . . . . . . . 109-110, 113, 118

Blue Flame Gas Co. v. Commissioner, 54 T.C. 584 (1970)

. . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Bridges v. Commissioner, 39 T.C. 1064 (1963)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105, 107

Bussing v. Commissioner 88 T.C. 449 (1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

In re CM Holdings, Inc., 301 F.3d 96 (3d Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110, 113

Casebeer v. Commissioner, 909 F.2d 1360 (9th Cir. 1990)

. . . . . . . . . . . . . . . . . . . . . . . . . . . 108

Coleman v. Commissioner, 16 F.3d 821 (7th Cir. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006) . . . . . . . . . . . . . . passim



v

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Commissioner v. Court Holding Co., 324 U.S. 331 (1945) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

Commissioner v. Duberstein, 363 U.S. 278 (1960) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203 (1990) . . . . . . . . . . . . . . . . . 100

Commissioner v. Tower, 327 U.S. 280 (1946) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Compaq Computer Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001) . . . . . . . . . . . . . . . . . 87

Deputy v. Du Pont, 308 U.S. 488 (1940) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Dow Chemical Co. v. United States, 435 F.3d 594 (6th Cir. 2006) . . . . . . . . . . . 87, 110, 118-119

Estate of Thomas v. Commissioner, 84 T.C. 412 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91, 93

Felcyn v. United States, 691 F. Supp. 205 (C.D. Cal.1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

Frank Lyon Co. v. United States, 435 U.S. 561 (1978) . . . . . . . . . . . . . . . . . . . . . . . . . . . . passim

Gilman v. Commissioner, 933 F.2d 143 (2d Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . 113, 118

Goldberg v. United States, 789 F.2d 1341, 1343 (9th Cir. 1986) . . . . . . . . . . . . . . . . . . . 108-109

Greenfield v. Commissioner, 44 T.C.M. (CCH) 1487 (1982) . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Gregory v. Helvering, 293 U.S. 465 (1935)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . 87, 108-109, 123

Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221 (1981) . . . . . . . . . . . . . . . . . . . . . 88

H.J. Heinz Co. & Subsidiaries v. United States, 76 Fed. Cl. 570 (Fed. Cl. 2007)

. . . . . . . passim

Helvering v. F. & R. Lazarus & Co., 308 U.S. 252 (1939) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

Helvering v. Gowran, 302 U.S. 238 (1937) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

IES Industries, Inc. v. United States, 253 F.3d 350 (8th Cir. 2001)

. . . . . . . . . . . . . . . . . . . . . 113

INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

International Paper Co. v. United States, 33 Fed. Cl. 384 (Ct. Cl. 1995) . . . . . . . . . . . . . . . . . 104

J. B. N. Telephone Co., Inc. v. United States, 638 F.2d 227 (10th Cir. 1981) . . . . . . . . . . . . . . . 87



vi

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Jade Trading v. United States, 80 Fed. Cl. 11 (2007) . . . . . . . . . . . . . . . . . . . . . 87, 110, 113, 118

James v. Commissioner, 899 F.2d 905 (10th Cir. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . 110, 124

Keener v. United States, 76 Fed. Cl. 455 (Fed. Cl. 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

Kirchman v. Commissioner, 862 F.2d 1486 (11th Cir. 1989)

. . . . . . . . . . . . . . . . . . . . . . . . . 109

Knetsch v. United States, 364 U.S. 361 (1960) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105, 113, 118

Kruesel v. United States, 63-2 U.S. Tax Cas. (CCH) ¶ 9714, 12 A.F.T.R.2d (RIA) ¶ 5701 (D.
Minn. 1963) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

Kuper v. Commissioner, 533 F.2d 152 (5th Cir. 1976) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Kwiat v. Commissioner, 64 T.C.M. (CCH) 327, T.C. Memo (RIA) 1992-433 (1992) . 95-96, 100

Lerman v. Commissioner, 939 F.2d 44 (3d Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . 109, 113

Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122
(D. Conn 2004)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113-114, 123

McCulley Ashlock v. Commissioner, 18 T.C. 405 (1952) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

N. Pacific Railway Co. v. United States, 378 F.2d 686 (Ct. Cl. 1967) . . . . . . . . . . . . . . . . . . . 123

National Starch & Chemical Corp. v. Commissioner, 918 F.2d 426 (3rd Cir.1990) . . . . . . . . 109

Neb. Department of Revenue v. Loewenstein, 513 U.S. 123 (1994) . . . . . . . . . . . . . . . . . . . 88, 89

Newman v. Commissioner, 902 F.2d 159 (2d Cir. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Nicole Rose Corp. v. Commissioner, 320 F.3d 282 (2d Cir. 2003) . . . . . . . . . . . . . . . . . . 108, 123

Old Colony R. Co. v. Commissioner, 284 U.S. 552 (1932) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

PACCAR, Inc. v. Commissioner, 85 T.C. 754 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96, 104

Rexnord, Inc. v. United States, 940 F.2d 1094 (7th Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985) . . . . . . . . . 109-110, 113

Rickey v. Commissioner, 502 F.2d 748 (9th Cir. 1974) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101



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Rogers v. United States, 281 F.3d 1108 (10th Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Rothschild v. United States, 407 F.2d 404 (Ct. Cl. 1969) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Saviano v. Commissioner, 765 F.2d 643 (7th Cir. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

Swift Dodge v. Commissioner, 692 F.2d 651 (9th Cir. 1982)

