Index - The Mary Polaski L Series
Preface and Summary
Preface and Summary
The Mary Polaski "L" Series is intended to provide my opinion about Large Group Awareness Training (LGAT) programs such as The Landmark Forum, Lifespring Basic, and others. My opinion is informed by extensive research that I have conducted on the topic, as well as my own first-hand experience.
Participation in such programs is not recommended. Case histories suggest that the powerful psychological techniques and emotional stressors used in LGAT can in some cases overwhelm the coping mechanisms even of "normal" people who otherwise were functioning well, leading to decompensation, mental breakdown, or transitory psychosis (#2). There is little to suggest that these mental breakdowns lead to long-term patterns of psychopathology. However, the outcome of transitory psychosis by itself is a severe injury. Although some people seem to enjoy the psychoactive effect of their LGAT participation, others who decompensated as a result of their participation have described it as "hellish". Even though the benefits sought by many participants are those of personal growth and psychological well-being, to my knowledge there is no credible evidence that LGAT participation leads to significant improvement in core measures of mental health. If it were not for the intangible nature of the psychological process, this form of amusement product would most likely be banned as unsafe.
Opinions about LGAT are polarized, with some people experiencing a "conversion" or becoming promoters of a particular LGAT system, while others may decry the same program as destabilizing, dangerous, or detrimental (#7). Those who do become converts or proponents of the particular LGAT they participate in, often seem to pay a significant cost in unpaid labor they perform for the LGAT corporation. This cost is usually not accounted for when deciding whether or not to enrol. One might also question whether such converts have been distracted from lifelong goals that they may have focussed on instead. While similar questions may be raised with respect to extreme religious conversion, the lack of labeling for the secular LGAT conversion process is especially problematic.
This polarization seems to exist within the mental health professions no less than among the general public. However, aside from case reports of psychological injury and the lack of evidence that LGAT has any real benefits (#3), consideration of professional ethics (#8) clearly mandates that mental health professionals should avoid LGAT involvement.
I have entered this document into the public domain in the year 2000 under the pen name "Mary Polaski". Please feel free to copy and redistribute this work. (Making a copy of this HTML file is preferable to creating a hyperlink to it. Use File / Save As to make a complete copy.)
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1. Mental Breakdown Directly Related To Landmark Forum
This section reports my experience of mental breakdown related to the Landmark Forum program. Information provided here is according to a clinical opinion I received on the episode.
A number of years ago I participated in a Landmark Forum training session. I decompensated starting toward the end of the sessions, with symptoms worsening over the subsequent few days. My condition improved substantially over the following weeks but did not completely disappear for several months. Extensive psychotherapeutic intervention was required; no medications were prescribed. Eventual recovery was complete.
I experienced ideas of reference, depersonalization and derealization, and paranoid delusions. I cried at length, experienced extreme fear, was extremely anxious, and sometimes incoherent to the point of forsaking language altogether. Diagnosis of transitory psychosis was made under DSM.
Some premorbid anxiety and difficult recent life events were evident on examination, including for example some experienced pain with no evident physical basis. However, there was no previous psychiatric history and no history of any similar episodes or in fact of any mental disorder. A non-immediate family member was treated for depression, and another non-immediate family member may have had a drinking problem. I was not taking medication or other drugs, and drank only very lightly.
The evidence clearly indicates that the Forum training was directly and substantially related to the metal breakdown. The relationship is evident from the timing of the episode, the thematic content of the symptoms, and the lack of any previous or subsequent history of similar disorder. Overall, the structure of the episode was analogous to post-traumatic stress disorder, except that onset was immediate.
Of course, the premorbid anxiety and difficult life situation were also relevant. However, without participation in the Forum training, it is highly unlikely that a psychotic episode would have been experienced. Most likely things would have continued with little change (i.e. no psychiatric diagnosis). If the situation had eventually worsened to a clinically significant degree, then it would be more consistent to have developed depression or an anxiety disorder rather than a brief psychosis.
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The following are some publicly reported cases of psychological disorder that subjects or their clinicians viewed as significantly related to participation in a Large Group Awareness Training (LGAT). Quality and verifiability of the reports relied on here may vary. As well, cases could conceivably overlap if the subject's name is not reported and if the reported symptoms or other details are similar. It is reasonable to assume that other cases have occurred that have not been reported.
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References for this section
 Glass, Kirsch, and Paris, "Psychiatric Disturbances After ..." American Journal of Psychiatry, v. 134, n. 3, 1977.
 Kirsch and Glass, "Psychiatric Disturbances Associated With ..." American Journal of Psychiatry, v. 134, n. 11, 1977.
 Higget and Murray, "A Psychotic Episode Following ...", Acta Psychiatrica Scandinavica, v. 67 n. 6, 1983.
 Finkelstein, Winograd, Yalom, "Large Group Awareness Training", Annual review of Psychology, v. 33, 1982.
 Leiberman, "Effects of a Large Group Awareness Training on ...", American Journal of Psychiatry v. 144, 1987.
 Solomon, "Psychotherapy of a Casualty ...", Cultic Studies Journal, v. 5, n. 2, 1988.
 Haaken, Adams, "Pathology as Personal Growth ...", Psychiatry, v. 46, 1983.
 Administrative Court of Berlin, VG 27 149.95, 1997.
 Anonymous, 1999, in http://www.rickross.com/reference/landmark/landmark26.html
 Lell, "Das Forum: Protocoll Einer Gehirnwasche ... " ("The Forum: Record of a Brainwashing ... ") ISBN 3-423-36021, Deutscher Taschenbuch Verlag, 1997.
 Anonymous, 11 Oct 1996, alt.support.ex-cult posting.
 Mary Polaski "L" Series #1, My Mental Breakdown Related to Landmark Forum, this series.
 Ney vs. Landmark Education et al., Fourth Circuit Court of Appeals, 92-1979, LEXIS 2373.
 Anonymous, 1999, in http://www.geocities.com/antilandmark/landmark.html (now a dead link)
 Anonymous, August 2000, in http://www.rickross.com/reference/landmark/landmark39.html
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Selected research on LGAT process and outcomes is discussed here. This does not include individual cases of disturbance; see the "L" Series #2. This review is meant to provide examples of the state of research; it is not exhaustive.
Fisher and others  studied the psychological impact of Landmark Forum participation, using mail-in tests. The sample size was 135. The authors used peer-nomination to select a control group. The authors found no significant outcome, whether positive or negative, of participation. The only exception was a short-term effect on perceived control, which the authors cautioned could be an artifact.
The study is not as conclusive as it seems to be. The study could not determine whether negative effects of participation might have led to early termination of the training and therefore exclusion from the study. A significant drop-out rate was experienced. The sample size would not be adequate to determine negative effects occurring in a small percentage of the population.Leiberman reported on Lifespring in several studies [2,3,4]. Five high stress responses were found among 289 Basic participants, including one transitory psychosis. Six out of thirty-three Advanced participants were DSM diagnosable after the training, but all were also diagnosable before. The author concludes that the training does not result in lifelong psychopathology. Some positive long-term shifts were found in some measures of values and adjustment, but no long-term changes in core measures of pathology were found.
The overall results suggest that no long-term injury is caused by LGAT. The reported possible long-term peripheral benefits could be attributable to factors coincident with LGAT training rather than the training itself. The author's interest in lifetime psychopathology seems to lead him to discount the importance of the transitory psychosis and other negative high-stress reactions which he himself noted in connection with the training.Langone  reported on an "est" prison trial conducted by other researchers . 313 inmates were randomly allocated to trial and control groups. Positive changes perceived by the "est" participants were not confirmed by behavioral or physiological tests.
The results are consistent with those of Fischer et al and Leiberman. Sample size had similar characteristics to that of Fisher et al, but drop out and control group issues were eliminated by the controlled prison setting. Subjective belief in the training did not translate into measurable behavior changes. The study reference is obscure, and the secondary source is relied on here.Haaken and Adams  conducted a participant-observer study of the Lifespring Basic training. They concluded that although many participants experienced a sense of enhanced well-being due to the training, these experiences were essentially pathological. They found that the training undermined ego functions and promoted regression, submission and surrender.
The report is interestingly consistent both with negative accounts that view such trainings as premeditated attacks on the self  and with positive participant stories that view the trainings as a source of elation. Applicability of the results to other LGAT trainings is a matter of judgement. See the "L" Series #7 for further discussion of this paper.
References for this section
 Fisher, Silver, Chinsky, Goff, Klar, and Zagieboylo, "Psychological effects of ... ", Annual Review of Psychology, v. 33, 1989.
 Leiberman, "Effects of Large Group Awareness Training..." American Journal of Psychiatry, v. 144, 1987.
 Leiberman, "Perceptions of Changes in Self ...", in "Self Change ... ", Klar, Fisher, Chinsky and Nadler eds., 1992.
 Leiberman, "Growth Groups in the 1980's ...", in "Handbook of Group Psychotherapy, ...", Furhriman and Burlingame, eds., 1984.
 Langone, "Essay: Large Group Awareness Training", Cult Observer, v. 15, n. 1, 1998.
 Hosfor, Moss, Cavior, Kerish, "Research on Erhard Seminar ..." Manuscript 2419, American Psychological Association, 1982.
 Haaken, Adams, "Pathology as Personal Growth ...", Psychiatry v. 46, 1983.
 Cushman, "Iron Fists, Velvet Gloves: A Study of a Mass Marathon ...", Psychotherapy, v. 26, 1989.
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Large Group Awareness Training is perhaps most easily delineated by simply referring to the programs which people consider to be LGAT. While this does not provide a definition for the purpose of social control or psychological research, it may still be helpful for general discussion.
Of course, each of the programs is unique. Most training processes have important features that are difficult to quantify. Therefore, observations and commentary about one program cannot be applied directly to others. Furthermore, many programs constantly change and evolve. By listing these programs as a group, one only means that various community members have labelled a version of them as large group awareness trainings. Most are currently listed under the heading of Large Group Awareness Training by a significant organization interested in the topic, while the others have been referred to in the literature as examples of LGAT. The trainings and the groups that sponsor them are quite diverse.
- Lifespring Basic Training
- The Forum (Landmark Forum)
- ManKind Project
- Context Associated program
- Sterling Institute of Relationship
- Silva Mind Control
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This brief section reports on recent business events at Lifespring.
A major business information service reports that the former Lifespring central office is closed.
The Lifespring office in Texas indicates that they have purchased the name from the former organization, subsequent to illness of the Lifespring founder.
Lifespring Basic Training seems to have been replaced by The Lifespring Adventure, while the old Lifespring Advanced course has become Lifespring Challenge. The third-level course is now Lifespring Quest. There are numerous other courses and programs, ranging in cost up to $15,000. Free promotions have been offered for the Lifespring Adventure, suggesting that the Texas office wishes to build membership.
The Awareness Page ( http://perso.wanadoo.fr/eldon.braun/awareness/) lists several organizations as former Lifespring regional offices.
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This note gives opinions on a few of the public statements of Landmark Education Corporation, which operates one of the most prominent LGAT programs.
