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VOLUME 15, NUMBER 8, WHOLE NUMBER 177 JUNE 1998

USDA JJudicial Officer
udicial Off icer announces
new
ne PA
w PA C A policies
The USDA’s Judicial Officer has announced three new policies regarding disciplin-
ary actions for violations of the “full payment promptly” requirements of the
Perishable Agricultural Commodities Act (PACA), 7 U.S.C. § 499a-499s. The new
policies concern the standards under which cases will be deemed to be “slow-pay”
and “no-pay” cases, when the payment of an antecedent debt for perishable
agricultural commodities with a promissory note will constitute payment under

INSIDE PACA, and the factors that will be considered in deciding whether to impose a civil
penalty or a license suspension in “slow-pay” cases. The new policies were announced
in In re Scamcorp, Inc., PACA No. D-95-0502 (Jan. 29, 1998).
Scamcorp, an Illinois corporation, has held a PACA license since it began operation
in 1991. Doing business under the trade name Goodness Greeness, Scamcorp rapidly
• Recent developments became the second largest distributor of organic produce in the United States. By
1996, it held most of the market share in Chicago and in states extending from
in estate and tax Wisconsin to Pennsylvania.
planning PACA licensees are required to make full payment promptly for the produce they
purchase. This “full payment promptly” standard requires a PACA licensee to pay
• Agricultural law its sellers within ten days after the day on which the produce is accepted unless the
bibliography parties agree in writing before entering into the transaction to other terms and those
terms are followed. See 7 U.S.C. § 499b; 7 C.F.R. § 46.2(aa)(5), (11). Sanctions for
violating the requirement include publication of the facts and circumstances of the
• Federal Register violation, license suspension or revocation, and civil penalties not to exceed $2,000
in brief for each violative transaction or each day the violation continues. 7 U.S.C. § 499h.
During the period from April, 1993 through June, 1994, Scamcorp failed to make
• Chloroplast full payment promptly to thirty-five produce sellers in 165 transactions. The
outstanding debt totaled $634,791.43.
transformation Based on these transactions, the USDA Agricultural Marketing Service instituted
disciplinary proceedings against Scamcorp in October, 1994. After a postponement,
Solicitation of articles: All AALA a hearing on the complaint was held in April 1996 pursuant to the USDA procedures
members are invited to submit for formal adjudications. Under these procedures, hearings are conducted by an
articles to the Update. Please in- Administrative Law Judge (ALJ), and either party may appeal to the USDA Judicial
clude copies of decisions and leg-
islation with the article. To avoid Continued on page 2
duplication of effort, please no-
tify the Editor of your proposed
article. ailure
F ailur exhaust
e to e adminstrati
xhaust adminstr ative
ati ve
bars
remedies bar s action against FCIC
IN FUTURE The Second Circuit has upheld the dismissal of a declaratory judgment action
against the Federal Crop Insurance Corporation (FCIC) brought by farmers who
alleged that their crop insurance indemnities were calculated in a manner that

I SSUES violated the Federal Crop Insurance Act, 7 U.S.C. §§ 1501-1521. Bastek v. Federal
Crop Ins. Corp., No. 97-6221, 1998 WL 257305 (2d Cir. May 22, 1998). The court
relied upon the statutory exhaustion requirement set forth in 7 U.S.C. § 6912(e).
Enacted in 1994, that statute essentially provides that all administrative appeal
procedures must be exhausted before a person can bring an action against the
• Secretary, the USDA, or a USDA agency, office, officer, or employee.
The plaintiffs were New York onion farmers who suffered major losses to their
crops in 1996. Though their crops were insured under FCIC catastrophic risk
insurance policies, the plaintiffs’ attorney took issue with the announced basis on
which the indemnities would be calculated. The attorney wrote to the Secretary and
the USDA Office of Risk Management arguing that the indemnity formula violated
the Federal Crop Insurance Act. The Acting Director of the Office of Risk Manage-
ment responded with a general defense of the indemnity formula. A month later,

Continued on page 7
PACA/CONTINUED FROM PAGE 1

Officer who renders the final decision on outlet for its produce, were among the for a period of up to ninety days. In both
behalf of the Secretary. See 7 C.F.R. §§ primary reasons why Made In Nature cases, “full compliance” requires pay-
1.130-.151. extended its loan to Scamcorp. ment of all sellers and the absence of any
By the middle of the month preceding Following the hearing, the ALJ con- credit agreements for more than thirty
the hearing, Scamcorp had paid its out- cluded that Scamcorp had violated PACA days. Id.