. . . . . . . . . . . . . . . . . . . . . 91

TIFD III-E , Inc. v. United States, 459 F.3d 220 (2d Cir. 2006) . . . . . . . . . . . . . . . . . . 94-95, 104

United Parcel Service of America, Inc. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001)

. . 110

United States v. Ingalls, 399 F.2d 143 (5th Cir. 1968) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Volvo Cars of N.A., Inc. v. United States, 92-2 U.S. Tax Cas. (CCH) ¶ 50,705 . . . . . . . . . . . . . 96

Waterman S.S. Corp. v. Commissioner, 430 F.2d 1185 (5th Cir. 1970) . . . . . . . . . . . . . . . . . . 123

Weller v. Commissioner, 270 F.2d 294 (3d Cir. 1959) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

Williams v. Commissioner, 1 F.3d 502 (7th Cir. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98-99

Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254 (1999)

. . . . . . . . . . . . . . . . . . . . 130-31

FEDERAL STATUTES AND REGULATORY MATERIAL

Jobs and Growth and Relief Reconciliation Act of 2003 (P.L. 108-27) at § 302 . . . . . . . . . . . . . 8

64 Fed. Reg. 26845 (May 18, 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 81

Rev. Rul. 72-543, 1972-2 C.B. 87 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Rev. Rul. 99-14, 1999-1 C.B. 835, modified & superseded by Rev. Rul. 2002-69, 2002-2 C.B.
760 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Rev. Rul. 2002-69, 2002-2 C.B. 760 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

CONGRESSIONAL MATERIALS

H.R. Rep. No. 108-755 at 660, 662-663 (2004)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8



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06-305 T

(Judge Marian Blank Horn)

IN THE UNITED STATES COURT OF FEDERAL CLAIMS



CONSOLIDATED EDISON COMPANY
OF NEW YORK, INC. & SUBSIDIARIES

Plaintiff,

v.

THE UNITED STATES,

Defendant.



UNITED STATES’ OPENING POST-TRIAL BRIEF



INTRODUCTION

This case concerns whether Plaintiff is entitled to certain tax deductions in connection

with the participation of its subsidiary, Consolidated Edison Development (“CED”), in a lease-

in, lease-out (LILO) tax shelter. Plaintiff, a United States taxpayer, through a CED, purported to

simultaneously lease a minority interest in a power facility, the RoCa3 Facility, from its owner,

N.V. Electriciteitsbedrifj Zuid-Holland (“EZH”), under a head lease and lease the property back

to EZH under a sublease. After the close of the transaction, EZH (or its successors) continued to

operate the RoCa3 Facility and retained all of the benefits and burdens associated with the

facility’s use and ownership. Nevertheless, on its federal income tax return, Plaintiff reported



Case 1:06-cv-00305-MBH Document 99 Filed 04/07/2008 Page 10 of 140

rental income and far greater tax deductions for purported rent, interest, and amortized

transaction costs in connection with the EZH LILO Transaction. The Internal Revenue Service

disallowed the deductions and disregarded the claimed rental income. Plaintiff then paid the

resulting deficiency, and filed this suit for a tax refund.1

The specific substantive issue raised in this refund suit is whether Plaintiff is entitled to

deductions for rent, interest, and transaction costs it asserts were incurred in 1997 in connection

with the EZH LILO Transaction. As discussed more fully below, Plaintiff’s claimed tax

deductions are improper for three reasons. First, looking at the EZH LILO Transaction as a

whole reveals that Plaintiff did not, in substance, acquire a present leasehold interest in the

RoCa3 Facility. Second, Plaintiff did not incur genuine indebtedness in connection with the

deal. Third, and alternatively, the Transaction should be disregarded under the economic

substance doctrine. Plaintiff bears the burden of proof on all these issues.

The general structure of the transaction is as follows: The EZH LILO Transaction was

carried out by a series of agreements, whereby a trust acting for CED (a subsidiary of Plaintiff)

purported to lease a minority interest in the RoCa3 Facility, located in the Netherlands, from a

foreign power company, EZH, for a period of 43.2 years, and simultaneously purported to

sublease it back to EZH for a period of 20.1 years. (Joint Stipulation of Fact (hereinafter “Stip.”)

¶¶ 104, 113, 135). After the papers were executed, EZH continues to operate and maintain the

RoCa3 Facility, just as it did prior to entering into the Transaction. (Tr. 1343 (Holzman)).

1The amount directly at issue in this case is the tax impact of the LILO shelter for only
two weeks – $328,066. The real amount is far greater. The shelter is expected to last twenty
years and the amounts of tax benefits claimed in subsequent years are and will be very
substantial.



2

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CED partially financed its purported upfront rental payment in the EZH LILO

Transaction through a purported non-recourse loan of $81 million from a foreign bank,

Hollandsche Bank-Unie N.V. (“HBU”), a subsidiary of ABN-AMRO Bank N.V. (“ABN

AMRO”). (Stip. ¶¶ 117, 131). Nevertheless, the entirety of the purported non-recourse loan

never left the ABN AMRO corporate umbrella, as the proceeds were first placed in an account at

ABN AMRO and, after a series of successive, circular transfers, were simply used by ABN

AMRO to pay down the purported non-recourse loan provided by its corporate subsidiary, HBU.

(Stip. ¶¶ 126, 127, 187, 189, 198, 199). Payments from the funds in the ABN AMRO account

(which served as the Debt Defeasance Account and bore the same interest rate as the purported

non-recourse loan) matched exactly the scheduled repayment of the purported non-recourse loan,

and thus were designed to be sufficient to satisfy all of CED’s payments on the purported non-

recourse loan. (Stip. ¶¶ 118, 188, 199; Tr. 1272 (Holzman)). In other words, CED simply

received the funds from HBU and caused them to be transferred them right back to HBU’s

parent company, who agreed to use those same funds to pay back the purported loan by HBU.