The specific statements by Landmark analysed here concern their founder, the nature of their program, and the "cult" label. These topics have little interest in themselves; the interest is in how Landmark interprets and presents matters. Landmark's attitude to fact and opinion is of interest because Landmark's dominant market position makes them central to the LGAT industry. Therefore the emphasis in this analysis is on Landmark's use of the marketing license, rather than the specific topics.
Quotations here are from the Landmark Education "controversies" web page, http://www.landmarkeducation.com/overvw/cntrvrsy(now a dead link) and immediately linked pages, as of 5/2000, except as noted.
The items discussed here in detail should be viewed as only a few examples. The reader is invited to analyse other Landmark statements if interested further.
Analysis of LEC statements: Landmark's portrayal of the inventor of The Landmark Forum
Landmark states, "Recently some of those misconceptions and misunderstandings have begun to be corrected in the mainstream media. For example, in the March 16th, 1998 issue of Time Magazine, false allegations about tax fraud and Mr. Erhard abusing his family were laid to rest." Landmark refers to articles in the LA Daily News (9/12/96) and Time Magazine (3/16/98).
This is a statement of opinion, that the Time Magazine article laid some public concerns to rest. The phrasing suggests that there have been many misconceptions that could be rectified. In this way the exoneration of Erhard is made to stand in for repair of an untold number of slanders against Landmark or Erhard.
A casual reading of the second sentence - referring to "false allegations about tax fraud ..." might give the impression that Erhard did not tax commit fraud or abuse his family. Reading more carefully, though, the statement only says there were some false allegations "about" these topics.
While Landmark may have the opinion that allegations of tax fraud were laid to rest by the Time Magazine article, others might well feel that Erhard's taxes were laid to rest by the Ninth Circuit Court of Appeals, in the ruling on cases 93-70357, 93-70359, and 93-70360 filed Feb 8 1995 (Appendix B). The judge thoroughly rejected Erhard's arguments, and upheld the imposition of penalties for "understatement of tax" based on the law concerning "any sham or fraudulent transaction". Appeal to the Supreme Court was denied, making the ruling final. It is hard to imagine a more plain assessment that Erhard did use fraudulent transactions in an illegitimate attempt to reduce his taxes.
One wonders whom the Time Magazine reporters relied on for information, as the Time article is clearly misleading and imbalanced. Time only reported that Erhard's tax fraud "proved false and won him $200,000 from the IRS". The article does not mention that Erhard was found to have understated his tax by engaging in sham transactions and that penalties were imposed on Erhard as a result. (The two statements can be reconciled: early reports of tax fraud might have mistaken some particular detail, might have been unprovable at the time they were made, or might have involved wrongful disclosure -- all such faux paux would be consistent with the Court's finding against Erhard.)
It is amazing that Landmark cites a "lack of thorough research" as the cause of "misleading and imbalanced stories" while also citing the Time article as correcting misunderstandings of Erhard. If Landmark knows of the ruling against Erhard -- and it is reasonable to think they might, given that Erhard's brother has been the long-time Chief Executive, that Landmark has held a long-term licensing agreement with Erhard, and that Landmark considers Erhard to be a "friend" -- then one may well question Landmark's promotion of this misleading and imbalanced story on their web page. Of course, it could simply be an oversight.
A detailed analysis of Erhard's alleged abusiveness is not attempted here, except to note that the allegedly repudiating daughter was not the only one to have commented negatively on Erhard. His other daughter made the same or similar allegations at or about the same time (see Newsweek Feb 18, 1991, p. 72).
Analysis of LEC statements: Landmark's statements on their program
Landmark writes, "... a few people in the 1980's without researching, characterized Mr. Erhard's programs as psychological in nature. The facts are clear that Landmark's programs do not constitute and are not based in psychology or psychotherapy. Dr Raymond Fowler, the head of the American Psychological Association, speaking personally about his experience of the Forum, said, '... what I experienced was nothing remotely like psychotherapy.'"
The first sentence refers to "psychological in nature", while the second and third sentences refer to "psychology or psychotherapy". These are two quite different things. The first refers to actual psychological impact, use of techniques, etc. The second seems to refer to a practice of psychology or psychotherapy, commonly regulated by law, and having certain traditions and practices.
By juxtaposing these two senses of very similar words -- "psychological" and "psychology" -- Landmark is near to equivocation. A true equivocation would be the use of the very same word in two different senses, in a single context. An equivocation tends to unify the two statements; a casual listener might transfer the sense of the word from one statement to the other. In this example, one might carelessly transfer the fact that Landmark's program is not a professional practice of psychology, and use this unjustifiably to support an opinion that the program is not psychological in nature.
It is a matter of fact that LGAT is not a legally prescribed practice of psychology, and it is undisputed that LGAT is not conducted according to the traditions of psychotherapy. It could still be, however, that the program is psychological in nature, utilizes an understanding of the human psyche developed through psychological research, has a powerful psychological effect, is sought by clients in order to achieve psychological change, etc. While some psychological effects may be testable, these latter claims are often a matter of judgement (i.e. opinion) concerning the nature and perceived effects of the program.
Certainly a number of professionals have viewed the Forum process as significantly psychological in nature. Indeed, before reports of negative psychological impact began to appear in professional publications, some psychologists felt that "est" might prove a useful adjunct to psychotherapy. (Although The Forum is not identical to "est", a number of professionals have viewed them as very closely related. As well, The Forum training product was a business successor to the "est" program and was designed by the same person as "est" was.) While a few people who _didn't_ do research might have characterized The Forum as psychological in nature, it's also true that other people who _have_ done a lot of research have viewed the programs from the perspective of psychological impact. See "L" Series #1, #2, and #3. The courts have also viewed the psychological impact of the Forum as worthy of discussion; see for example the Ney case (Appendix A) in which it was found that psychological injury was not actionable absent of physical injury. Finally, the origins of LGAT as a type of "encounter group" has extensive connections to the origins of group psychotherapy. For example, one popular textbook series discussed encounter groups as an alternative type of therapy whose goal of "happiness" is broader and more diffuse than the goals originally associated with psychotherapy.
Landmark's repeated reference to Dr Fowler as head of the APA, merits some scrutiny. It is clear that Fowler is writing in his personal capacity. As such, his comments carry no more weight than that of any other psychologist. Yet, Landmark's repeated reference to his capacity in the APA cannot help but entwine the authority of the APA in Fowler's personal commentary. The APA itself, however, does not endorse such programs. There is no reason I know of to think that any important fraction of professionals views LGAT favorably. One psychologist I spoke with exclaimed "that's reckless!" when he realized that no pre-encounter psychological testing is required. Referring to Landmark's conduct, a psychiatrist commented "it makes me angry". Both are members in good standing of their respective professional organizations.
Such comments are not solicited and promoted by Landmark. On the contrary, one well-known professional -- a psychologist specializing in persuasion, LGAT, and cults, Dr. Singer -- could only speak her mind about LGAT at the cost of extensive legal correspondence. Many individuals are not willing to take such risks or to pay the dollar or emotional costs of encountering a multimillion-dollar corporation. As Landmark states, their policy is to "take appropriate action" concerning their representation in the public eye.
Analysis of LEC statements: Landmark's statement concerning the "cult" label
Landmark claims, "The allegation that the work of Landmark Education is cult-like has been shown to be completely inaccurate in every sense". They cite Dr. Fowler, Lowell Streiker, Dr. Singer, and a legal settlement with Cult Awareness Network.
The statement is one of opinion. The phrasing is absolutist, stating their opinion as having been proven, complete, and covering every sense. The evidence cited by Landmark fails, on the whole, to convincingly support the immoderate nature of this statement.
Landmark's hyperbole is of interest because it could be viewed as a use of the "anchoring" effect. Psychological studies have shown that people are influenced by an initial presentation even if they know the presentation to be irrelevant. For example: when presented with a small random number and then asked to guess the date on which a certain historical event occurred, people tend to guess a much earlier (i.e. smaller) date than they do if initially presented with a large random number -- even if they are told the initial number was chosen randomly. In the present example, one can assume that Landmark's opinion about their own program should be taken with a grain of salt, since it is in their own interest to promote the program. Yet, one might still unwittingly use this extreme and absolute view as a kind of "anchor" in subsequently evaluating opinions of the program. That could result in a more favorable ending opinion than would otherwise be the case.
What then of the evidence cited by Landmark?
The citations of Dr. Singer and of the CAN agreement are examples of, in a sense, co-opting the enemy. Both parties were actual or potential legal adversaries of Landmark Education.
Landmark currently promotes a single sentence by Dr. Singer stating that in her opinion Landmark and its program is not a cult. Hardly an endorsement on its own right, this sentence does not reveal Dr. Singer's complete opinion. In her book she expressed the view that LGATs differ from cults in their economic structure, in the fact that participants are used to enrol their family members, and in the length of time that LGATs retain participants -- but that LGATs may have some important similarities to cults in some of the psychological techniques used during indoctrination. Far from supporting Landmark's claim, Dr. Singer seems to have the view that programs like the Landmark Forum, while they are not cults, do in fact have some coercive features that can be usefully compared to cult coercion.
It certainly is odd to cite the former CAN as an authority stating that Landmark is not cult-like. After all, Landmark brought a suit against CAN essentially for giving the impression that it is cult-like. The CAN agreement must be understood in the context of a series of lawsuits by Scientology, and one by Landmark Education, leading to bankruptcy proceedings. In any case, the CAN agreement does not support Landmark's extreme statement above. Under the agreement, CAN did not claim that Landmark is a cult -- nor did they say it isn't. The agreement certainly doesn't say that all cult allegations have been shown to be false. Indeed, according to one transcript, CAN leader Cynthia Kisser testified in court that Landmark "might be" a cult or might have cult-like features.
However, another version of the transcript of Kisser's testimony, reportedly received from Landmark, omits this part of Kisser's testimony. Likewise, the citation of the CAN agreement currently promoted by Landmark on their web site is also an extract. It does not include such information as the reference to Steve Pressman's book -- a book which Landmark reportedly prefers not be made available. Nor does this extract contain the description of how CAN provided information titled "Destructive Cults" and "Who Are They" and included The Forum in a list of groups. In these cases, Landmark seems to show a willingness to selectively edit documents so that only information favorable to Landmark is presented. (Note: these documents were obtained from D. Chase's web site; some documents were provided in multiple versions, one or more of which were referenced as being provided by Landmark.)
Landmark's citations of Fowler and Streiker are less retrograde: Fowler and Streiker are supporters rather than detractors.
While Dr Fowler's report does state his view that Landmark Forum is not cult-like, it is primarily concerned with other issues such as the applicant screening process. See the "L" Series #8 for a detailed discussion of his report.