standing indebtedness to all but one of its by failing to make full payment promptly Another issue on appeal was whether
sellers and had entered into an agree- in each of the 165 transactions. A civil Scamcorp was in full compliance with
ment with the remaining seller. Under penalty of $30,000 was imposed on the PACA at the time of the hearing in
that agreement, the seller, Made In Na- Scamcorp. Seeking the suspension of view of the promissory note between
ture, Inc., loaned Scamcorp $235,385.29. Scamcorp’s PACA license, the Agricul- Scamcorp and Made In Nature. Though
A portion of that sum was in cancellation tural Marketing Service appealed to the the Judicial Officer concluded that
of the produce debt Scamcorp owed to Judicial Officer. Scamcorp and Made In Nature had in-
Made In Nature and was evidenced by a Among the issues raised on appeal was tended for the promissory note to extin-
promissory note calling for the debt to be whether the hearing had been resched- guish the produce debt owed by Scamcorp
repaid in installments. uled by the ALJ to give Scamcorp time to to Made In Nature, he agreed that the
The evidence introduced by Scamcorp pay its sellers. Concluding that the re- debt should be viewed for the purposes of
at the hearing attributed its failure to scheduling was done for another reason, the PACA as unpaid. Accordingly, as to
make prompt payment fully on its rapid the Judicial Officer observed that the future cases, the Judicial Officer adopted
growth and lack of internal controls. By then-current policy discouraged expedi- the policy that “payment of antecedent
the time of the hearing, however, tious hearings. Under that policy, cases debt for perishable agricultural commodi-
Scamcorp had acquired expert financial in which the respondent had failed to pay ties with a promissory note ... will not
guidance and had gone from having a by the date of the hearing were referred constitute payment ... even if a respon-
negative equity to being within at least to as “no-pay” cases. In such cases, the dent can show that the parties agreed
one month of having a positive equity. respondent’s PACA license was revoked. that the promissory note would extin-
This improvement, coupled with its de- On the other hand, if the respondent had guish the debt and constitute payment
sire to keep Scamcorp in business as an paid its sellers in full by the hearing and and the agreement to accept the promis-
was otherwise in full compliance with sory note as payment was an arm’s length
PACA, the case was deemed a “slow-pay” transaction and not the product of a
case. The sanction for “slow-pay” cases respondent’s superior bargaining posi-
was license suspension. While this policy tion.” Id. at 50-51 (footnote omitted).
encouraged payment, it also gave respon- Finally, the Judicial Officer changed
dents an incentive to seek to postpone his policy regarding civil penalties to
hearings and to thus further delay pay- reflect his finding, based on the text and
ment. legislative history of the PACA civil pen-
VOL. 15, NO. 8, WHOLE NO. 177 June 1998 To remedy this problem, the Judicial alty provision, that the imposition of a
AALA Editor..........................Linda Grim McCormick
Officer announced a new “slow-pay/no- civil penalty should be considered in lieu
Rt. 2, Box 292A, 2816 C.R. 163 pay” policy. Under this policy, the case of a license suspension or revocation in
Alvin, TX 77511 will be considered a “no-pay” case if:
Phone/FAX: (281) 388-0155 “slow-pay” cases. That finding was at
E-mail: lsgmc@flash.net odds with the position of the Agricultural
• the “respondent has failed to pay in Marketing Service, which contended,
Contributing Editors: Drew L. Kershen, Norman, OK;
Roger A. McEowen, Manhattan, KS; Christopher R. accordance with the PACA and is not in among other contentions, that neither
Kelley, Hastings, MN; Pat Traynor, Virginia Tech; full compliance with the PACA within license suspension nor revocation were
Linda Grim McCormick, Alvin, TX.
120 days after the complaint is served on “excessive” sanctions and that a civil
For AALA membership information, contact that respondent, or the date of the hear- penalty should not be considered as ei-
William P. Babione, Office of the Executive Director, ing, whichever comes first”;
Robert A. Leflar Law Center, University of Arkansas, ther the primary or sole alternative avail-
Fayetteville, AR 72701. able to address violations of the PACA.
• the “respondent fails to file a timely In adopting the new policy that a civil
Agricultural Law Update is published by the
American Agricultural Law Association, Publication answer to the complaint”; or penalty may be imposed in a “slow-pay”
office: Maynard Printing, Inc., 219 New York Ave., Des case, the Judicial Officer stated the deci-
Moines, IA 50313. All rights reserved. First class
postage paid at Des Moines, IA 50313.
• the “respondent admits the material sion whether to impose a civil penalty or
allegations in the complaint and makes a license revocation would involve con-
This publication is designed to provide accurate and no assertion that the respondent has
authoritative information in regard to the subject sideration of the following factors:
matter covered. It is sold with the understanding that achieved full compliance or will achieve
the publisher is not engaged in rendering legal, full compliance with the PACA within (1) the length of time during which a
accounting, or other professional service. If legal advice
or other expert assistance is required, the services of 120 days after the complaint was served respondent was in violation of the pay-
a competent professional should be sought. on the respondent, or the date of the ment requirements of the PACA; (2)
Views expressed herein are those of the individual
authors and should not be interpreted as statements of
hearing, whichever comes first. . . .” In re the number of a respondent’s viola-
policy by the American Agricultural Law Association. Scamcorp, Inc., slip op. at 29-30. tions and the dollar amounts involved;
Letters and editorial contributions are welcome and (3) the roll-over debt, if any, incurred
should be directed to Linda Grim McCormick, Editor, In a “no-pay” case, license revocation by the PACA violator; (4) the time it
Rt. 2, Box 292A, 2816 C.R. 163, Alvin, TX 77511. will follow a finding of flagrant or re- takes the PACA violator to achieve
Copyright 1998 by American Agricultural Law peated violations of the PACA. compliance with the PACA; (5) the
Association. No part of this newsletter may be The case will be considered a “slow- impact of the violations on the industry
reproduced or transmitted in any form or by any means,
electronic or mechanical, including photocopying,
pay” case if the respondent is in full as a whole; and (6) whether the PACA
recording, or by any information storage or retrieval compliance with the PACA within 120 violator’s financial condition is such
system, without permission in writing from the days after service of the complaint or the
publisher. that an appropriate civil penalty, large
date of the hearing, whichever comes enough to be an effective deterrent to
first. In a “slow-pay” case, the violator future violations of the PACA, would
faces civil penalties or license suspension
C ontinued on page 7

2 AGRICULTURAL LAW UPDATE JUNE 1998
gr
Ag icultural
ricultur law
al la bibliogr
w bibliog aphy
raphy
Agribusiness corporations Source Water Pollution, 23 Colum. J. Between the Pesticide’s Phase Out Dates
Envtl. L. 89, 135 (1998). Under the Clean Air Act and the Montreal
Glade & Tavis, Actualizing the Devel- Protocol on Substances that Deplete the
opmental Response of Multinational Cor- Farm Labor Ozone Layer, 4 Envtl. L. 577, 610 (1998).
porations: The Case of Agribusiness in Collective Bargaining Note, Clarifying FIFRA Section 6(a)(2):
the Mexican Countryside, 18 U. Pa. J. Casenote, Did Old MacDonald Have a The Post Registration Reporting Obliga-
Int’l Econ. L. 1211, 1234 (1997). Farm? Holly Farms Corp. v. NLRB, 116 tions of Pesticide Registrants, 4 Envtl. L.