The remainder of CED’s supposed initial rent payment was funded by a $39 million

purported equity investment, but EZH was required to use approximately $31 million of that sum

to purchase zero risk U.S. Treasury STRIPS with a predetermined maturation amount that

matched CED’s entire expected return from the transaction. (Stip. ¶¶ 208-210; Tr. 2174-75

(DePlautt); Tr. 3738-39, 3875-76 (Bent); DX 20194, Bates 25120). These Treasury STRIPS

were placed in an investment account (which served as the Equity Defeasance Account) (Stip. ¶

213), pledged to Plaintiff (and expressly not pledged to the lending institutions involved in the

transaction), and could not be withdrawn by EZH. (Stip. ¶¶ 218, 219; Tr. 1447 (Holzman)).



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EZH also allocated approximately $1.4 million of the equity investment to purchase a standby

letter of credit to virtually eliminate any risk to CED of recovering its investment and expected

return. (JX 330, Bates 7110 (report from pricing run reflecting letter of credit allocation); DX

20193, Bates 25093). EZH retained the remaining approximately $6 million of the equity

investment as its fee for participating in the transaction. (Tr. 3706, 3718-19 (Bent); DX 20193,

Bates 250872).

At the end of the initial 20 year term, the operative documents provided that EZH had the

option, the Sublease Purchase Option, to terminate the entire transaction for a preset purchase

price, which price would be satisfied by the maturity value of the Treasury STRIPS and the

remaining funds in the Debt Defeasance Account. (Stip. ¶¶ 165, 235; DX 20035, Bates 21361;

DX 20195, Bates 25190). In other words, EZH could end the Transaction without cost by

electing to have ABN AMRO credit to HBU the remainder of the funds securing the non-

recourse loan, and transfer back to CED the Treasury STRIPS purchased with CED’s equity

investment at the beginning of the transaction. EZH would keep its fee and CED would have

2As explained in Stipulation ¶¶ 208 and 209 n.9, the final pricing run (conducted after the
close of the transaction and never changed by Cornerstone (CED’s advisor) to match the amount
identified on JX 372) reflects that the amount used to purchase the Treasury STRIPS is
$30,083,052.77; JX 372 indicates the amount used to purchase the Treasury STRIPS was
$31,252,643.73. The difference in these amounts accounts for the difference in the projection of
the Government’s expert in equipment lease transactions (including the structuring, arranging
and negotiation of those transactions), Mr. Paul Bent, of a $7.5 million fee to EZH at closing
(DX 20193, Bates 25093), versus the approximately $6 million fee listed above. (Tr. 3707
(Bent)). In any event, the difference does not impact the mechanics of the Transaction, except to
the extent it results in the computation of a different fee to EZH. With respect to the designation
of expertise sought for Mr. Bent, as well as the other experts proffered by Defendant in this case
(Drs. LaRue (Tr. 5045-46 (LaRue)) and Thomas (Tr. 4473-74 (Thomas)) and Mr. Ray (Tr. 4707
(Ray)), the Government sought these designations from the Court because of the nature of the
assignment each expert was given in relation to this case. (Tr. 5373-74).



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claimed tax deductions, without other real economic effect. (Tr. 3720-23 (Bent); DX 20194,

Bates 25142). At least for the first 20 years, CED’s return from this transaction was essentially

the result of an investment in U.S. Treasury STRIPS (wrapped in the complicated artifice of a

purported lease transaction) and its tax deductions. (Tr. 3738 (Bent)). The investment in

Treasury STRIPS is something that CED could have done on its own, without sinking millions in

transaction costs (Stip. ¶ 106; JX 508; JX 890; JX 892; JX 934; JX 1109, Bates 16272) to

generate tax benefits by creating the appearance of a lease transaction. Further, CED’s return

from the EZH LILO Transaction is essentially riskless. (See DX 20193, Bates 25061 (noting

that the defeasance mechanisms employed in the EZH LILO Transaction virtually assured

CED’s return from the transaction); JX 388, Bates 8021 (noting transaction is “fully defeased”);

JX 397, Bates 8123 (noting that EZH’s obligations to CED are fully secured by the U.S.

Treasury STRIPS and letter of credit) and Bates 8124 (noting that in the event of default by

EZH, CED can simply draw on the U.S. Treasury STRIPS and letter of credit to obtain its

expected return); Tr. 3736-37, 3807 (Bent)).

The EZH LILO Transaction is structured for tax purposes to appear that EZH would not

necessarily exercise the Sublease Purchase Option at year 20 and end the Transaction.3 (See Tr.

1978 (Muoio) (noting that the purchase option price was set above fair market value for tax

purposes); JX 329, Bates 7065 (Shearman & Sterling letter discussing requirement that the

purchase option price must be set above market value)). Thus, the transaction documents

provided that in the event EZH did not exercise the Sublease Purchase Option, subject to certain

3A tax indemnity agreement entered into by EZH specifically prohibited a formal

agreement or arrangement whereby EZH would be required to exercise the Sublease Purchase
Option. (Stip. ¶ 280-281; JX 9, Bates 676-77).



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prerequisites, CED had the right to require EZH to renew the sublease for another 16.5 years

(“the Sublease Renewal Option”), or to require EZH to return the undivided lease interest to

Plaintiff for the duration of the lease term (“the Retention Option”). (Stip. ¶ 169).