The 1993 letter from Lowell Streiker, provided by Landmark, is of interest in a number of ways. First of all, the letter is addressed to "Herr Kristensen" and begins "I have been informed that Landmark Education is listed by your organization as a 'cult'"; the letter then proceeds with a rebuttal. On whose behalf is Streiker writing? Who informed him about Kristensen? It almost sounds as though Streiker is writing on behalf of Landmark Education, as if he were an employee or assistant of theirs. If so, his independence is in question. In any case, Streiker's sense of judgement is certainly under question. He is filed under "Cult Apologists?" by Rick Ross (http://www.rickross.com), with a quotation from the "new CAN" newsletter (Vol. 1, Issue II) describing him as "of invaluable help to the new CAN". According to Rick Ross's other reports, the new CAN is operated by the Foundation for Religious Freedom, listed as a "Scientology-related" entity under an IRS-Scientology agreement. The Scientology-related take-over of CAN after its bankruptcy was widely publicized. If these reports are accurate, Streiker's involvement with Scientology completely negates any credentials he might have had in the matter of judging what is or isn't a cult.
Landmark's citation of Streiker is also interesting for the extensive annotations and interpretations which Landmark provides. For each cult characteristic in Streiker's letter, Landmark attaches their own claim of why the Forum does not have the characteristic. Although consisting primarily of opinions, these statements also have some true but largely irrelevant facts interspersed. The truth of the factual statements may incline one to accept the statements of opinion, even when the two are actually unrelated. As just one example, consider Streiker's statement that "cult initiation techniques are frequently based on deception and psychological coercion". To support the opinion that there is no deception or coercion, Landmark adduces the following claims:
(1) To show a lack of deception or coercion, Landmark cites a study as showing high customer satisfaction and high customer belief that the training was valuable.
The study as reported does not have any direct bearing on the use of deception or coercion. Furthermore, no information was given about the methodology of the study, making it impossible to assess its worth. Finally, on the face of it, a high degree of belief among members could be taken as evidence that the system is cult-like, rather than that it isn't.
(2) To show a lack of deception or coercion, Landmark claims "There is no deception."
This statement of opinion just reasserts the original claim without any other support. Whether or not deception occurs depends, of course, on many factors. For example, would a false understanding arise if a reader encountered Landmark's discussion about Erhard's taxes? (see above). Not if the reader already was prepared with supplementary information about the court ruling against Erhard. But a casual reader who did not have such information might come to a wrong conclusion about Erhard's honesty in tax matters. There is only a fine difference between asserting a false fact, and providing true facts that could lead to a wrong impression. Ultimately, the term "deception" refers to the speaker's intentions -- whether they intend the listener to reach a correct conclusion or an erroneous conclusion. As the speaker's intentions are not objectively verifiable, ultimately the matter of deception is one of opinion.
(3) To show a lack of deception or coercion, Landmark claims that no participants are separated from their family or environment, "and the notion of being coerced to take the Landmark Forum is ludicrous."
The last statement is again simply a statement of opinion, restating the claim to be proved but not adding any evidence or discussion. Separation from family and workplace is irrelevant to the question of deception. Although coercion could involve separation from family or environment, such separation is not strictly necessary for coercion to occur. Not all coercion is physical, and it may be either strong or mild. Much like deception, "coercion" refers ultimately to important subjective elements - such as the participant's evaluation of what their alternatives are at any given time. For discussion of coercion in the Forum program, see the "L" Series #8. Finally, to my knowledge no-one has studied whether LGAT participation leads to increased or decreased family cohesion.Analysis of LEC statements: Landmark's enrolment process
Landmark requires that each attendee to complete a disclosure and enrolment form prior to attending the training sessions. The form refers to "stress", but does not describe in detail the techniques used in the Landmark Forum.
It is common for the prospective client to verbally agree to attend the Landmark Forum and to provide their credit card number for the purpose of payment, prior to receiving the enrolment and disclosure forms. In fact, this seems to be Landmark's standard procedure; when I asked for a copy of the enrolment and disclosure information prior to agreeing to attend The Forum, my request was refused.
Under such procedures, the client has a prior commitment to attending when reading the disclosure form. This could lead the client to psychologically discount any negative features of the disclosure, given the only other alternative of retracting their prior commitment. How can the disclosure be instrumental in deciding to participate, if the client has already agreed to participate before receiving the disclosure? Furthermore, the "disclosure" fails to plainly state the nature of the program itself; terms such as "a rigorous inquiry" are hardly adequate descriptors. Unfortunately, practicalities prevent a full discussion; however, see the "L" Series #8 for further comments on consent and intimidation in The Landmark Forum.
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This section of the "L" Series compares Lifespring marketing materials to the independent observations made by Haaken and Adams in their participant-observer study. This is not simply a study of dichotomies; of interest are the points at which the two perspectives coincide.
Lifespring marketing materials quoted here are drawn from their recent web site (www.lifespringusa.com). The Haaken and Adams study dates from 1983, raising the question of whether the two can be compared. While programs do change over time, and Lifespring has recently undergone corporate changes and has revised its offerings, it seems doubtful that these changes could be extensive enough to account for the very substantial difference in perspective of the two sources. This is all the more the case as the marketing materials are of a general rather than detailed nature.
The Haaken and Adams study, titled "Pathology as Personal Growth: a Participant-Observer Study of Lifespring Training", appeared in Psychiatry v. 46, August 1983; a transcript is available online at http://www.rickross.com/reference/lifespring.
In general, and not surprisingly, Lifespring marketing materials promote the training in very favorable terms as "empowering" and "allowing you to fully engage your heartfelt commitments with freedom and passion". In contrast, Haaken and Adams argue that
"[...] while many participants experienced a sense of enhanced well-being as a consequence of the training, these experiences were essentially pathological. First, ego functions were systematically undermined and regression was promoted by environmental structuring, infantilizing of participants and repeated emphasis on submission and surrender. Second, the ideational or interpretive framework provided in the training was also based upon regressive modes of reasoning -- the use of all-or-nothing categories, absolutist logic and magical thinking, all of which are consistent with the egocentric thinking of young children. Third, the content of the training stimulated early narcissistic conflicts and defenses, which accounts for the elation and sense of heightened well-being achieved by many participants. The devaluation of objective constraints upon a person's action promoted grandiose fantasies of unlimited power. A corollary to this devaluation of the external world was that interactions with others laced substance. People appeared to be interchangeable, so that ephemeral, indiscriminate emotional contacts were experienced as profound and meaningful. Identification with Lifespring necessitated considerable idealization so that any threat to this experience was aggressively defended against".
Lifespring describes the training as "designed to enhance the individual's effectiveness and satisfaction". Haaken and Adams describe the training as having a "disinhibitive effect" in which "[r]easoning and intellectual processes were minimized while affective states were intensified". Arguably, a bath in affect could be a source of satisfaction for a person who is out of touch with their feelings. However, effectiveness could only be increased in the sense of affective awareness. True effectiveness requires substantial reasoning and intellectual processing, precisely what was devalued by the training. Ultimately, satisfaction also requires significant ego development and an exercise of autonomy. Yet Haaken and Adams found that a major feature of the training was regression and a shifting of ego functions to the session leader, coupled with an extraordinary emphasis on submission and surrender. This contradicts Lifespring's use of the term "individual", as autonomous action was found to be denigrated in the session. Specifically Haaken and Adams found that "Audience responses were managed in a way which reduced the ability of the participants to think critically and simultaneously inflated their self-esteem. [...] What was rewarded by the trainer was compliance or pseudo-compliance. Participants who [...] suggested a different way of conceptualizing a problem had their statements dismissed, were subjected to ridicule, or were confused with paradoxical logic." One of the authors was subjected to attacked for maintaining an independent viewpoint.
These observations also contradict Lifespring's assertion that "Lifespring is not interested in telling participants what to think, but rather in allowing them to observe their own patterns of thinking [...]". It is not easy to see how the phrase "allowing them" can apply to the Lifespring training, given the extremely controlled and rigid training features described by Haaken and Adams. For example, they commented "[w]e found that the experience of having our movements monitored throughout the five days (while being told to be spontaneous) was particularly unsettling, evoking feelings of powerlessness and dependency. The prolonged eye contact required in all pair exercises had a certain hypnotic effect in that it became increasingly difficult to withdraw from the influence of the exercise". What comes to mind is the transactional analysis of an early "est" observer who referred to bringing about a "forced closure of previously energetically avoided" conflicts. It seems like a perversion, however, to suggest that by forcing someone into a certain psychological state you "allow" them to experience feelings that they otherwise might not. "Force" here must be understood as psychological persuasion and environmental structuring bringing about an effect intended by the trainer, irrespective of the original intentions of the client. All indications in the Haaken and Adams report are that developing client autonomy is not of any interest to Lifespring.
Where Haaken and Adams might agree with Lifespring is in Lifespring's promotion for their Trainer-in-Training program: "Since 1974, Lifespring has demonstrated an unparalleled skill in training men and women from all walks of life to mold themselves into Lifespring Trainers." The promotion agrees with Haaken and Adams' observation that over the course of the training "participants came increasingly to identify with the trainer", leading to childish feelings of omnipotence. Noting that "Exercises which mobilized [...] feelings of inflated well-being and exaggerated personal power, were alternated with attacking exercises [that] evoked feelings of shame and worthlessness [...]". Seemingly, given the polarized alternatives of becoming powerful by identifying with the leader vs. being cast into a state of infantile badness, many participants opt for the former. The promotion by Lifespring contains an extra twist: they claim not only that they mold people into their own image, but that they teach people to view themselves as malleable and to mold themselves into this "powerful" form. This, however, cannot mean greater autonomy and independence, because it only extends so far as clients mold themselves into Lifespring trainers; i.e. in a manner prescribed by Lifespring.
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Fowler's comments are divided into four sections: harm caused, screening of applicants, relation of Forum to psychotherapy, and thought reform / manipulation used. In all cases Fowler's report is favorable to his client (Landmark). Although this rebuttal follows the outline of Fowler's report, other issues related to LGAT generally, such as ethics, are also discussed.
Response to Fowler: Harmful effects
Fowler's comments in this section are based on his observation of a Forum session that he attended; he "saw nothing [...] to suggest that it would be harmful to any participant." This claim is at variance with my own experience, in which the psychoactive effects of the group encounter led directly to decompensation and a brief psychosis ("L" Series #1). Fowler's statement is also at odds with several other case reports of psychological harm in relation to Forum participation (see "L" Series #2). By these reports, one might speculate that the emotional stress of Forum participation can result in overwhelmed -- or in any case lowered -- psychological defenses and the temporary disruption of accustomed coping mechanisms, leading to an uncontrolled outcome such as transitory psychosis.
Fowler does not define what he would consider to be "harm" resulting from Forum participation. While some might view "harm" very narrowly, as the instigation of lifetime psychopathology, a more appropriate standard of "harm" is the onset of any DSM diagnosable condition. That standard includes a brief decompensation.
Fowler's comments do not seem to be informed by any legal or other correspondence Landmark may have had with former clients relating to claims of injury. The existence of individual reports of harm, suggests that Landmark may have significant information relating to claims of harm. If so, it seems disingenuous of Landmark to promote a report on the topic that does not refer to such information.
Finally, Fowler does not refer to the psychology literature on the Forum, on LGAT, or on group encounters (See "L" series #3 for a very small sample of the literature). Fowler's report ignores the substantial and troubled history of LGAT and other encounter programs, including specifically the Landmark Forum and its predecessor, est. This lack of perspective may make the report suitable for Landmark's publicity purposes, but greatly reduces its objectivity and usefulness as a source of information. Such an endorsement can hardly be called a "study."
