Note: As part of a sophisticated tax shelter, Eastern Air Lines, Inc. sold airplanes it had purchased to investors, including Brown & Williamson Tobacco Corp., Savannah Foods & Industries, Inc., Indopco Inc., Cheeseborough-Pond's Finance Corporation, Northern States Power Co. and Southern Living, Inc., then leased them back, conveying the investment tax credits from the transaction to the investors. Known as tax benefit transfer ("TBT") sale and leaseback agreements, these agreements had an average duration of eighteen years during which time the investors continued to receive tax credits. The TBT agreements included an indemnification clause which provided that if a disqualifying event occurred invalidating the tax benefits of the agreement, the airline would "indemnify the beneficiaries for losses resulting from unrealized tax benefits". According to a separate agreement, when the airline filed for bankruptcy, collateral supporting the indemnification was replaced by standby LCs naming the investors as beneficiaries. Subsequent to this bankruptcy plan, the investors alleged that the tax benefits of the TBT agreements were lost due to the occurrence of the disqualifying event. Accordingly they drew on the LCs, determining their damages based on the 46% federal corporate income tax rate that prevailed when the leases were signed. Applicant disputed the occurrence of the disqualifying event and alleged that, even had it occurred, the beneficiaries were entitled only to the prevailing 35% tax rate at the time of the drawing and not to the inflated amount, and it sued for the excess proceeds from the LC draw. The U.S. Bankruptcy Court for the Southern District of New York, Lifland, J., reserved for trial a determination of whether the disqualifying event had occurred. The court ruled that any damages should be based on the 35% corporate tax rate in effect at the time of such disqualification, noting that the excess draw would result in a windfall payment to the beneficiaries, equating to punitive damages since the beneficiaries had not actually paid taxes at the 46% rate, and therefore could not be indemnified at that rate.


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