Even assuming that EZH does not exercise the Sublease Purchase Option, CED’s total

return on its investment would be assured because it could exercise its renewal option, and EZH

would be required to reinvest the money arising from the maturation of the original Treasury

STRIPS in a similar investment vehicle that would have a maturity date towards the end of the

lease term, simply deferring the riskless return for CED until the end of the 44 year lease term.

(JX 397, Bates 8121 (“If the utility did not purchase the plant at year 20 the trust [for the benefit

CED] would have the option to . . . require the utility to re-lease the plant for an additional 17

years at prices that would assure CED of its expected return.”); JX 390 (“In either case

[comparing EZH’s exercise of the Sublease Purchase Option and CED’s exercise of the renewal

option], CED will receive sufficient funds from the EZH Sub-lessee (as rent and/or proceeds

from the sale of the head lease pursuant to the [Sublease Purchase Option]) to pay-off the third

party loans, recover its equity investment, and earn a return.”)). While Plaintiff will claim that in

such a situation it will be responsible for making a large back end rental payment in year 44, in

fact, such a payment is non-recourse to Plaintiff and is made up of a series of offsets that require

no additional deposit of funds and is entirely funded by Plaintiff’s original equity. (Tr. 3744-47,

3920-21 (Bent); Tr. 1292-95 (Holzman); Tr. 5064-65 (LaRue); JX 130, Bates 3160; JX 555,

bates 9961; DX 20193, Bates 25072-73; DX 20199, Bates 25337, n.22). Alternatively, as will be

demonstrated below, the EZH LILO Transaction was entered into with the expectation and

understanding that EZH would, in fact, exercise the Sublease Purchase Option and terminate the



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transaction during year 20, never reaching this back end payment. (See JX 1142, Bates 16776;

JX 3904, Bates 8029 (noting that it is questionable that this back end payment will ever be

made)).

PROCEDURAL BACKGROUND

On its consolidated U.S. Corporate Income Tax Return (Form 1120) for taxable year

1997, Plaintiff reported rent income received in the EZH LILO Transaction and it deducted rent,

amortized transaction costs, and interest expense resulting from the Transaction. Specifically,

Plaintiff reported amounts characterized as rental income ($399,693) and deducted amounts

characterized as rental expenses ($1,072,652), amortization of transaction costs ($9,698), and

interest expenses ($254,954) related to a purported property interest and indebtedness incurred in

connection with the EZH LILO Transaction, for a net loss of $937,331. (Stip. ¶¶ 299-300).

Upon audit of Plaintiff’s 1997 federal income tax return, the Internal Revenue Service

(“Service”) disregarded the income, and disallowed the deductions, reported by Plaintiff from

the EZH LILO Transaction. The Service’s proposed adjustments in connection with the EZH

LILO Transaction resulted in an increase of $937,331 in Plaintiff’s taxable income for 1997. As

a result of its proposed adjustments, the Service assessed against Plaintiff a deficiency for 1997

in the amount of $328,066. Plaintiff paid this amount and filed a claim for refund (Form 1120X)

with the Service on December 2, 2005. The Service denied the claim, and on April 19, 2006,

Plaintiff filed the instant suit seeking a refund of the amount of the deficiency. (Stip. ¶¶ 297-

306).



4JX 1235 is identical to JX 390.

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FACTUAL STATEMENT

I.

REGULATORY AND STATUTORY BACKGROUND

This case concerns the propriety of certain tax deductions that Plaintiff claimed as a

result of its participation in a LILO tax shelter. In 1999, the Service advised taxpayers that it

would disallow under the economic-substance doctrine the rent and interest-expense deductions

claimed in LILOs. Rev. Rul. 99-14, 1999-1 C.B. 835, modified and superseded by Rev. Rul.

2002-69, 2002-2 C.B. 760. The Service later ruled that it also would deny those tax benefits

under the substance-over-form doctrine. Rev. Rul. 2002-69, 2002-2 C.B. 760.5

Because Congress considered LILOs and related abusive shelters to be a widespread

problem, it amended the Code in 2004 to prophylactically eliminate them by statute, leaving to

the Service the responsibility to challenge such transactions (using common-law doctrines)

entered into prior to the law’s effective date. Jobs and Growth and Relief Reconciliation Act of

2003 (P.L. 108-27) at § 302. As the legislative history to those amendments provides, the

amendments were “not intended to affect the scope of any other present-law tax rules or

doctrines applicable to purported leasing transactions,” and “[n]o inference is intended regarding

the appropriate present-law tax treatment of transactions entered into prior to the effective date.”

H.R. Rep. No. 108-755 at 660, 662-663 (2004).

5As a practical matter, taxpayers (including Plaintiff (Tr. 2035-36 (Muoio))) stopped

engaging in LILOs after May 1999, when the Service adopted final Section 467 Treasury
Regulations, which treat rent prepayments as loans and eliminate the tax benefits sought by
parties entering into LILO Transactions. See 64 Fed. Reg. 26845 (May 18, 1999).



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II.