S. Ct. 1396, 69 U. Colo. L. Rev. 295, 330 641, 662 (1998).
Animals—animal rights (1998).
Book note, Abrogating Property Status Torts
in the Fight For Animal Rights. (Review- Fruits & Vegetables—Perishable Ag- Note, “A Pig in the Parlor Instead of the
ing Gary L. Francione, Rain Without ricultural Commodities Barnyard”? An Examination of Iowa
Thunder: The Ideology of the Animal Centner, The New “Pick-your-own” Agricultural Nuisance Law, 45 Drake L.
Rights Movement), 107 Yale L.J. 569, 574 Statutes: Delineating Limited Immunity Rev. 935, 961 (1997).
(1997). From Tort Liability, 30 U. Mich. J.L.
Comment, Reconsidering Animal Reform 743-779 (1997). Uniform Commercial Code
Rights: Should Selling Live Animals For Article Seven
Food Consumption Be Banned? 6 Dick. J. International trade Kershen, Article 7: Documents of Title
Envtl. L. & Pol’y 279, 298 (1997). Black, Winnowing the Chaff: Cana- 1996 Developments, 52 Bus. L. 1565-
dian Grain Trade and International Law, 1574 (1997).
Biotechnology 13 Am. U. Int’l L. Rev. 1, 70 (1997).
Boyd, Nonobviousness and the Biotech- Note, The SPS Agreement Applied: The Water rights: agriculturally related
nology Industry: A Proposal For a Doc- WTO Hormone Beef Case, 4 Envtl. L. 537, Comment, The Search For New Sup-
trine of Economic Nonobviousness, 12 576 (1998). plies: Salvaging the Remains of Agricul-
Berkeley Tech. L.J. 311, 343 (1997). tural Water Conservation in California,
Comment, From Flav’r Sav’r to Envi- Land use regulation 31 U.C. Davis L. Rev. 591, 623 (1998).
ronmental Saver? Biotechnology and the Land use planning and Graff & Yardas, Reforming Western
Future of Agriculture, International farmland preserva Water Policy: Markets and Regulation,
Trade, and the Environment, 9 Colo. J. tion yechniques 12 Nat. Resources & Envt. 165-169, 220-
Int’l Envtl. L. & Pol’y 145, 166 (1998). Juergensmeyer, Florida’s Private Prop- 221 (1998).
Comment, “Attack of the Killer Toma- erty Rights Protection Act: Does it Inordi- Kanazawa, Efficiency in Western Sater
toes?” Corporate Liability For the Inter- nately Burden the Public Interest? 48 Fla. Law: The Development of the California
national Propagation of Genetically Al- L. Rev. 695, 707 (1996). Doctrine, 1850, 1911, 27 J. Legal Stud.
tered Agricultural Products, 10 Transnat’l 159, 185 (1998)
L. 153, 194 (1997). Pesticides
Cross, The Consequences of Consensus: If you desire a copy of any article or
Environmental issues Dangerous Compromises of the Food further information, please contact the
Kluge, Farming By the Foot: How Site Quality Protection Act, 75 Wash. U. L.Q. Law School Library nearest your office.
Specific Agriculture Can Reduce Nonpoint 1155, 1206 (1997). —Drew L. Kershen, Professor of Law,
Note, Methyl Bromide: The Disparity The University of Oklahoma,
Norman, OK.

Chloroplast
Chlor transf
oplast tr ansformation:
ansf ormation: biological
containment ffor transgenes
or transgenes
Gene flow, or the exchange of genetic Some strategies to reduce the risk of formed chloroplasts. This result advances
information between crops and wild rela- gene flow from transgenic crops, such as the potential for chloroplast transforma-
tives, is a naturally occurring phenom- the use of male sterile plants, work well tion to be an effective strategy to manage
enon. The normal movement of genes via but are limited to a few species. For the the risk of gene flow.
pollen dispersal provides a mechanism, many crops in which chloroplasts are Glyphosate, a broad spectrum herbi-
however, for foreign genes to “escape” strictly maternally inherited, which is to cide, works by inhibiting EPSPS, an en-
from a genetically engineered crop and say not transmitted through pollen, trans- zyme involved in synthesis of aromatic
spread to weedy relatives growing nearby. formation of the chloroplast genome amino acids in plants and microorgan-
Gene flow becomes an environmental should provide an effective way to con- isms. Genes for glyphosate-resistant
issue when the associated trait confers tain foreign genes. As described in the forms of EPSPS have been used to geneti-
some kind of ecological advantage. This April issue of Nature Biotechnology, cally engineer herbicide resistant crops.