Response to Fowler: Screening of applicants
Fowler describes Landmark screening procedures, consisting primarily of: an application questionnaire; follow-up question procedures that are triggered by negative responses on the questionnaire; and observation by program leaders. Fowler judges that these procedures provide adequate control. However, there are a number of serious defects to these procedures when viewed from the perspective of ensuring safety (and informed consent) of the participants.
First, the screening is driven by self-report by the client. Most obviously, lying in response to the questionnaire may be a sign of mental illness or incompetence. Therefore, Fowler's statement that "[...] mentally ill and emotionally disturbed individuals are screened out of Landmark Forum [...]" is not justified.
Perhaps more at issue is the person with no history of mental illness of any kind and with no experience in psychological change settings, who has a novel experience of disorientation, confusion or imminent decompensation during the training sessions. It would be absurd for a professional psychologist to claim that a lay person in such a situation can be relied upon to evaluate their psychiatric situation and take remedial action. Yet the Landmark self-report procedure requires exactly that. While The Forum exposes participants to considerable psychic stressors, Landmark's stance toward the psychological well- being of its clients fails the most basic requirement: evaluation and testing of the subject. Clients are not tested for psychological strength prior to participation, and no individual attention is given to a client unless and until they act out -- by which time it may be too late. Landmark's approach may sometimes allow them to pick up the pieces, or to avoid participation by the most extremely disturbed, but it hardly can be viewed as a responsible approach to safety during self-exploration.
Fowler's opinion is that "the application form is well designed to inform applicants of the nature of the program and the requirements and responsibilities of a participant". My own experience of the Landmark application process, however, is that it provides very little information about the course methods, process, or result. The most informative part of the application gives the formal hours of the course and advises that the course is not just an intellectual exercise -- whatever that might mean. The training description, as far as there is any description, negatively states what the training is not, rather than what it is. The positive phrases, such as "rigorous inquiry", have little specific meaning. The application does not discuss the nature of the group process, the intense self-disclosure by participants, the frequency with which clients are brought to tears, the highly structured (some would say controlling) nature of the program, the provision of an alternative cognitive framework, etc. While applicants do briefly attend one of the follow- up group sessions before enrolling, this experience is not comparable to the LGAT experience because the follow-up sessions are different from the LGAT sessions and because the applicant exposure is brief and is contextualized by the application process. Informed consent is discussed below.
In another section of his report, Fowler claims that "participants are challenged to examine their ways of thinking much as they might be in a philosophy course". But it surely stretches the limits of credulity to claim that that the process of marathon group encounter is somehow like the process in a course in philosophy, such as a university course. The Forum process is characterized by powerful emotional stressors, the disengagement of critical faculties, outright denial of any independent views put forward by participants, subtle psychological manipulation including an emphasis on obedience, direct escalating confrontation resulting in intimidation, intensive self-disclosure by clients, and a general emotional exhaustion or catharsis often accompanied by tears. What limited philosophical content there is in The Forum, is of an extremely radical kind which generally devalues external reality or which makes absolutist claims e.g. that people are programmable machines. A philosophy course, on the other hand, is characterized by a clear syllabus and emphasis of content over process, engagement of critical abilities by the extensive discussion of alternative viewpoints, intellectual more often than emotional engagement, infrequent if any emotional self disclosure, extensive time for reflection between classes, and the production of researched writing and commentary rather than catharsis and tears.
Fowler's conflation of philosophical content and psychological process is typical of the way in which Landmark promotes itself as "educational". Inappropriate analogies to education and philosophy, when promoting a group encounter product, may be symptomatic of a basic dilemma of the industry: accurate description of the product requires that one refer to psychological concepts and psychological effect, yet public laws limit the use of such terms as "psychology" and "psychologist". If LGAT operators were to claim psychological benefits, even if not claiming to be psychologists, they might be at risk of a suit for practicing psychology without a license. Nonetheless, many of the reasons that clients take the training, and many of the benefits that are promoted, are manifestly psychological in nature.
Fowler's comparisons of The Forum to Peace Corps training, or to conversations among friends and family, are similarly misplaced. Peace Corp training traditionally is in a small group and is focussed on learning a foreign language and acquiring the technical skills required for the tasks at hand; "sensitivity" in this context refers mainly to intercultural differences. Conversations with family and friends may have considerable emotional intensity, but this intensity is generally spread out over time and is in the context of one or a few intimate and multifaceted relationships. Neither the family nor the Peace Corps has significant resemblance to LGAT.
Finally, Fowler notes that "[t]hose who have questions about their ability to handle stress are recommended to not participate". The application process, however, does not indicate the kinds of emotional stressors and the overall group dynamics that are used in the training. Indeed, the terms "normal" and "everyday" are used when discussing stress and emotions on the Landmark application. Given the misplaced comparisons and extremely vague descriptions promoted by Landmark, one might easily conclude that the stress alluded to is normal, everyday, or like that of a university course. Few have any questions about their ability to handle such stress. Even if the client were to fully realize the nature of LGAT participation, there is little to suggest that the client can accurately self-assess their ability to handle emotional stress. Finally, a lack of questions from the client does not indicate that the client is well informed.
Informed consent is a complex topic. At the least, informed consent requires that the client actually understands what they are agreeing to and introspectively agrees with direct implications of their decision; furthermore the decision must be consistent with the client's long-established world view. An impulsive decision, one informed on paper only, one which cannot be considered rational in the context of the person's long-established beliefs and goals, or a decision whose implications are not agreed to, is most likely not an informed decision. From this perspective, it is questionable whether it is even possible to ensure informed consent with respect to LGAT, because the intense emotional marathon is difficult to comprehend prior to experiencing it, and there is no opportunity to reflect on it until it is past. One cannot assume the client has the capacity to introspect, assess their psychological state, and decide to discontinue participation during such a compressed encounter. In psychotherapy this problem of consent is significantly mitigated by the extended time period and gradual nature of the therapy, whereby the client has several days or a week after each hour of process, in which to introspect and determine if they consent to continuing.
Response to Fowler: Relation of Forum to psychotherapy
Fowler correctly observes that The Forum is not a practice of psychology, does not follow the traditions of psychotherapy, and does not have the benefits of psychotherapy. This is not to say, however, that The Forum does not have a powerful psychological or psychoactive effect. Some researchers have viewed the techniques used in some LGAT programs as closely related to those used in some psychotherapies. See the "L" Series #6. Fowler's attempts to say what The Forum is, rather than what it is not, are less successful. His comparisons to a philosophy course, a family relationship, and the Peace Corps have been discussed above.
What is missing from Fowler's discussion of The Forum and psychology is any concern with professional ethics.
LGAT is not a professional practice of psychology, and therefore is not bound by the ethical code of that profession. But the significant involvement of professionals such as Dr. Fowler raises important ethical issues. It is evident that LGAT clients seek, and sometimes claim to have obtained, benefits of personal growth, improved relationships, improved attitude, happiness, productivity, or other forms of improved psychological well-being. When a professional psychologist endorses a training product that is marketed to such ends, the professional has endorsed a particular means of achieving personal growth. If an endorsement of LGAT occurs in the context of individual psychotherapy, then the LGAT process is even more intimately bound up with therapeutic ends. In either case, the professional must be able to subscribe to the means used. Here lies the difficulty, because the means used in the LGAT industry are grossly incompatible with professional codes of conduct. Among other matters, the use of clients as unpaid workers to fulfil business requirements is an exploitation of the client relationship that is completely inadmissible in professional practice, and for good reason. The psychologist or psychiatrist who endorses an LGAT is in the untenable position of endorsing an unethical system (i.e. contrary to professional standards) for achieving personal growth and improved psychological well-being.
Furthermore, there is no research I know of that convincingly demonstrates any core long-term psychiatric benefit of LGAT participation (see the "L" series #3 for discussion). From the perspective of achieving lasting, measurable behavioral benefits other than those of just being a member in a system, LGAT seems to be mostly quackery. Just because some clients like it, is no reason to think that it is actually beneficial. Any professional endorsement of LGAT that implicitly suggests improved psychological health is at risk of being inappropriate due to being a recommendation of an ineffective intervention. Generic endorsements also risk being ill-suited to the psychological situation of the individual.
The only explanations that come to mind for endorsements of LGAT by psychologists or psychiatrists is that professionals endorsing LGAT either have lost their objectivity by becoming "converts" themselves, or else as long-time practitioners are so well defended against psychological attack that they underestimate the effect of LGAT on the inexperienced and sensitive layman.
It is quite shocking that a few of our most highly placed professionals have allowed their personal enthusiasm to obscure major ethical problems and have let themselves endorse a system of exploitative quackery as a route to personal growth.
Response to Fowler: Thought reform / manipulation used
In this section of his report, Fowler categorically rejects the proposition that Landmark has any characteristics typical of a cult, and he also questions the concepts of "thought reform", and "mind control."
Whether or not one subscribes to theories of thought reform, research conducted under that heading is based on sound observation; a rejection of the theory is of little use without an alternative explanatory theory. In any case, one need not subscribe to theories of thought reform to undertake a common-sense examination of LGAT.
Every social group draws its members in towards itself -- the difference is the speed and strength of that gravitational pull. What certainly is evident about The Forum is that the conversion process is often rapid, occurring over a weekend session; that eventual membership in the Assisting Program entails significant although not total dedication of one's time and resources without material compensation; and that involvement with Landmark often requires extensive obedience of precise rules and instructions, even if the instructions are not extreme in nature. On the one hand there is no evident cult leader; on the other, the vague concept of "The Forum" is over-emphasised until it is nearly an ideal.
By this discussion one may see that some "cult" characteristics are present to some degree in the system constructed by Landmark, just as they are in many ordinary organizational systems. The degree of importance this has in the case of Landmark is a matter of debate. What is of most interest is the fact that Fowler and Landmark spend such energy on the topic. What is it about Landmark and their training system that has engendered so much concern among members and did-not-become-members? Whatever the explanation, the outcry surrounding Landmark's cult-or-non-cult status indicates that something is amiss.
Fowler's comments on the topic of thought reform, cults, brain- washing, "or other forms of manipulation" are remarkable for the fact that he only addresses cult-related issues; he does not discuss psychological manipulation. The Forum, a highly controlled and closely scripted group process, is rife with psychological manipulation. So too are most popular movies; the question then is whether the manipulation is so extensive as to be repugnant to basic human values. I certainly find it very questionable, partly because of the controlling extent of the manipulation and partly because it seems entirely geared towards having the client become an unpaid worker on behalf of this for-profit corporation.
Only a few tiny examples of manipulation in The Forum are given here, due to limitations of time.
The first example has already been alluded to: procedures in the training whereby any dissent is met by escalating confrontation that almost invariably results in intimidation of the client. If a client stands up and makes a statement that is not according to Forum dictates or not in the interests of Landmark, then the session leader questions or otherwise contradicts the statement. If the client persists, the session leader will be more emphatic and will begin to march down the aisle toward the client. The leader escalates by raising his or her voice more and more loudly and approaching the client more and more closely in what can easily seem to be an aggressive manner. The client almost invariably backs down or revises their statement. This is simple intimidation. While the client had dissenting views at the outset, they most likely were not prepared for an all-out conflict. The session leader simply escalates the conflict beyond the point at which the client becomes intimidated. It is hard to think of a sense in which this is not coercive.