DETAILED STRUCTURE OF THE EZH LILO TRANSACTION

EZH and CED (through a wholly owned subsidiary, Consolidated Edison Leasing

(“CEL”), by way of a trust6) implemented the EZH LILO Transaction by executing a series of

interrelated agreements. (Stip. ¶ 104). Under these agreements, EZH purported to lease a

47.47% interest in the RoCa3 Facility to CED for 43.2 years (i.e., from December 15, 1997

through February 24, 2041). (Stip. ¶ 113). CED simultaneously subleased its interest in the

RoCa3 Facility back to EZH for 20.1 years (the “Sublease Basic Term”). (Stip. ¶ 135). At the

end of the Sublease Basic Term (i.e., January 2, 2018), EZH can exercise the (prefunded by

CED) Sublease Purchase Option to purchase CED’s leasehold interest. (Stip. ¶ 165; Tr. 1326-29

(Holzman); Tr. 3047 (Mintun) (noting that one of the purposes of the defeasance accounts was to

provide sufficient funds for EZH to exercise the Sublease Purchase Option); Tr. 3720-22 (Bent);

JX 329, Bates 7063; JX 766, Bates 12462; DX 20193, Bates 25081-82; DX 20202, Bates

25384). If EZH does not exercise its prefunded Sublease Purchase Option, CED can, subject to

fulfilling certain requirements, exercise the Sublease Renewal Option, renewing EZH’s sublease

until 2034 (the “Sublease Renewal Term”) (Stip. ¶¶ 136, 169-78) or exercise the Retention

Option, electing to have EZH return its 47.47% interest in the sublease to CED for the remainder

of the lease term (i.e, through 2041). (Stip. ¶¶ 179-80).

6For ease of reference this brief will treat CED as the party to the transaction unless the

need to distinguish the trust and/or CEL arises in a specific instance.



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To this day, EZH7 owns and operates the RoCa3 Facility as if the LILO Transaction

never occurred.8 As was the case prior to the Transaction, EZH has maintained possession of the

RoCa3 Facility, continues to operate the facility in the normal course of its energy generation

business, invests in major capital improvements to the RoCa3 Facility, remains responsible for

all costs associated with its use and maintenance, and retains all of the income generated from

the operation of the RoCa3 Facility. (Stip. ¶ 137; see Tr. 1343 (Holzman); JX 352, Bates 7476

(noting that the successor to EZH has worked very aggressively to improve efficiency and

productivity); JX 369 and JX 876, Bates 13723 (installation of remote control systems in the

Control Room); JX 370 (RoCa3 upgrade to GT brushseals)). Conversely, as long as EZH’s

sublease rent is “paid,” CED cannot use or possess its leasehold interest in the RoCa3 Facility

until 2018, and then only if EZH abandons its Sublease Purchase Option and CED complies with

7In or about January 2000, EZH, through a series of mergers and stock purchases, became

E.On Benelux Generation n.v., a subsidiary of E.On Energie A.G. a German energy company.
(Stip. ¶¶ 69-72; JX 292; JX 293; JX 294; JX 295). However, for ease of reference, EZH and its
successor entities will be referred to as EZH throughout the brief unless it is necessary to refer to
the successor entity by its specific name.

8In an effort to claim EZH undertook significant obligations by entering into the EZH

LILO Transaction, Plaintiff will likely claim that EZH is under various requirements to maintain
the RoCa3 Facility in a certain manner, provide yearly officer’s certificates concerning its
operations, maintain other logs and reports in its business, and maintain insurance on the facility.
However, a close look at these requirements reveals that they effectively impose no greater
burden on EZH than it has as an owner. For example, EZH must only maintain insurance of the
same type it maintains on other facilities it operates. (JX 4, Bates 417). Similarly, EZH is
required to use the same maintenance practices it uses at its other facilities. (JX 4, Bates 399).
Further, many of the requirements concerning maintaining of reports only apply if EZH is
already maintaining such reports. (JX 4, Bates 404; Stip. ¶ 148). Finally, the annual officer’s
certificate (see JX 367) is essentially a one page document with minimal information, attaching
EZH’s annual report created for shareholders – a de minimis undertaking that is simply
insufficient to justify Plaintiff’s assertions. Simply put, EZH undertook essentially no
responsibilities greater than it already held as owner of the RoCa3 Facility. (See DX 20193,
Bates 25087).



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all of the requirements to exercise the Retention Option. (Stip. ¶ 180; Tr. 559-62 (Burke)).

Further, CED cannot actually use or possess the RoCa3 Facility itself, because it possesses only

a 47.47% leasehold interest, and the remainder of the facility (the majority share) is subject to a

LILO transaction with Banc One Leasing Corp. (Stip. ¶ 58 n.2; JX 402, Bates 8143; Tr. 2867

(Mintun)). Because of the operation of the “Control Documents,” which set forth the rules in the

event EZH does not exercise its prefunded Sublease Purchase Option, CED, as minority

leaseholder, has no power to insert itself as the operator of the RoCa3 Facility even if, for the

sake of argument, EZH chose not to exercise its prefunded Sublease Purchase Option.9 (Stip. ¶¶

266-68; JX 11, Bates 737; see also Tr. 3980 (Bent)).

A.

Transaction cash flows

1.

Lease Rent

The Lease Agreement required CED to pay rent to EZH in two installments: $120.1

million advance rent due (the “Initial Basic Rent Payment”) on the closing date, and $831.5

million deferred rent, theoretically due in 2041. (Stip. ¶ 116) For tax purposes, the $120.1

million advance rent was allocated to the first five years of the lease term, and the deferred

$831.5 million rental payment was allocated to the remaining years of the transaction on an

undiscounted basis, serving as the basis for Plaintiff’s claimed rental deductions in each of the

9Thus, CED’s use of its leasehold interest in the case of exercise of the Retention Option
would be limited to obtaining its share of the output of the RoCa3 Facility (offset by its paying
its share of the operation and maintenance expenses associated therewith) (Tr. 2250 (DePlautt);
see Tr. 1393 (Holzman)), with the specifics of these future contingencies remaining undefined in
large part. (See JX 11, Bates 738, 747). Further, as explained by Defendant’s expert, Mr. Bent,
the combination of the Access Agreement and the Control Documents implies that CED can only
require EZH to wheel an amount energy from the facility for which it already has an agreement
in place to sell. (Tr. 3932-35 (Bent)).