is a particular concern in the case of Henry Daniell and colleagues at Auburn The Auburn group used two vectors to
herbicide resistance genes, for example, University introduced a gene for herbi- introduce a petunia EPSPS gene into
where transfer of the resistance trait to cide resistance into tobacco, showed that tobacco together with a selectable marker
weedy relatives raises the possibility of it was stably integrated into the chloro- gene conferring resistance to
creating “super-weeds” that are more plast genome, and demonstrated that spectinomycin. One vector was designed
difficult to control. transgenic plants contained only trans- specifically for integrating foreign genes
Cont. on p.6

JUNE 1998 AGRICULTURAL LAW UPDATE 3
Recent developments in estate and tax planning
By Roger A. McEowen

Deduction denied for interest paid held that unrestricted control, standing 34, § 312(a), 111 Stat. 188, amending §§
with funds from same lender. alone, is not sufficient to justify a deduc- 121, 1034. Section 121 formerly provided
Davison v. Commissioner , 98-1 tion if funds have been borrowed from the that taxpayers over age 55 were entitled
U.S.T.C. (CCH) ¶ 50,296 (2d Cir. 1998). same lender for the primary purpose of to a one-time exclusion of $125,000 on the
financing interest on a prior loan. The sale of their principal residence. In this
The taxpayers formed a cash-basis Service has also indicated that it will case, the court held that the debtor’s
partnership with other investors to ac- deny an interest deduction if the tax- bankruptcy estate was entitled to the
quire, operate, and sell farm properties. payer borrows funds from the same lender new I.R.C. § 121 exclusion.
A life insurance company loaned $20 to satisfy the interest obligation to that When the debtors filed bankruptcy,
million to the partnership in May of lender, or rolls over the remaining bal- the principal residence (titled only in the
1980. Under the credit arrangement, the ance of the loan into a new line of credit husband’s name) was scheduled with an
partnership was required to make an for the next year. I.R. News Rel. 83-93, estimated fair market value of $150,000,
interest payment of $1.5 million in Janu- July 6, 1983. subject to a mortgage of $110,000. A sale
ary of 1981. The partnership was short of Here, the Tax Court acknowledged that of the residence would have yielded $8,600
cash and sought a $1.5 million loan from the taxpayers appeared to have met the of equity after accounting for the mort-
the life insurance company. The lender unrestricted control test since the funds gage, commissions, sale costs, the
wired $1.5 million to the partnership’s were in the borrower’s bank account. trustee’s fee, and the taxpayer’s home-
account, and the partnership wired back Even though the taxpayer had physical stead exemption of $7,500, but without
to the lender the next day $1.5 million to control of the funds for a short period of taking into account the capital gains tax
cover the interest payment. The Service time, the Tax Court recognized that the due on the sale. Since the taxpayer’s cost
disallowed the taxpayers’ portion of the borrower did not have unrestricted con- basis in the property was approximately
partnership’s loss attributable to the trol over the borrowed funds in any mean- $70,000, the court calculated a capital
partnership’s interest deduction, and the ingful sense. The court noted that the gains tax due of approximately $12,000.
Tax Court upheld the Service’s determi- failure to make the interest payment The debtor argued that the estate was
nation. Davison v. Commissioner, 107 would have resulted in a breach of the not entitled to the $250,000 exclusion of
T.C. No. 4 (1996). terms of the original credit with the I.R.C. § 121. The debtor sought to have
In a 1947 case involving a lender that lender. The Tax Court denied a deduc- the property abandoned because, after
gave up control of funds that were com- tion, concluding that the interest was two homestead exemptions and payment
mingled with the taxpayer’s funds before deferred rather than repaid. (Arguably, of the capital gains tax, no sale proceeds
the interest was paid, the Tax Court if a borrower can demonstrate that it has would be available for creditors.
developed the “unrestricted control” test other funds to pay the interest, it might The court held that under local (Illi-
for determining the deductibility of in- be easier to justify a deductible interest nois) law, only the husband was entitled
terest paid with funds obtained from the payment.) to a homestead exemption because the
same lender. Burgess v. Commissioner,8 On appeal, the court agreed that if the wife did not have an ownership interest
T.C. 47 (1947). Under this test, a cash- purpose and economic substance of the in the residence. [The court noted that
basis borrower can deduct interest used transaction was to postpone, rather than the Rights of Married Persons Act (750
to satisfy an obligation borrowed from extinguish, the borrower’s interest obli- Ill. Comp. Stat. 65/0.01 et. seq.) did not
the original lender, but the lender must gation, the borrower should not be en- give the wife a sufficient ownership in-
give up control of the borrowed funds, the titled to a tax deduction solely because terest in the residence to entitle the wife
funds must be commingled with the the lender has temporarily placed the to an exemption.] The court also con-
borrower’s other funds in an account at funds under the borrower’s control. In cluded that the estate succeeded to the
an institution separate from the lender, addition, the court expressly rejected the taxpayer’s holding period and that the
and the borrower must have unrestricted Tax Court’s “unrestricted control” excep- property’s character included its use as
use of the borrowed funds to make the tion. Thus, the vitality of Burgess ap- the taxpayer’s principal residence for at
interest payment. However, the Fifth pears questionable—having been rejected least two of the previous five years. The
and Eighth Circuits have rejected the now by three circuit courts. court held that because the bankruptcy
unrestricted control test as being too estate succeeded to those attributes, it
easily manipulated by the borrower. See also succeeded to the I.R.C. § 121 exclu-
Wilkerson v. Commissioner, 655 F.2d 980 New home sale capital gains exclu- sion. The court noted that its holding was
(9th Cir. 1981), rev’g. 70 T.C. 240 (1978); sion rules apply to bankruptcy es- consistent with the principle of treating
Battelstein v. Internal Revenue Service, tate. In re Popa, 98-1 U.S.T.C. (CCH) the bankruptcy estate as the debtor, and
631 F.2d 1182 (5th Cir. 1980), cert. de- ¶ 50,276 (Bankr. N.D. Ill. 1998). that bankruptcies should mirror
nied, 451 U.S. 938 (1981). These courts nonbankruptcy entitlements instead of
Effective for sales and exchanges after changing the character of a particular
May 6, 1997, the Taxpayer Relief Act of transaction.