The second example of manipulation is more subtle; it relates to the much- heralded fact that in The Forum, unlike in its predecessor 'est', people are actually permitted to leave the room. Fowler writes, "Participants were informed that leaving the program at times other than scheduled breaks or otherwise missing parts of the seminar would detract from the experience, but there was no coercion to remain in the room, and it was not unusual for people to leave and return." More exactly, in the training session I attended, we were informed that we would not receive the full benefits of The Forum if we left the room during the sessions. According to these instructions, to utilize The Forum product one should remain in the room. We were also told that if we went out, we would be met outside by a representative and that we should then explain to him why we wanted to go. If one comes back to the room even a few seconds late from a scheduled break, then the door may be closed until you give an explanation for your shortcoming. The effect of all these together is to create a kind of psychological gradient, whereby there are several psychological negatives to leaving or being out of the room: doing something wrong and having to explain why you are doing it. Coercion may be too strong a word for this example, but I don't hesitate to say it is manipulative.
A more complex example of manipulation is the process in which clients fill out a confidentiality agreement. Clipboards and forms are given out, and the usual session leader is supplanted by a man in a white lab coat, casually worn open, and holding a clipboard. An explanation is given and clients are asked to follow instructions. Subjects are instructed that there is a pencil under the chair but not to pick it up until told to do so. All hundred or more participants bend over to pick up the pencils simultaneously. Subjects are then to follow along each box with the speaker, even though the form is simple to complete. Instructions are given to stand up, then to sit down. All comply simultaneously. In this and numerous other details, clients become accustomed to unthinkingly obeying instructions. Manipulation occurs in the sequencing of requests so as to elicit an extraordinary compliance. What is also remarkable is the overt resemblance of the props -- clipboard and open lab coat -- to the authority symbols used in Stanley Milgram's infamous experiments on obedience and authority. In the Milgram experiments, a large percentage of subjects obeyed instructions to administer tortuous electric shocks to another person, despite that person's agonizing screams of pain. Obedience was elicited by gradual escalation of requests, framing the requests in a explanatory context, and by using authority symbols such as the clipboard and loosely worn lab coat. The same techniques, while put to different ends, can reasonably be described as features of the Landmark process as well.
The Milgram behavioral experiments were subsequently decried as unethical. The ethical problem was due to the manipulative structure which implied a lack of consent: psychological stress resulting in personal change was exerted without it having been adequately described in advance. It is difficult to see how consent could be obtained for such experiments, not only because the experience of stress is indescribable but also because an adequate description of the manipulative process would alter the effect of the process. It seems possible that similar issues may arise with respect to consent in the Landmark process.
Fowler's limited assertion that Landmark is not a cult, hardly scratches the surface of this program.
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I feel it is important, both personally and for the polity, to provide the basic facts of my experience and some of what I have learned in several years of research. Landmark's evident policy of viewing injuries as a business expense, and of attempting to reduce concomitant publicity through legal correspondence, is contrary to the public interest. I hope that this information will encourage others to come forward so that society has the knowledge required to make an assessment of LGAT practices.
Concerning LGATs themselves, my overall conclusion is that the industry culture emphasises pursuit of one's own interests above all else. While staying within the confines of the law, this view disregards all ethical principles. Dishonesty, intimidation, insult, and blaming the other person become merely tools in striving to dominate and prevail. All flows from a canny knowledge of how to manipulate people, developed in the absence of any professional principles -- one might say, absence of adult sensibilities.
At the same time, society must accept a degree of fault for failing to address public needs. By stigmatizing mental health issues, society has left its members open to any form of hucksterism that promises relief without the label of mental illness that would be implied by seeking professional help. The Surgeon General recently reported that 20% or more of Americans suffer from a mental health difficulty such as depression, anxiety, or elevated stress levels. Insecure and unwitting, emotionally uneducated people are prime candidates for entering an LGAT session without realizing that the emotional sequence may add up to pathological regression. Such clients often have fragile defences (thin skulls, one might say) or are unable to recognize when they are becoming overextended emotionally, putting them at risk of decompensation. Society has failed to reach this large segment.
The psychology, psychiatry, and social work professions have failed in a more specific respect. The responsible bodies have not dealt effectively with the relationship of professional to unprofessional treatments, particularly concerning the fact that many non-professional industries have procedures which are grossly contrary to professional principles. The endorsement and assistance of professionals in the exploitation of people seeking a means of psychological growth, is utterly inexcusable. These professions should be leading the way to regulating unprofessional interventions, rather than promoting them.
With God's will, this writing closes a most difficult chapter of my life.
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STEPHANIE NEY, Plaintiff-Appellant, v. LANDMARK EDUCATION CORPORATION; RON ZELLER, Defendants-Appellees, and WERNER ERHARD; WERNER ERHARD AND ASSOCIATES; PETER SIAS, Defendants.
UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT
1994 U.S. App. LEXIS 2373
February 2, 1994, Decided
NOTICE: RULES OF THE FOURTH CIRCUIT COURT OF APPEALS MAY LIMIT CITATION TO UNPUBLISHED OPINIONS. PLEASE REFER TO THE RULES OF THE UNITED STATES COURT OF APPEALS FOR THIS CIRCUIT.
SUBSEQUENT HISTORY: Reported in Table Case Format at: 16 F.3d 410, 1994 U.S. App. LEXIS 7498.
PRIOR HISTORY: Appeal from the United States District Court for the Eastern District of Virginia, at Alexandria. James C. Cacheris, Chief District Judge. (CA-91-1245-A).
COUNSEL: Argued: Richard Alan Seligman, Washington, D.C., for Appellant.
Argued: Robert Powel Trout, DUNNELLS & DUVALL, Washington, D.C., for Appellees.
On Brief: Gerald F. Ragland, Jr., CARTER, KRAMER & RAGLAND, Alexandria, Virginia, for Appellant.
On Brief: John Thorpe Richards, Jr., DUNNELLS & DUVALL, Washington, D.C., for Appellees.
JUDGES: Before MURNAGHAN and NIEMEYER, Circuit Judges, and KAUFMAN, Senior United States District Judge for the District of Maryland, sitting by designation.
A damage suit by Stephanie Ney was brought against Werner Erhard and a corporation wholly owned by him, Werner Erhard & Associates (WE&A). Also joined as defendants were 1) Landmark Education Corporation (Landmark) which had purchased the assets of WE&A, 2) Peter Sias, and 3) Ronald Zeller. Landmark conducted activities, especially The Forum, which were, in substantial degree, like those which WE&A had conducted. Claims against Sias were withdrawn while Ronald Zeller, a former employee of WE&A, it being contended that he was a leader of The Forum, remained as a defendant with respect to claims of intentional infliction of emotional distress.
WE&A and Erhard were not personally served, nor did they appear in the district court or on appeal. A default judgment for $501,970 was entered against them but is not before us on appeal. We, therefore, express no opinion on its validity.
In September 1989, Ney attended a program known as "The Forum," conducted by Erhard d/b/a/ WE&A. The Forum, a successor to the well-known "est" program, might be described as a group therapy/self-improvement program.
Ney's attendance at The Forum apparently passed without incident, and she left the weekend spent attending it feeling satisfied and hoping to return. As a result of her experience at The Forum, however, she decided that she should become more open in her life. To that end, two days later she confessed to her husband a "crush" that she had on a fellow graduate student. Ney's husband in turn told her that he had conducted several extramarital affairs. The following day she confessed her crush to her faculty advisor, who explained that the graduate student should be avoided since he was a Satan worshipper and had wrecked marriages in the past.
Ney began a process of psychological decompensation. At the end of a three- day period she had a psychotic break with reality, suffered apparently permanent psychological injuries, and had to be hospitalized at the Psychiatric Institute of Montgomery County for fourteen days. While in the hospital, she was medicated and at times strapped to a bed in four-point restraints to prevent her from harming herself.
WE&A originally was established in the 1970's to deliver a program known as "est" or the "est training." The est training was phased out in 1984, and in 1985 WE&A began offering a program named "The Forum." Landmark was a newly formed company managed by employees of the now defunct WE&A, which had purchased the assets of Erhard and received a license from him to run the Forum.
The Forum was alleged to have caused severe emotional upset in some participants, and it was claimed that the defendants were on notice for many years of such "casualties," yet failed to a give adequate warnings or adopt changes in the program.
At the time Ney attended the Forum, it was owned by Erhard, doing business under the trade name WE&A. Erhard was the sole owner. He was also the sole owner of Werner Erhard & Associates International (WE&AII), which delivered the Forum outside the United States.
By December, 1990 Erhard had been the subject of substantial adverse publicity. The time came when, to avoid adverse publicity associated with his name, Erhard approached his top executives about selling the assets and licensing another entity to continue to present the Forum. Soon after, the Internal Revenue Service issued a Notice of Levy for $7 million on Erhard's assets.
At the time of the sale, WE&A consisted of a business with offices in 21 cities throughout the United States. After the sale, Landmark continued to operate out of the same offices, presenting the same programs throughout the United States. As of the date of the sale, WE&A had 216 employees. Most of the same employees remained with Landmark. Landmark acquired all assets of WE&A that were necessary to continue to present the Forum. Landmark also acquired the right to use the names and addresses of all individuals who had completed the Forum.
After the sale, WE&A ceased doing business, and Landmark began doing business immediately with the assets and the license acquired from WE&A and Erhard. There was little change in the format of the Forum. At the time of the sale, Landmark's six directors were highlevel employees of WE&A and WE&AII. Neither Donald Cox nor Erhard, however, became part of Landmark. The key negotiators for Landmark in the sale of WE&A assets consisted of the same group of top executives, one of whom was Erhard's brother. The only bidder aside from Landmark was Cox.
The parties calculated the value of WE&A's assets at $8,600,000. Landmark also acquired Erhard's stock in WE&AII, which was valued at $1,200,000. Landmark agreed, as payment for the WE&A assets and WE&AII stock, to assume liabilities in the amount of $6,800,000 and to pay an additional $3 million to Erhard. The agreed on downpayment of $300,000 was paid out of the account of WE&AII, whose stock was sold to Landmark. The $2,700,000 balance was to be paid by January 30, 1992, but payment was later extended and the due date delayed.
Landmark obtained from Erhard a license to present the Forum for 18 years in the United States and internationally with the exception of Japan and Mexico. Erhard retained ownership of the license. The license was not assignable without Erhard's express written consent, and was to revert to Erhard after 18 years.
Furthermore, under the Agreement, Erhard was promised 2% of Landmark's gross revenues payable on a monthly basis and, in addition, 50% of the net (pre-tax) profit payable quarterly. Such payments to Erhard were not to exceed a total payment of $15 million over the 18 year term of the license.