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respective years. (Stip. ¶ 120; see Tr. 1360-64 (Holzman)). As shown below, CED’s obligation

to make the $831.5 million payment in 2041 is eliminated or offset by other rights and

obligations under the operative documents, and CED will not be required to make any further

investment in the transaction beyond its initial equity investment. (See infra at 39-40; DX

20193, Bates 25071-73). CED paid the $120.1 million Initial Basic Rent Payment with an

$80,792,270.36 non-recourse loan from HBU (the “Lender’s Commitment”), and

$39,320,000.00 of its own money (the “Investor’s Commitment”).10 (Stip. ¶ 117). HBU is a

wholly-owned subsidiary of ABN AMRO. (Stip. ¶ 131; JX 401; Tr. 1272 (Holzman)).

Although the loan agreement is nominally between Wilmington Trust Company (“WTC” as

trustee for CED) and HBU, the funds for the loan were furnished by ABN AMRO. (Stip. ¶ 126

(noting that the “lender’s commitment” was located in an account at ABN AMRO)). ABN

AMRO recognized this when early discussions concerning provision of the loan for the

transaction were underway with EZH: “Thank you for inviting ABN AMRO Bank N.V. (‘ABN

AMRO’) to act as lender and defeasance bank in a U.S. Lease Transaction . . . .” (JX 401

(emphasis added); Tr. 1273 (Holzman) (noting that he assumed Capstar, EZH’s advisor,

arranged for this)). Tellingly, it was ABN AMRO that was paid the fee for the loan provided by

HBU. (Stip. ¶ 129; JX 43).

The EZH LILO Transaction is structured so that the loan proceeds remain with ABN

AMRO. (Stip. ¶¶ 126-128, DX 20194, Bates 25129-31). The parties to this transaction refer to

the “loan” involved in this case as “loop debt” in an apparent reference to the circular nature of

10The source of this $39,000,000.00 was actually Consolidated Edison Company of New

York (“CECONY”). (Stip. ¶¶ 122-123).



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the movement of the funds through the ABN AMRO banking family with practically no risk to

the financial entity. (See JX 401 (ABN AMRO memorandum noting that the loan would be

structured in such a way that it would be accredited a 0% risk weighting for ABN AMRO’s

purposes); JX 943 (fax from Shearman & Sterling, counsel for CED, describing the

transaction)).11

On the closing date, payments due under the various agreements were effected through a

series of ownership transfers of two accounts, the WTC Account and the ABN AMRO Account.

As explained in more detail below, the WTC Account is the source of funds used to obtain the

Treasury STRIPS placed in the Equity Defeasance Account, and the ABN AMRO Account

eventually becomes the Debt Defeasance Account. A subsidiary of CED, Consolidated Edison

Leasing, transferred the Investor’s Commitment to the WTC Account and then transferred its

rights in the account to WTC as trustee, essentially for the benefit of CED. (Stip. ¶¶ 124, 125;

JX 43). The funds for the Lender’s Commitment came from an ABN AMRO Account. (Stip. ¶

126). HBU transferred its rights to the ABN AMRO account to CED (by way of the trust).

(Stip. ¶ 126). Through the trust, CED then transferred its rights to these two accounts to EZH.

(Stip. ¶ 128).

EZH, pursuant to the Rotte Agreement (JX 23, Bates 1067) and the Sublease Deposit,

Pledge and Repledge Agreement (JX 24, Bates 1106), then in turn irrevocably transferred its

rights to the ABN AMRO Account to the Rotte Foundation (JX 43, Bates 1444), a foundation

11Because of the lack of risk associated with the loan and the fact that ABN AMRO

treated the loan as if it stood on both sides of the deal, the representations in section 10(c) of the
Participation Agreement (JX 1, Bates 42) lack any real meaning, notwithstanding that Plaintiff
will refer to them in an effort to show the debt is bona fide.



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(i.e., trust) formed by EZH to insulate the funds deposited therein from bankruptcy. (Stip. ¶ 187;

Tr. 1268 (Holzman) (noting that EZH could not remove the funds from this account)). The Rotte

Foundation granted a first priority security interest in the ABN AMRO Account CED (through

the trust) (Stip. ¶ 193; JX 24), and subsequently the Rotte Foundation then transferred its rights

to the ABN AMRO Account to ABN AMRO. (Stip. ¶ 189; JX 43). The interest rate on the

funds in the ABN AMRO Account (also referred to as the Sublease Deposit) was 7.10%

compounded annually (Stip. ¶ 188), the same interest rate HBU charged on its loan to CED,

using these very funds. (Stip. ¶ 118; Tr. 1272 (Holzman)). Because of these identical interest

rates and because the funds in the ABN AMRO Account were only used to pay down the HBU

Loan, the amount remaining in the ABN AMRO Account at any point in time would be equal to

the outstanding payment owed on the HBU Loan. (Stip. ¶ 199). As the funds in the ABN

AMRO Account were credited to HBU as “payments” on the HBU Loan, the loop was

completed – all without the funds ever leaving ABN AMRO (other than the split second

transfers of ownership of the ABN AMRO Account that occurred at closing). (See DX 20194,

Bates 25130-31).