1997 amended I.R.C. § 121 to provide an
Roger A. McEowen is Associate Professor exclusion of up to $500,000 for married
of Agricultural Economics and Extension couples ($250,000 for other taxpayers) on Create your own basis—court holds
Specialist, Agricultural Law and Policy, the sale of a principal residence every that unsecured promissory note in-
Kansas State University, Manhattan, two years, as long as the taxpayer has creased shareholder’s basis in con-
Kansas, and is a Member of the Kansas owned and lived in the residence two of tributed property. Peracchi v. Com-
and Nebraska Bars. the previous five years. Pub. L. No. 105- missioner, 1998 U.S. App. LEXIS 8174

4 AGRICULTURAL LAW UPDATE JUNE 1998
(9th Cir. Apr. 29, 1998), rev’g, T.C. corporation to cover the excess indebted- this simply could not be the correct re-
Memo. 1996-191. ness on contributed property over that sult. In addition, the court noted that the
property’s basis did not give the taxpayer taxpayer was creditworthy and likely to
In general, a shareholder can contrib- a basis for I.R.C. § 357 purposes because have funds to pay the note. The note bore
ute capital to a corporation without rec- it cost the taxpayer nothing to write the a market rate of interest related to the
ognizing gain on the exchange if certain note. The Tax Court adopted this reason- taxpayer’s credit worthiness and had a
requirements are met. See, e.g., I.R.C. § ing (Alderman v. Commissioner, 55 T.C. fixed term. In addition, nothing suggested
351. However, contributing property with 662 (1971)), but the Second Circuit Court that the corporation could not borrow
liabilities in excess of basis triggers im- of Appeals in Lessinger v. United States, against the note to raise cash. The court
mediate recognition of gain as to the (872 F.2d 519 (2d Cir. 1989), rev'g 85 T.C. also pointed out that the note was fully
amount of the excess. See I.R.C. § 357(c). 824 (1985)), held that a shareholder’s transferable and enforceable by third
This is a serious concern especially upon personal note, while having a zero basis parties.
incorporation of farm and ranch opera- in the shareholder’s hands, had a basis The Ninth Circuit did acknowledge
tions because of the typically low basis equivalent to its face amount in the that its assumptions would fall apart if
(compared to fair market value) of many corporation’s hands under I.R.C. § 357. the shareholder were not creditworthy,
of the operational assets. Here the tax- In this case, the Tax Court avoided the but the Service stipulated that the
payer faced this problem and attempted chicanery of Lessinger by concluding that shareholder’s net worth far exceeded the
to escape gain recognition by also con- the indebtedness was not genuine. How- value of the note. That seems to be a key
tributing an unsecured promissory note ever, the Ninth Circuit reversed the Tax point that the circuit court overlooked. If
so as to increase the taxpayer’s basis. The Court and held that the taxpayer had a the taxpayer was creditworthy, then a
taxpayer claimed that the note had a basis of $1,060,000 (face value) in the legitimate question exists concerning why
basis equivalent to its face value, which note. As such, the aggregate liabilities of the taxpayer failed to make payments on
made the taxpayer’s total basis in the the property contributed to the corpora- the note before being audited. Clearly,
property contributed greater than the tion did not exceed aggregate basis, and the taxpayer never had any intention of
total liabilities associated with the prop- no gain was triggered under I.R.C. § paying off the note. Thus, the note did not
erty. Accordingly, the taxpayer argued 357(c). The court reasoned that the represent genuine indebtedness. The
that gain was not triggered under I.R.C. Service’s position ignored the possibility Ninth Circuit also appears to have over-
§ 357(c), and that no tax was due. that the corporation could go bankrupt, looked the different basis rules under
The taxpayer, in order to comply with an event that would suddenly make the I.R.C. § 1012 and I.R.C. § 351. An ex- b
Nevada’s minimum premium-to-asset note highly significant. The court also changed basis is obtained in accordance
ratio for insurance companies, contrib- noted that the taxpayer and the corpora- with an I.R.C. § 351 transaction which
uted two parcels of real estate to the tion were separated by the corporate precludes application of the basis rules of
taxpayer’s closely-held corporation. The form, which was significant in the matter I.R.C. § 1012.
transferred properties were encumbered of C corporate organization and reorgani- The Ninth Circuit was careful to state
with liabilities that together exceeded zation. Contributing the note placed a that the court’s rationale was limited to
the taxpayer’s total basis of the proper- million dollar “nut” within the corporate I.R.C. § 357(c) involving C corporations.