Claims of Personal Injury
The assertions Ney sought to prove were claims of negligent infliction of emotional distress as well as other negligence claims brought by Ney. In addition, she sought to prove that Landmark was but a mere continuation of WE&A.
Ney asserts that the district court erred in granting Landmark's and Zeller's motion for summary judgment with respect to her claim of negligent infliction of emotional distress. Her principal criticism of the district court is that it misinterpreted Virginia's requirement that there be some physical injury associated with a claim for negligent infliction of emotional distress. In addition, she has asserted on appeal that the district court failed to recognize that her Complaint asserted negligence claims beyond mere infliction of emotional distress, including claims for "psychological" and physical injuries.
Despite her attempt to segregate her claims into three distinct sorts of injuries, at bottom, she seeks relief for infliction of emotional distress. She relies almost exclusively on cases considering that type of damage, and it is clear that her claims for psychological, physical, and emotional damage are, in fact, intertwined.
To support her claim that the district court misinterpreted Virginia law in awarding summary judgment to Landmark and Zeller, Ney relies on three Virginia cases, Naccash v. Burger, 223 Va. 406, 290 S.E.2d 825 (1982); Hughes v. Moore, 214 Va. 27, 197 S.E.2d 214 (1973); and Howard v. Alexandria Hosp., 429 S.E.2d 22 (Va. 1993). She has read the cases as either requiring an extremely low threshold of physical harm to accompany a claim for emotional distress, or, in some cases, as allowing claims for emotional distress to proceed with no physical injury whatsoever. In addition, she has argued that her psychological injury, psychosis, has rendered her case distinguishable from Virginia cases preventing recovery for pure emotional harm. She has read Naccash as eliminating entirely the physical injury requirement where, as here, there is no claim that the harm is feigned or fraudulent.
Even if physical injury is required, moreover, Ney has claimed that her "injuries" would meet the requirements of Virginia law. She has argued that, since she has been treated with medication, her injuries have a "biochemical" aspect that is "physical" and "material." She also has suffered headaches. Finally, she has suffered rectal bleeding ascribed to lithium which has been prescribed for her. Although none of these injuries has been disputed, their nature and their cause remain in dispute.
Claims for purely emotional distress are "not favored in the law." Ruth v. Fletcher, 237 Va. 366, 377 S.E.2d 412, 415 (1989). Courts are reluctant to embrace such claims, because they require difficult questions of proof and causation, and fraudulent emotional injuries can be difficult to detect.
Like other states, Virginia has attempted to cabin the universe of emotional- distress claims by requiring the plaintiff to show some accompanying physical injury. The plaintiff must prove that the "physical injury was the natural result of fright or shock proximately caused by the defendant's negligence." Hughes , 197 S.E.2d at 219. The general rule of proximate cause is also narrowed, so that recovery is permitted "if, but only if, there is shown a clear and unbroken chain of causal connection between the negligent act, the emotional disturbance, and the physical injury." Id.; Myseros v. Sissler, 239 Va. 8, 387 S.E.2d 463, 464 (1990).
Ney has read the Virginia case of Naccash v. Burger as eliminating the physical injury requirement "entirely where there was no claim that the harm was feigned or fraudulent, the harm was the direct rather than the indirect result of the negligent conduct and the causal connection is unbroken." Br. of Appellant, at 17. Since in the instant case, neither party contends that her injuries are fraudulent, Ney asserts that the policy rationales for disfavoring claims of emotional distress are not applicable here, and that, therefore, Naccash controls.
Naccash, a wrongful birth action, involved the emotional distress suffered by the parents of a child born with Tay-Sachs disease. Naccash v. Burger, 223 Va. 406, 290 S.E.2d 825 (Va. 1982). In that case, the Virginia Supreme Court refused to apply the general rule enunciated in Hughes v. Moore, which required that physical injury accompany the claim for emotional distress. The court observed:
The circumstances of this case justify another exception to the general rule that damages for emotional distress are not allowable unless they result directly from tortiously caused physical injury. The restrictions upon recovery ... were designed to discourage spurious claims asserted by chance witnesses to physical torts involving others. The considerations prompting imposition of the limitations do not exist here; no one suggests that the [parents'] emotional distress was feigned or that their claim was fraudulent. Indeed, to apply the restrictions here ... would constitute a perversion of fundamental principles of justice.
Naccash, 290 S.E.2d at 831 (emphasis added) (citation omitted). Further, the Naccash Court found that the evidence showed an "unbroken chain of causal connection directly linking" the parents' claim for emotional distress and the birth of the child. Id.
Ney's attempt to apply the Naccash holding to the instant case must be rejected, however, for in a recent case, the Virginia Supreme Court explicitly stated that the Naccash exception to the physical injury rule is unique and "confined to its particular facts." Myseros, 387 S.E.2d at 464 n.2; accord Bulala v. Boyd, 239 Va. 218, 389 S.E.2d 670, 674 n.1 (1990); see also Timms v. Rosenblum, 713 F. Supp. 948, 955 (E.D. Va. 1989) ("Plaintiff's heavy reliance on the Naccash and Bulala decisions is misplaced. These decisions are sui generis and this Court finds no warrant in Virginia law for extending those decisions beyond the specific egregious facts there presented."), aff'd, 900 F.2d 256 (4th Cir. 1990). Indeed, although it has not been claimed that Ney's condition was fictitious, it cannot be said, as she has claimed, that it is not of the type of harm that might be faked and so would support the policy rationale of the physical injury requirement of Virginia law. In any event, contrary to Ney's assertion, Virginia law expressly requires that a claim for emotional distress be accompanied by physical injury and the Naccash exception does not come into play.
On the assumption that the physical injury requirement does exist under Virginia law and here applies, Ney has claimed that her injuries were sufficient to meet the Hughes test. (Note 1) She has noted that Hughes itself required only a slight physical injury. The Hughes plaintiff witnessed a car crashing into her front porch. She became nervous, felt pains in her chest and arms, could not breast feed, and her menstrual cycle began. Hughes, 197 S.E.2d at 215-16. In the instant case, Ney complains of injuries that "clearly have a biochemical element which is physical and material since she has been treated on more than one occasion with medication." Br. of Appellant, at 19. Additionally, she has suffered headaches, and rectal bleeding, which she attributes to the Lithium she was prescribed.
Note 1: Landmark and Zeller have pointed out that Ney never alleged physical injury until she presented her opposition to summary judgment, which was filed two months after the pretrial conference and after the close of discovery. While it is true that there was no pleading in the complaint specifically setting out a claim of physical injury, we will, for the sake of argument, assume the claim is properly before us.
While Hughes may require only minimal physical injuries, the case cannot be read as dispensing with the physical injury requirement altogether. It seems clear that the "biochemical element" of psychosis, to the extent that it in fact exists, does not rise to the level of physical injury required by Hughes. In addition, the Hughes plaintiff could show an unbroken chain between the accident and her symptoms. Here, there is substantial evidence in the record that Ney received a number of blows to her psyche besides those sued on in the same week she attended the Forum.
Ney has also attempted to rely on the rectal bleeding to fulfill the physical injury requirement. The difficulty with that argument is that the rectal bleeding was caused by prescribed medication, not by the Forum. As support, Ney has attempted to rely on a recent Virginia Supreme Court case, Howard v. Alexandria Hosp. , 429 S.E.2d 22 (Va. 1993). In Howard, a case decided after summary judgment was granted in the instant case, the Virginia Supreme Court considered a claim for emotional distress arising out of medical malpractice. In Howard, the defendant hospital failed to sterilize properly operating instruments before surgery was performed on the plaintiff. The hospital admitted that it was negligent, that its negligence caused the plaintiff's injuries, and that she was reasonably distressed by the remedial treatment the hospital required thereafter. Although the plaintiff never actually acquired any disease from the negligent hospital procedure, she had to remain hospitalized longer than normal, had to receive antibiotics, and had an intravenous line inserted and blood drawn.
Ney has attempted to show that her injuries were sufficient to sustain a claim of "professional negligence," not merely negligent infliction of emotional distress. She has claimed that the Virginia Supreme Court rejected in Howard the theory advanced by Landmark and Zeller in the instant case:
The defendant's argument actually is a contention that the plaintiff sustained no direct physical injury, only emotional disturbance. But the plaintiff's evidence, at the very least establishes a prima facie case of injury.
The term "injury" means "positive, physical or mental hurt to the claimant." ... Clearly, as a result of the hospital's use of inadequately sterilized instruments, the plaintiff sustained positive physical and mental harm.
As a direct result of the wrong, the plaintiff's body was invaded by intravenous tubes, needles administering" pain shots," and instruments used to withdraw blood. She experienced the physical pain and discomfort for headache, nausea, vomiting, fever, chills, and unusual sweating ... Her "symptom complex" was due to enterocolitis, a side effect of the antibiotic therapy "necessarily prescribed" because of the hospital's negligence.
Id. at 24-25 (emphasis added) (citations omitted). Appellant has asserted that both "in Howard and in [the instant] case the physical symptoms were secondary to medical treatment." Br. of Appellant, at 21. Her claim is that, just as the doctors in Howard were negligent for the failure to meet medical standards, so should the Forum be liable for the injury caused by their practice of "psychotherapy."
The problem, however, with Ney's reading of Howard is that the Howard court clearly was confronted with a case of emotional distress arising out of the physical injury caused by the negligent hospital, not a case, as here, of physical harm allegedly arising out of emotional or psychological injury. The hospital's malpractice arose out of its physical battery of the Howard plaintiff. Here there is no such physical battery, and even were the Forum held to have committed "malpractice" that claim could not arise out of emotional injury. Howard does not dispense with the general and consistently applied Virginia rule that physical injury is a necessary element of a claim for emotional distress.
Howard is distinguished further by Myseros, 239 Va. 8, 387 S.E.2d 463 (Va. 1990), the same case that limited Naccash to its facts. In Myseros, the Virginia Supreme Court rejected the notion that symptoms of emotional harm could satisfy the physical injury requirement. The Myseros plaintiff alleged that his emotional problems, which stemmed from a traffic accident, were "accompanied by sweating, dizziness, nausea, difficulty sleeping and breathing, constriction of the coronary vessels, two episodes of chest pain, hypertension, unstable angina, and an electrocardiogram showing marked ischemia loss of appetite and weight, change in heart function, and problems with the heart muscle." Id. at 465. He also claimed "headaches, dizziness, and chest pain." Id. He had been under constant psychiatric care since the accident which had caused his problems. Id . The Supreme Court of Virginia reversed a jury verdict in favor of the plaintiff and found, as a matter of law, that symptoms such as these simply did not satisfy the physical injury requirement of Virginia law. Id. at 466. ("What Hughes v. Moore requires, however, and what this case lacks, is clear and convincing evidence of 'symptoms' or 'manifestations' of physical injury, not merely of an underlying emotional disturbance.") (emphasis in original). The unmistakable thrust of Virginia law is that psychiatric disorder of the kind suffered by Ney simply is not recognized as actionable absent physical injury.