At the same time, pursuant to the IJssell Agreement (JX 19, Bates 972), in conjunction

with the Sublessee Pledge and Security Agreement (JX 20, Bates 994), and the Custody

Agreement (JX 22, Bates 1041), EZH transferred to the IJssell Foundation (another trust)

approximately $31 million (from CED’s equity investment) to be held in a Custodial Account by

Credit Suisse as custodian (which served as the Equity Defeasance Account). (Stip. ¶¶ 208-209;

Tr. 3702 (Bent); DX 20194, Bates 25120). Pursuant to the Custody Agreement, Credit Suisse

was required to immediately purchase Treasury STRIPS in amounts and with maturity dates



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sufficient to meet EZH’s obligations under the operative documents (which in turn would

provide CED’s expected return from the transaction (Tr. 2174-75 (DePlautt); Tr. 3738-39

(Bent)) and place them in the Custody/Equity Defeasance Account.12 (Stip. ¶¶ 208, 210-213;

DX 20194, Bates 25120). The Equity Defeasance Account was pledged to CED (and expressly

not pledged to the lending institutions involved in the transaction) (Stip. ¶¶ 218, 219, 225; JX 1,

Bates 126-129; JX 7, Bates 615; JX 20, Bates 994), and could not be withdrawn by the IJssell

Foundation prior to satisfying its obligations under the operative documents.13 (JX 19, Bates

973; Tr. 2705 (Reed)).

Only after the transfers identified above were completed, did EZH receive the remaining

amounts in the WTC Account, which after allocating approximately $1.4 million dollars as the

present value estimate for purchase of the required standby letters of credit (JX 330, Bates 7099-

7100 (showing undiscounted letter of credit fee estimates), Bates 7110 (report from pricing run

reflecting letter of credit allocation); JX 332, Bates 7196 (same); DX 20193, Bates 25093; DX

20194, Bates 25128), left approximately $6 million, which is referred to by the parties to the deal

as the NPV (net present value) benefit to EZH and is driven by CED’s tax benefits (Tr. 2971-73

(Mintun)). As described next, the cash flows were carefully structured so that CED was

guaranteed the ability to repay the HBU loan through the Debt Defeasance Account and recoup

its investment through the Equity Defeasance Account.14

12The account and the Treasury STRIPS located therein are also referred to as the IJssell

Deposit. (Stip. ¶ 214).

13See infra at 19-23.

14Plaintiff argues that the rent from leverage leases is typically pledged to the lender to

secure the outstanding debt payments so as to convince the Court that the payment arrangement
between ABN and HBU is not in any way unusual. (See, e.g., Tr. 1406-07 (Holzman)).



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2.

Debt Defeasance Account

Except for years 1997 through 2003 and part of 2004 (when no payments are due to be

made), during the Sublease Basic Term, both CED’s loan payments and EZH’s rent payments

(which are structured to offset each other, other than the inclusion of one free cash payment to

CED15) are made out of the Debt Defeasance Account (i.e. the ABN AMRO Account). (Stip. ¶¶

195-199; Tr. 1282-83 (Holzman)). As security for EZH’s obligation to make its rent payments

under the sublease, CED was granted a first priority security interest in the Debt Defeasance

Account. (Stip. ¶ 193; Exhibit 24, Bates 1089-1091). CED then pledged that security interest to

HBU as security for the debt service payments on the HBU loan. (Stip. ¶ 194; JX Exhibit 24,

Bates 1086; Bates 1091). CED directed that all rental payments (coming from ABN AMRO

However, as Defendant’s expert, Paul Bent, explained, while investors in traditional leverage
lease transactions often structure the transaction such that the lessee’s rental payments satisfy the
outstanding debt, the funds in those instances come from the lessee’s operation of the asset (or at
least its operations generally), not from the funds fronted by the “loan” itself and put to the side
in an account to make those payments. (See Tr. 3717-18 (Bent); see also JX 288, Bates 5637
(where management of EZH questions why the defeasance accounts must be established instead
of allowing EZH unfettered use of the funds injected into the Transaction at closing)). Thus,
Plaintiff’s argument simply ignores what is different than a so-called “typical leverage lease”
with respect to the loan repayment in the EZH LILO Transaction – the source of the funds used
to satisfy the rental payments and HBU loan repayments. Even Ms. McCartney, chair of the
board of CED, recognized the unique nature of the rental structure of the EZH LILO Transaction
when she noted that (contrary to the structure of the actual Transaction) it would be “logical”
that EZH’s ability to make its rental payments would derive from its ability to generate revenues
from the operation of the RoCa3 Facility. (Tr. 951 (McCartney)).

15In 2012 an additional $5,220,969.87 in “rent payment” is made by EZH directly to CED

in the form of a free cash payment. (JX 330, Bates 7084; Tr. 1277-78 (Holzman); Tr. 3711
(Bent)). This payment is completely funded by the maturity of a Treasury STRIP from the
Equity Defeasance Account as described in further detail infra, and is not a payment from EZH’s
own funds. (Tr. 1277-78 (Holzman)). This “free cash” payment is the first of the scheduled
payments from the Equity Defeasance Account that provides CED with its cash return. (Tr.
3711 (Bent)).