ties by more than $500,000. In order to “shell,” according to the court, thereby Thus, the opinion will not apply in the S m
avoid the immediate gain recognition of exposing the taxpayer to the “nutcracker” corporation setting for shareholders at-
I.R.C. § 357(c) as to the amount of excess of corporate creditors in the event the tempting to create basis to permit loss
liabilities over basis, the taxpayer also corporation went bankrupt. Without the pass-through. Likewise, Rev. Rul. 80-
executed a promissory note, promising to note, the court reasoned, no matter how 235, 1980-2 C.B. 229, specifies that a
pay the corporation $1,060,000 over a deeply the corporation went into debt, partner in a partnership cannot create
term of ten years at eleven percent inter- creditors could not reach the taxpayer’s basis in a partnership interest by con-
est. The taxpayer remained personally personal assets. With the note on the tributing a note. In any event, the Service
liable on the encumbrances even though books, however, creditors could reach is likely to continue challenging “basis
the corporation took the properties sub- into the taxpayer’s pocket by enforcing creation” cases on the ground that the
ject to the debt. The taxpayer did not the note as an unliquidated asset of the contribution of a note was not a bona fide
make any payments on the note until corporation. The court noted that, by transfer. The more prudent approach
after being audited, which was approxi- increasing the taxpayer’s personal expo- would be to have creditworthy share-
mately three years after the note was sure, the contribution of a valid, uncondi- holders of closely-held corporations bor-
executed. The Service argued that the tional promissory note had substantial row the money from an independent third
note was not genuine indebtedness and economic effect reflecting true economic party under a binding contractual ar-
should be treated as an enforceable gift. investment in the enterprise. The court rangement and contribute the borrowed
In the alternative, the Service argued also noted that, under the Service’s theory, funds to the corporation.
that even if the note were genuine, its if the corporation sold the note to a third
basis was zero because the taxpayer in- party for its fair market value, the corpo-
curred no cost in issuing the note to the ration would have a carryover basis of Sale of conservation servitude on
corporation. As such, the Service argued, zero and would have to recognize special use elected land did not trig-
the note did not increase the taxpayer’s $1,060,000 in phantom gain on the ex- ger recapture
recapture. Estate of Gibbs v.
basis in the contributed property. change even if the note did not appreciate United States, 98-1 U.S.T.C. (CCH)
In Rev. Rul. 68-629, 1968-2 C.B. 154, in value at all. The court reasoned that ¶60,307 (D. N.J. 1997).
the Service held that a note given to a
Continued on page 6

JUNE 1998 AGRICULTURAL LAW UPDATE 5
RECENT DEVELOPMENTS/Cont. from page 5
An estate did not trigger recapture tax ally prohibiting all institutional, indus- which are not related to the farm or
on the sale of a conservation servitude on trial, and commercial use of the elected business use (such as mineral rights) are
special use elected land to the state of land. The Service noted that even if a not to be eligible for special use valua-
New Jersey. The servitude stipulated conservation easement in gross were clas- tion.” H.R. Rept. No. 1380, 94th Cong. 2d
that the land was to be maintained as a sified as a restrictive covenant, such clas- Sess. 24 (1976). Consequently, the dispo-
farm in perpetuity. By virtue of the spe- sification would not negate the charac- sition of oil rights was ruled not to be a
cial use election, the value of the farm- terization of the servitude as an interest disposition triggering recapture tax. Rev.
land in the decedent’s estate was reduced in property. See 5 R. Powell, Powell on Rul. 88-78, 1988-2 C.B. 330. The ruling
from a fair market value of $988,000 to a Real Property, § 60.01[2] at 60-10 (rev. did state, however, that “well-drilling
special use value of $349,770 for estate ed. 1997), which states “the great weight activity and the subsequent extraction
tax purposes. The heirs sold the servi- of authority regards equitable restric- process” would constitute a “cessation of
tude to the state for $1,433,493.72. The tions as recognitions of an equitable prop- use” for purposes of recapture because
deed of easement imposed restrictions on erty interest in the burdened land, ap- farming activity would be interrupted.
the property that ran with the land, purtenant to the benefitted land, similar How do these rulings square with
thereby binding the heirs and all future to an easement.” Indeed, the Uniform Gibbs? It appears that the court reached
title holders to its provisions. Conservation Easement Act specifically the right result in, but for the wrong
The Service argued that the granting characterizes a conservation easement reason. The Gibbs court reached its con-
of an easement to the state triggered as an interest in real property. Uniform clusion on the narrow ground that the
recapture because an interest in real Conservation Easement Act, § 1(1), 12 qualified heirs did not dispose of an inter-
property was conveyed. The Service also U.L.A. 170 (1996). The preferatory note est in land because, under New Jersey
maintained that recapture tax was due to the Uniform Act indicates that the law, land use restrictions are construed
because the heirs realized the develop- drafters intentionally designated the in- as “equitable servitudes” involving con-
mental value of the property during the terests covered by the Act as “easements.” tract rights rather than property inter-
recapture period. The heirs argued that Id. ests. However, as mentioned above, the
the state’s acquisition of the conserva- Also, in Technical Advice Memoran- rulings do not generally support that
tion servitude was not a disqualifying dum 8731001, Mar. 19, 1987, the trans- position. See, e.g., Rev. Rul. 77-414, 1977-
disposition of an “interest” in the farm fer of an agricultural preservation ease- 2 C.B. 299; Priv. Ltr. Rul. 8940011; TAM
because the easement grant imposed only ment for consideration resulted in recap- 8731001. A better reason for holding that
a contractual restriction upon the ture of estate tax. Five years after the the granting of a conservation servitude
farmland’s future use guaranteeing that decedent’s death, a qualified heir ex- does not constitute a disqualifying dispo-
the property would be used as farmland ecuted a deed of easement for all of the sition under I.R.C. § 2032A(c)(1) is that
well beyond the recapture period. elected farmland in favor of the state for there was no interruption of the surface
In ruling for the estate, the court noted $490,000. The easement restricted sub- use in Gibbs. Revenue Ruling 88-78, 1988-
that New Jersey law construes land use division of the farm so as to preserve the 2 C.B. 331, and Private Letter Ruling
restrictions as “equitable servitudes” in- farm solely for agricultural use. The Ser- 9035007, May 25, 1990, support that
volving contract rights rather than prop- vice cited Rev. Rul. 59-121, 1959-1 C.B. proposition. That is the result irrespec-
erty interests. Thus, according to the 212, for the notion that consideration tive of whether the grant of a conserva-
court, the granting of a conservation ser- received for the granting of an easement tion easement involves an interest in real
vitude did not create a possessory inter- with respect to land constitutes proceeds property under state law. See, e.g., Rev.