Moreover, it is uncontested that the rectal bleeding complained of was the result of the drug administered to Ney by her psychiatrist. The bleeding was not caused directly by the Forum, unlike the physical invasions in Howard, which were caused by the negligent hospital. Finally, as Landmark and Zeller have pointed out, Ney's assertion that her receipt of medication established a "biochemical element" to the harm she suffered, remains an unsubstantiated hypothesis. No evidence supports her contention, and no experts testified to it.
The district court properly awarded summary judgment to Landmark and Zeller. Although none of Ney's "physical" symptoms have been disputed, they cannot overcome Virginia's test for negligent infliction of emotional distress. Moreover, to the extent that Ney's argument is that the Forum, as a "psychotherapy" exercise, caused her injury through medical malpractice, the argument is undeveloped. While Ney has characterized her complaint as stating a cause of action for "effectively practicing psychotherapy without credentials or training," she nowhere has demonstrated how the claim should be considered. To the extent that her claim for "professional negligence" is legitimate, it only concerns the standard of care. Causation has not yet been shown and Ney still may not recover because her injuries are not cognizable under Virginia law.
Similarly, although perhaps her participation in the Forum might have led in part to her psychotic reaction, even if that nexus had been established, Ney did not produce sufficient proof to recover under Virginia law.
We now turn to consideration of the attempt to hold Landmark liable on a theory of successor liability. (Note 2) Ney has grounded her argument for successor liability on the theory that Erhard, the owner of WE&A, has maintained "ownership" over Landmark through a combination of control over the license to present The Forum and his receipt of Landmark profits.
Note 2: Because of our holding that Virginia law does not permit Ney to recover for her alleged injuries, Ney cannot in any event hold Landmark liable unless Landmark is deemed liable as a successor entity for the default judgment entered against WE&A and Erhard. As indicated in the body of this opinion, we express no opinion as to the validity of that default judgment. Assuming, however, arguendo only, that that judgment is valid, we reach the successor liability issue pertaining to Landmark and decide that issue in favor of Landmark for the reasons set forth infra in this opinion.
Since Ney's claim for successor liability was dismissed on a motion for directed verdict, the court must accept her facts as presented in her case in chief, and afford her the benefit of all reasonable inferences therefrom. Wright & Miller, Federal Practice and Procedure, § 2524, at 543-45.
There are four traditional exceptions to the general rule of nonliability of a successor corporation for the debts or torts of a predecessor:
In order to render the purchasing company personally liable for the debts of the selling corporation, it must appear that (a) there be an agreement to assume such debt; (b) the circumstances surrounding the transaction must warrant a finding that there was a consolidation of the two corporations (the de facto merger exception]; or (c) that the purchasing corporation was a mere continuation of the selling corporation; or (d) that the transaction was fraudulent in fact.
Crawford Harbor Associates v. Blake Constr. Co., Inc., 661 F. Supp. 880, 883 (E.D. Va. 1987); Harris v. T.I., Inc. , 243 Va. 63, 413 S.E.2d 605, 609 (1992). Ney has asserted that the district court erred when it stated, following her motion for reconsideration, that "under the mere continuation exception, there must be identity of the officers, directors and stockholders in the selling and purchasing corporations." Br. of Appellant, at 22. Ney has claimed that the district court incorrectly determined that the ownership of the buyer must be identical to that of the seller, when "the correct standard in Virginia is whether there was 'substantial' commonality between the management or ownership of the predecessor and successor corporations." Id. at 23.
Relying on a treatise of corporation law, Ney has concluded that the "touchstone of the 'mere continuation' doctrine is whether the successor corporation as a whole is 'substantially the same' as its predecessor. What the test really comes down to is whether the 'purchasing corporation maintains the same or similar management and ownership but wears a new hat.'" Br. of Appellant, at 24 (quoting W. Fletcher, Cyclopedia of the Law of Private Corporations at § 7124.10, 291-292).
Moreover, in addition to arguing that successor liability arises out of the "mere continuation" prong of the four-part test articulated above, Ney has asserted alternatively that either a de facto merger (Note 3) occurred or that the transaction between Landmark and WE&A was fraudulent. (Note 4)
Note 3: Appellant has asserted but does not argue the de facto merger theory. It plainly does not apply to the facts of the instant case. See, e.g, Bud Antle, Inc. v. Eastern Foods, Inc., 758 F.2d 1451, 1458 (11th Cir. 1985) ("a consolidation or merger always involves a transfer of the assets and business of one corporation to another in exchange for its securities") (emphasis added). Here, Landmark exchanged no stock for the assets sold by Erhard. See Crawford, 661 F. Supp. at 884 ("The essential characteristic of a de facto merger is the succession of the selling corporation's stockholders to stockholder status in the purchasing corporation.") (citation omitted). Erhard owned all the stock in WE&A. He owns none of the stock in Landmark.
Note 4: The district court dismissed the fraud claim on the ground of improper pleading, saying that "fraudulent conveyance was never pled by plaintiffs." (July 8, 1992, Tr. Vo. III, p.22) (cited in Br. of Appellant, at 36).
Appellant objects, saying that when the Court earlier ruled against defendant's motion for summary judgment on the successor liability issue, it must have done so in part on appellant's memorandum in opposition, which contained an assertion of fraud. Since the District Court did not grant summary judgment on successor liability, appellant infers that the Court sub silentio denied defendant's objections to the fraud claim. Therefore, appellant asserts defendant "was on notice well in advance of trial of plaintiff's intent to pursue this theory of successor liability." Br. of Appellant, at 37.
She relies on the following factual predicate for all three theories: consideration was insufficient; the management of the two corporations was composed of essentially the same people; Landmark continued operating the business in an uninterrupted manner at the same physical locations throughout the nation, using the same assets and facilities; and, virtually all of the same employees continued working for Landmark after the sale.
Finally, Ney has insisted that the jury should have been able to consider the question of continuity of ownership. She asserts that since the $300,000 downpayment was made not by Landmark but by WE&AII, the international branch of WE&A, Erhard himself effectively was buying the company at the same time he was selling it. The failure of Landmark to pay the balance owed of $2,700,000 on time is further evidence, she alleges, that the transaction was fraudulent. Ney has argued that Erhard's licensing agreement in which he was allowed 2% of the annual gross revenue and 50% of the net pre-tax profits should have given the jury enough evidence to conclude that "ownership" had remained unchanged throughout the transaction.
Before discussing the facts of the instant case, it bears noting that Virginia law governing "mere continuation" for successor liability is stricter than the interpretation which Ney has offered. The Virginia Supreme Court recently reaffirmed its definition principle of successor liability:
A common identity of the officers, directors, and stockholders in the selling and purchasing corporations is the key element of a "continuation."
Harris, 413 S.E.2d at 609 (emphasis added); see also United States v. Carolina Transformer Co., 978 F.2d 832, 838 (4th Cir. 1992) ("The traditional rule with regard to the 'mere continuation' exception is that a corporation is not to be considered the continuation of a predecessor unless, after the transfer of assets, only one corporation remains, and there is an identity of stock, stockholders, and directors between the two corporations.").
Although Ney has asserted that Virginia law requires only a "substantial commonality for ownership or management," she has done so without authority, and Virginia law appears to hold the contrary. (Note 5) Harris, 413 S.E.2d at 609; Taylor v. Atlas Safety Equipment. Co., 808 F. Supp. 1246, 1251 (E.D. Va. 1992) ("Key element. . . is 'a common identity of the officers, directors, and stockholders in the selling and purchasing corporations.'" Crawford, 661 F. Supp. at 884-85 (no liability without continuity of ownership, management and inadequate consideration).
Note 5: Ney has relied heavily on the Fourth Circuit's unpublished opinion in Acme Boot Co. v. Tony Lama Interstate Retail Stores, Inc., 929 F.2d 691 (4th Cir. 1991) (unpublished), for the proposition that ownership may be understood more broadly than it was by the District Court. Tony Lama does indeed share many similarities with the instant case. There, a majority of the Court decided to remand the case, because it believed that the continued association of the prior owner and the successor corporation could allow a finding by the jury of successor liability. Judge Wilkins wrote separately in favor of judgment for the defendant. Following the remand, the district court entered judgment for the defendant.
While the Tony Lama case does share similarities with the instant case, it did not contradict Virginia law. The panel merely sent the case back for further factual determination in the District Court. As controlling authority, the unpublished opinion seems rather weak and in any event is not precedent.
The problem here is that while the successor corporation continued the work of its predecessor, there is not a continuation of the corporate entity of the predecessor. See, Taylor, 808 F. Supp. at 1251 (essential inquiry is whether there has been continuation of the seller's corporate entity, not whether there has been a continuation of its business operations). (Note 6) WE&A was a sole proprietorship owned by Werner Erhard. (Note 7) Landmark is owned by its employees, and Erhard owns no stock in the new company.
Note 6: Ney has attempted to distinguish between the "mere continuation" exception recognized in Virginia, and the "substantial continuation" exception recognized in a minority of other jurisdictions. The "substantial continuation" theory, applied mainly to tort cases, relaxes the requirements of identity of ownership and employment, and allows a variety of other factors to determine whether there is successor liability. The more generous standard would be helpful to Ney, but it has been rejected expressly by the Supreme Court of Virginia. Harris v. T.I., Inc., 243 Va. 63, 413 S.E.2d at 609-10 (1992).
Note 7: Ney has asserted that because WE&A employees participated in a profit sharing plan under I.R.C. § 401 (1993), they could be considered "owners" of the business. She cites no authority for the proposition that a monetary interest in a qualified retirement plan qualifies as ownership of a business enterprise.
The question of whether there was identity of management is more difficult to ascertain. There is evidence that with one or two exceptions, all of the executives of Landmark are the same as all of the executives of WE&A. The difficulty with the argument advanced by Ney is that it appears that while there was substantial overlap in personnel, it cannot be said that there was identity of management, since the primary "managers" of WE&A did not continue as a part of Landmark. Indeed, Donald Cox, the chief executive officer of WE&A, competed with Landmark to buy WE&A's license and lost out to Landmark.
Nevertheless, on review of a directed verdict, the facts must be viewed in a light most favorable to the non-moving party, and it is conceivable that because almost all of the managers of the predecessor corporation continued to manage the successor corporation, a jury could conclude that there was an identity of management. Such an apparent dispute of fact, however, is not material since the test for continuity in Virginia still turns primarily on ownership, and, as discussed above, ownership changed hands. See Taylor, 808 F. Supp. at 1251 ("it appears that identity of ownership is the most important component [under Virginia law] to sustain a finding of mere continuation").
Finally, Ney has argued that the consideration paid by Landmark to Erhard was insufficient since the downpayment was paid "not by the buyer" but by WE&AII, and because the $2.7 million balance of the purchase price was not paid on time. Even if the issue of consideration were significant to a determination of "mere continuation," which it is not under Virginia law, Landmark has made a persuasive case that the consideration was adequate. In the first place, the $300,000 was paid out of corporate stock in WE&AII acquired by Landmark. Whether Erhard withdrew the $300,000 from the WE&AII treasury before the sale or whether he received it, as he did, after the sale, is immaterial. In either case, the value of WE&AII was worth $300,000 less to the purchasing company than it would have been without the payment. Finally, there is no evidence in the record to suggest that the $2.7 million is not a genuine debt and that it will not be paid. Landmark negotiated an extension for payment, and that extension was granted.