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under the Rotte Agreement) be made directly to HBU, thus satisfying CED’s debt service

obligations. (Stip. ¶ 194A; JX 4, Bates 389-390). Because the amount initially deposited in the

Debt Defeasance Account was equal to the “loan” provided by HBU; the interest rate on the

account was identical to the interest rate on the HBU loan; EZH’s scheduled rent payments

(other than the free cash portions) under the Sublease Agreement equaled, in both timing and

amount, CED’s scheduled debt payments to HBU; and the periodic transfers of funds from ABN

AMRO, which when made satisfied both EZH’s rental obligations as well as CED’s debt service

obligations, the remaining balance in the Debt Defeasance Account would always be sufficient

to cover the remaining debt service on the HBU loan at any given time. (See DX 20194, Bates

25132 (chart setting forth a comparison of the HBU loan and the ABN AMRO Debt Defeasance

Account).

The transfer from the Rotte Foundation to ABN AMRO was irrevocable. (JX 43, Bates

1432) Upon transfer, the funds in the Debt Defeasance Account became ABN AMRO’s asset,

pledged to HBU. (Id. (noting that the Rotte Foundation transferred to ABN AMRO all of its

“rights, title and interest in and to, exclusive dominion and control over” the Debt Defeasance

Account)). Neither EZH nor its creditors has any right to the money in the event of EZH’s

bankruptcy. (Stip. ¶ 190A; see Tr. 1268-69 (Holzman) (noting that EZH had no access to the

funds in the Debt Defeasance Account)). Essentially, this circular financing arrangement from a

defeased account ensures that the sublease rent and HBU loan are paid at no cost to either EZH

or CED, and virtually eliminates any risk of loss on the Transaction (except tax risk). (DX

20194, Bates 25129-32, 25148, 25155-56; DX 20193, Bates 25061-64; Tr. 3736-44 (Bent); Tr.

5054-55 (LaRue)).



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Case 1:06-cv-00305-MBH Document 99 Filed 04/07/2008 Page 26 of 140

If EZH elects the Sublease Purchase Option, ABN AMRO will cause HBU to credit the

remaining $123,615,472 in the Debt Defeasance Account on January 2, 2018 toward CED’s

obligations to HBU, also in the amount of $123,615,472. (Stip. ¶¶ 234, 236; JX 24; DX 20193,

Bates 25081). Thus, if the Sublease Purchase Option is elected the HBU Loan will be paid in

full without cost to CED. (Stip. ¶ 236).

In order to further reduce the already minimal risk that ABN AMRO would not make

payment to HBU under the terms of the operative documents, the Transaction provided further

steps to replace ABN AMRO as the debt defeasance holder with other more secure defeasance

mechanisms. (JX 1, Bates 66-67, 113-14 ; Tr. 1329-30 (Holzman) (noting that there were steps

in place in the transaction to mitigate any risk of ABN AMRO’s default on its obligations)).

Thus, the only way that the debt defeasance mechanism would not perform its designated

function and a payment default would occur is if the parties to the transaction decided not to use

the alternative debt defeasance mechanisms provided in the Transaction and ABN AMRO

subsequently defaulted on its obligation to make the payments to its own subsidiary HBU. This

is simply an unrealistic result. In any event, EZH also served as a backstop to these various

defeasance protections. As Mr. Mintun of Capstar acknowledged, the only risk of non-payment

would be a failure of the defeasance accounts – i.e., the failure of all available debt defeasance

mechanisms (including ABN AMRO, an AA rated bank, and the permitted substitute defeasance

mechanisms) and the failure of the United States government in the case of the equity

defeasance–coupled with the inability of EZH to actually make payments from its own funds.

(Tr. 3051 (Mintun)).



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Case 1:06-cv-00305-MBH Document 99 Filed 04/07/2008 Page 27 of 140

3.

Equity Defeasance Account

As discussed above, like the HBU loan proceeds (which remain with HBU’s parent, ABN

AMRO), most of the equity portion of CED’s advance rent (except the approximately $6 million

paid to EZH as an accommodation fee and the portion allocated to purchase the letter of credit)

was transferred to the IJssell Foundation and deposited with another highly accredited bank –

Citibank – pursuant to the IJssell Agreement and the Custody Agreement with Credit Suisse to

fund the equity portion of EZH’s sublease rental payments. (Stip. ¶¶ 208-209; Tr. 1287-89

(Holzman)). Again, this account was specifically excluded as collateral for the HBU loan16 and

the IJssell Foundation granted CED a security interest in the Equity Defeasance Account

superior to that of EZH. (Stip. ¶¶ 218 -219, 221-223; JX 20, Bates 995; JX 21, Bates 1029-30;

Tr. 1447 (Holzman)). As consideration for the transfer of funds, the IJssell Foundation agreed to

undertake certain Payment Obligations of EZH, including the obligations to make payment of

any equity portion of sublease basic or renewal rent, the equity portion of the Sublease Purchase

Option price, any termination payments, and any free cash17 payments required to be made under

the operative documents. (JX 19, Bates 971-73). The IJssell Foundation could not withdraw the

16This is an important distinction from a traditional leverage lease. Since CED’s equity
investment is not actually at risk of seizure by HBU, Plaintiff’s LILO Transaction is unlike a
traditional leverage lease described by Plaintiff’s expert, Dr. Ellis, in which a substantial portion
of the overall investment by an equity investor may be at risk in the event of a default. (PX
10073, Bates 19999, ¶ 38).

17CED defined “free cash payments” as rents in excess of debt service and other

obligations of the trustee. (JX 1142, Bates 16777). The free cash payments derived from the
Equity Defeasance Account are the source of CED’s retur