est in the burdened land because the from a sale of an interest in real property. Rul. 88-78, 1988-2 C.B. 330; H.R. Rept.
burden imposed was enforceable only as As such, the grant of the preservation No. 1380, 94th Cong. 2d Sess. 24 (1976).
a contract right. Accordingly, the grant of easement for consideration was a dispo-
a conservation servitude was not a dis- sition resulting in the imposition of re-
position of an interest in land resulting in capture tax under I.R.C. § 2032A(c)(1).
recapture of estate tax under I.R.C. § However, in Priv. Ltr. Rul. 9035007, Chloroplast/Cont. from p. 3
2032A(c)(1). May 25, 1990, the granting of a subsur- into tobacco chloroplasts; the other is a
The court’s opinion in Gibbs is ques- face pipeline easement was ruled to not universal expression and integration vec-
tionable. Real property servitudes simi- be a recapture-triggering event because, tor used to transform chloroplasts ge-
lar in nature to the one presented in the easement neither interrupted nor nomes of several plant species. Both vec-
Gibbs have been treated as interests in affected the use of the elected land. Simi- tors include chloroplast gene sequences
real property for tax purposes. For ex- larly, in Rev. Rul. 88-78, 1988-2 C.B. 330, flanking the EPSPS and marker genes to
ample, in Rev. Rul. 77-414, 1977-2 C.B. the grant of a lease in subsurface oil and promote insertion into the chloroplast
299, the taxpayer sold the development gas interests that also involved the ex- DNA by homologous recombination.
rights in his farm to the county in accor- traction of oil and the disposition of roy- Transformed plants were character-
dance with a county statute designed to alty rights on elected land did not trigger ized to determine whether the genes had,
ensure the preservation of farmland. The recapture tax. Normally, the interest of a in fact, integrated into the chloroplast
ruling concluded that the disposition con- lessee in oil and gas in place is an interest genome. Pairs of primers were designed
stituted the sale of an interest in real in real property for federal income tax such that one would ‘land’ within the
property for purposes of §§ 1221, 1231 purposes (see,e.g.,Rev. Rul. 68-226, 1968- inserted sequence and the other would
and 453(b)(1)(A) of the Code. Similarly, 1 C.B. 362), and a royalty interest is a fee anneal to native chloroplast sequence
in Priv. Ltr. Rul. 8940011, Jun. 30, 1989, interest in mineral rights and real prop- adjacent to the insertion site. PCR analy-
the mere donation of a conservation ease- erty (Rev. Rul. 73-428, 1973-2 C.B. 303). sis produced fragments of the size ex-
ment to the county triggered recapture Thus, the disposition of oil rights would pected for chloroplast integration of the
tax. Under the facts of the ruling, the usually be considered the disposition of foreign genes by both vectors.
grant of the easement would have re- an interest in real property. However, a The authors established that the plants
stricted the use of the land in perpetuity 1976 committee report involving I.R.C. § are homoplasmic, having copies only of
to agricultural and related uses, gener- 2032A states that “elements of value the transgenic genome and not the native
untransformed genome. Southern blot
C ontinued on page 7

6 AGRICULTURAL LAW UPDATE JUNE 1998
CHLOROPLAST/Cont. from p. 6 FCIC/Cont. from page 1 PACA/Cont. from page 2
analysis showed that DNA from trans- plaintiffs filed their declaratory judg- not substantially increase the risk that
formed plants lacked a specific fragment ment action challenging the indemnity the PACA violator’s future produce sell-
characteristic of the native chloroplast calculations. The next day, the Office of ers may not be paid in accordance with
genome, but did contain an extra frag- Risk Management sent a letter to each of the PACA.
ment generated by insertion of the the plaintiffs denying their claims for Id. at 55-56 (footnote omitted).
transgenes. Transformed plants contain- indemnity at a rate higher than the an-
ing a mixture of transformed and nounced rate and notifying them of their As explained by the Judicial Officer,
untransformed chloroplast would give administrative appeal rights, including the imposition of a civil penalty may
rise to variegated progeny when grown the right to appeal to the USDA National promote the public interest better than a
on spectinomycin. Seeds collected after Appeals Division (USDA NAD). The license suspension. For example, the
the first self-cross all germinated nor- plaintiffs did not file administrative ap- imposition of a civil penalty on a finan-
mally in the presence of spectinomycin peals, and the time for filing administra- cially strong violator reduces the risk
and the seedlings remained green. The tive appeals lapsed. posed by a license suspension “that a
lack of variegated progeny confirms that The district court dismissed the de- PACA violator may not pay those who
the transgenic plants are homoplasmic. claratory judgment action on the grounds sell produce to the violator between the
The tobacco chloroplast genome is present that the plaintiffs had failed to exhaust time of the hearing and the effective date
in 5,000 to 10,000 copies per cell. By their administrative remedies as required of the sanction, thereby thwarting one of
showing that all of the chloroplasts con- by 7 U.S.C. § 6912(e). On appeal, the the purposes of the PACA.” Id. at 57.
tain inserted DNA, the authors estimate plaintiffs argued that the exceptions to Also, a suspension is more likely than a
there are 5,000 to 10,000 copies of the the judicially created exhaustion require- civil penalty to put the violator out of
EPSPS gene per cell in the transformed ment should apply to the statutory ex- business, a result that may not be in the
plants. haustion requirement. Relying on McNeil public interest.
Herticide resistance was tested by v. United States, 508 U.S. 106 (1993), and As to “no-pay” cases, however, civil
spraying transformed and control tobacco other authority for the proposition that penalties do not apply. In the words of
plants with varying concentrations of unambiguous statutory exhaustion the Judicial Officer, “a civil penalty would
glyphosate. Control plants died within a requirments cannot be ignored by the not be an appropriate sanction in a “no-
week of spraying with 0.5 mM glyphosate, courts, the Second Circuit affirmed the pay” case in which the violations are
but transgenic plants survived concen- dismissal. flagrant or repeated because the PACA
trations as high as 5 mM. Given that the The Second Circuit also rejected the violator’s failure to get back into compli-
petunia EPSPS used in these studies has plaintiffs claim that exhaustion should ance with the PACA promptly would
a relatively low tolerance to the herbi- be excused because they were challeng- indicate that the violator continues to be
cide, it may be possible to achieve signifi- ing the generally applicable indemnity financially irresponsible, and limiting
cantly greater levels of resistance by us- formula. The court noted that while the participation in the perishable agricul-
ing genes from other sources. Bacterial USDA NAD does not have jurisdiction to tural commodities industry to financially
genes would be good candidates as they hear challenges to rules of general appli- responsible persons is one of the primary
would likely be expressed at higher lev- cability, under 7 U.S.C. § 6992(d) the goals of the PACA.” Id. at 57-58 (footnote
els in the prokaryotic-like chloroplast USDA NAD does have the authority to omitted).
compartment of the cell. This approach determine whether an appeal presents As to Scamcorp, the Judicial Officer
may prove to be a significant tool for such an issue. It therefore ruled that the rejected the request by the Agricultural
ensuring the environmentally safe use of plaintiffs should have first presented their Marketing Service that Scamcorp’s PACA
herbicide resistant crops where the pres- claims to the USDA NAD: “Under the license be suspended for ninety days. The
ence of weedy relatives is a cause for clear terms of the statute, plaintiffs’ ar- Judicial Officer, however, concluded that
concern. gument that their broad challenges to the facts warranted an increase in the
—Pat Traynor, reprinted with FCIC calculations could not adequately civil penalties assessed against Scamcorp
permission from ISB News Report— have been presented within normal ad- by the ALJ to $500.00 per violation, for a
April 1998, pp. 2-3. ministrative channels is itself an argu- total of $82,500.00.
EDITOR’S NOTE REPRINTED: [We reprint a ment that was required to be tested and —Christopher R. Kelley, Hastings, MN
clarification to a previous reprint of an ISB News exhausted before being presented in fed-
Report.] An article in the December ISB News eral court.” Bastek, 1998 WL 257305 at
Report, “Gene Flow Between Crops and Distantly *5.
Related Weeds,” contained potentially misleading —Christopher R. Kelley, Hastings, MN
statements that need to be clarified. The article
reported on the escape of a transgene for herbi- F ederal Register
cide resistance from oilseed rape plants to wild Conference Calendar
radish. First, it was not made explicit that the News in br ief
bri
Report article was based on a note in the Scientific 1998 Summer Agricultural Law The following is a selection of items that
Correspondence section of the journal Nature, not Institute were published in the Federal Register
on a peer-reviewed research paper. Secondly, the Drake Univ. L. School, Des Moines, IA from March 27 to April 28, 1998.
News Report article referred to the maternal trans- June 8-11: Taxation of Agricultural Businesses 1. Farm Credit Administration
Administration. In-
mission of the transgene and raised the question (Prof. Jim Monroe) terest rate risk management; proposed
as to whether chloroplast transformation of crop June 15-18: Agricultural Insurance: Liability and policy statement with request for com-
plants, proposed as a means of containment for Property Coverage (Prof. John Copeland) ments by 6/22/98. 63 Fed. Reg. 27962.
engineered genes, is as benign as claimed by by June 22-25: Formation of “New Wave” Farmer — Linda Grim McCormick, Alvin, TX
its proponents. In fact. The Nature correspon- Cooperatives (Sarah Vogel)
dence described maternal transmission of a nuclear July 6-9: Law and the New Agriculture: Direct
transgene, not a chloroplast transgene. The re- Marketing (Prof. Neil Hamilton)
ported observations had no bearing on the biosafety July13-16:WaterLawandAgricul-ture(Prof.Jake
applications of chloroplast transformation, thus Looney)
the comment was inappropriate. We regret the For info., call 515-271-2947.
error.

JUNE 1998 AGRICULTURAL LAW UPDATE 7
AALA Award nominations sought
The AALA Awards Committee is seeking nominations from the general membership for consideration in the following
categories:
1. AALA Award for Excellence in Scholarship for 1998;
2. AALA Award for Excellence in Student Writing for 1998;
3. AALA Award for the Ag Law Update for 1998; and
4. AALA Distinguished Service Award for 1998.
The deadline for submitting nominations is July 1, 1998. Winners will be honored during the 1998 annual educational
conference on Oct. 23-24 in Columbus, Ohio. Nominations should be submitted to the 1998 AALA Awards Committee
Chairman: David C. Barrett, Jr., National Grain and Feed Association, 1201 New York Ave., N.W., Washington, DC
20005; phone: 202-289-0873; e-mail: dbarrett@ngfa.org
dbarrett@ngfa.org.