While there is much in the record suggesting that Ney's psychological difficulties are real and quite terrible, her negligence claims against the Forum when conducted under WE&A ownership cannot be supported under Virginia law. And, while there should be legitimate concern over changes in corporate form undertaken by an individual and his wholly owned corporation who, among other things, apparently owe the federal government millions of dollars in unpaid taxes, the lack of identity in the two corporations makes proper the district court's directed verdict on the successor liability.
The judgment is accordingly
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WERNER H. ERHARD, Petitioner-Appellant, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellee.
No. 93-70357, No. 93-70359, No. 93-70360
UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT
46 F.3d 1470; 1995 U.S. App. LEXIS 2276; 95-1 U.S. Tax Cas. (CCH) P50,074; 75 A.F.T.R.2d (RIA) 957; 95 Cal. Daily Op. Service 984; 95 Daily Journal DAR 1795
November 17, 1994, Argued, Submitted, San Francisco,
February 8, 1995, Filed
SUBSEQUENT HISTORY: Certiorari Denied October 16, 1995, Reported at: 1995 U.S. LEXIS 7011.
PRIOR HISTORY: Appeal from a Decision of the United States Tax Court. Tax Ct. No. 39473-85. Tax Ct. No. 46712-86. Tax Ct. No. 39532-87.
CORE TERMS: est, a.e.c, entity, phase, transferred, sham, computation, withheld, increased interest, circular, accounting, economic substance, fraudulent, acquired, offshore, deposit, repaid, business purpose, indebtedness, asset acquisition, tax motivated, demand loan, organizational, purportedly, ownership, assigned, planning, owed, reconsideration, deductible
COUNSEL: Michael I. Saltzman, Baker & McKenzie, New York, New York, for the petitioner-appellant.
William J. Patton, Tax Division, United States Department of Justice, Washington, D.C., for the respondent-appellee.
JUDGES: Before: Donald P. Lay, * Harry Pregerson, and Diarmuid F. O'Scannlain, Circuit Judges. Opinion by Judge O'Scannlain.
* The Honorable Donald P. Lay, Senior United States Circuit Judge for the Eighth Circuit, sitting by designation.
OPINION BY: O'SCANNLAIN, Circuit Judge:
We are invited to follow the winding paths of circular money movements to determine whether they lead to transactions of economic substance for federal income tax purposes.
Werner Erhard has offered a variety of seminars, workshops, and other programs in personal effectiveness since 1971. At that time, Erhard hired tax attorney Harry Margolis to be his personal financial and legal advisor. Margolis arranged the formation and financing of Erhard Seminars Training, Inc.
In 1975, Margolis created a new corporation, "est, a.e.c.," to assume the activities of Erhard Seminars Training, Inc. The stock of est, a.e.c. was seemingly owned by a complex web of offshore entities created by Margolis. (Note 1) Erhard purported to be just an employee of est, a.e.c., without any legal ownership interest.
Note 1: The ownership of est, a.e.c. was so complex that when Erhard decided to alter the organizational structure in 1981, it apparently took his legal and financial advisors months to sort through the complicated legal and financial structures that Margolis had used in his planning.
Integral to both est, a.e.c. and its predecessor, Erhard Seminars Training, Inc., was the Harry Margolis "system." The system was composed of offshore and domestic corporations, trusts, banks, partnerships, and other entities that were used to implement Margolis' tax planning. Such so-called "system entities" were controlled either directly or indirectly by Margolis. The est, a.e.c organizational structure devised by Margolis was a maze of intertwined organizations with numerous agreements among the entities involved. After Margolis created est, a.e.c., he created a variety of system entities which dealt only with est, a.e.c. As Erhard's counsel explained, the main purpose of such an organization was "to try to get money paid offshore in a deductible fashion, and then the money would find its way onshore in a non-income fashion." Reporter's Transcript, volume 22 at 102.
In implementing this tax planning, Margolis devised orchestrated money movements that were structured by contractual arrangements. In a typical circular money movement, funds would pass from one system entity to a taxpayer, and then from the taxpayer to a second system entity for some ostensible business purpose of the taxpayer. Thus, the taxpayer would appear to have incurred a substantial expenditure, whereas he in reality had merely taken money from, and then returned it to, the system. Consequently, Margolis' transactions have been described as "financial gymnastics, devoid of economic substance." Goldberg v. United States, 789 F.2d 1341, 1343-44 (9th Cir. 1986).
Margolis maintained so-called "system accounting" for his clients which consisted of a chronological list of the client's transactions within the system and which kept track of the client's balance, either positive or negative, vis a vis the system. All funds that went into the system from a client or a non- system entity were entered as a credit to the client while all funds that went out of the system to a client or a nonsystem entity were entered as a debit to the client. A client earned interest on positive balances in the system accounting and was charged interest on negative balances. Transactions between system entities were not recorded because the funds stayed in the system. Though Erhard purportedly had no ownership interest in est, a.e.c., Margolis maintained only one combined system accounting for Erhard and est, a.e.c.
The tax court found that Margolis' representation of clients generally consisted of three phases. During the initial phase, the client's goals were defined and documents were drafted to realize the goals. Then, followed an implementation stage during which the required relationships were established. Finally, there was a clean-up phase when the client wished to terminate the contractual relationships. Where required, money movements would be made in order to complete the clean-up phase. Erhard v. Commissioner, 1991 Tax Ct. Memo LEXIS 336, 62 T.C.M. (CCH) 1, 3, 1991 T.C. Memo 290 (1991). In a memorandum of May 1980, Margolis stated that at the time est, a.e.c. was formed in 1975, it was contemplated that the corporation would not exist for more than three years. Id. at 4.
In 1976, Margolis was indicted on criminal tax charges. He was acquitted of all charges in 1977, but after the indictment, Erhard allegedly became concerned about negative publicity surrounding Margolis' involvement in est, a.e.c. Further, the Margolis system was so complex that Erhard could not assess his own financial condition or that of est, a.e.c. Thus, in January 1980, Erhard announced the initiation of a project to "create est anew." To that end, Erhard formed a task force composed of est, a.e.c. executives, staff members, and outside legal advisors. In May 1980, Erhard issued a memorandum advising his staff that Erhard, Margolis, and the task force had jointly determined to replace Margolis as the general and tax counsel of est, a.e.c.
The task force recommended that Erhard convert the operation into a sole proprietorship. Accordingly, Werner Erhard and Associates ("WEA") was established as a sole proprietorship in February 1981. At this point, WEA needed to acquire the assets of est a.e.c. WEA also needed funds for the acquisition. As for the funds, Margolis indicated that, "the truth is that there is no source other than the accumulated values of the past decade." Id. at 12.
The asset acquisition was accomplished in four phases. In the first phase, which occurred in June and July 1981, Erhard borrowed $2,200,000 from Terla, B.V., a system entity and $5,000,000 from Barclays Bank of San Francisco. Barclays Bank was not a system entity, but the loan was a back-to-back loan secured by Parallax Corp., a system entity. (Note 2) Thus, the money lent to WEA originated with the system. WEA immediately transferred $4,950,677 back to various system entities, allegedly in payment for assets. However, out of the aggregate loan proceeds of $7,200,000, Erhard retained $2,249,323 for operating expenses.
Note 2: A back-to-back loan occurs when a bank loan is collateralized with a cash deposit from a third party. When the loan principal is repaid, then the compensating deposit is released. In the Margolis' system accounting, a system entity's deposit securing a back-to-back loan was treated as a charge against the client receiving the loan from the bank. The client's account was credited when the loan was repaid and the deposit released back to the system entity.
Phase two occurred on or about August 27, 1981 and was financed through three separate loans to WEA from Terla, a system entity, in the aggregate amount of $6,580,000. WEA retained $850,854 and transferred the rest back into the system through a number of system entities. Thus, in phases one and two, Erhard retained a total of approximately $3 million while the rest of the money cycled out of, and back into, the system.
Phase three took place on September 15, 1981. At this point, WEA owed approximately $13,800,000 in short-term debt to Terla and Barclays Bank. Erhard desired to replace his short-term debt with a long-term loan. Accordingly, Erhard called Wolfgang Somary, co- founder of Intercultural Cooperation Foundation ("ICF"), seeking to borrow money for WEA. ICF had no money to lend; however, shortly thereafter, Margolis called Somary and arranged for ICF to accept funds from a Margolis system entity and then to lend those funds to WEA. Margolis also contacted Fernando Flores, co-founder of the St. John Fundacion, who likewise agreed to act as a conduit for the loan so long as the funds were made available to him. As nonsystem entities, ICF and St. John were enlisted to participate because Erhard's outside lawyers regarded a fully disclosable source of the loan as essential to an acceptable asset acquisition plan.
The ultimate source of the $14 million eventually loaned to Erhard during phase three was Island Bank, a system entity. On September 15, 1981, Island Bank transferred $96 million to Sineuri, S.A., another system entity. From this amount, Sineuri transferred $15 million to Brown Education Corp. ("BEC"). BEC had been formed just prior to this transaction as part of Margolis' tax planning. BEC then purported to loan $14 million to ICF. BEC transferred the money to an account in the name of Everd van Walsum, a Margolis associate who was acting on behalf of ICF. (Note 3) BEC was ostensibly loaning this money to ICF, yet ICF never provided BEC financial statements. The agreement that ICF and BEC did execute had been drafted with significant help from Margolis. Moreover, ICF agreed to receive funds from BEC only on condition that ICF would not be liable to BEC if WEA defaulted on the loan.
Note 3: BEC also transferred $1 million back to Island Bank.
ICF then loaned the $14 million to St. John Fundacion, transferring the money to Paul Mason, a Margolis associate who was acting on behalf of St. John. Margolis also had a hand in drafting the documents executed between ICF and St. John. St. John then made a loan of $14 million to Erhard and WEA. St. John did nothing to ensure that the loan would be repaid by Erhard. Indeed, Flores immediately endorsed the instrument to ICF. BEC also assigned to Island Bank all right, title, and interest in the promissory note from ICF.
On the same day that Erhard received the money (which was the same day that all the above transactions occurred), Erhard transferred it all back to Island Bank, a system entity. Island Bank then transferred $8,976,284.95 to Terla B.V. as payment for the loans Erhard obtained during phases one and two. Island Bank also transferred $5,023,500 to Barclays Bank in payment for the loan Erhard obtained during phase one. Payment of the Barclays loan released the collateral deposit back to Parallax, the system entity that had secured the loan.
Phase four took place in December 1981, ostensibly because Erhard needed more money to complete the asset acquisition. This phase was financed with a $1 million demand loan again from ICF through St. John. The source of the funds was Antigua Banking, Ltd., and ABC Trust Company, both system entities. Over a four- month period, Antigua and ABC funneled the funds to the Harry E. Wright, Jr. Charitable Trust, a Margolis client. On August 27, 1981, the Trust transferred $750,000 to Island Bank. On December 17, 1981, the Trust transferred $250,000 to Island Bank. On December 18, 1981, Island Bank transferred $1 million to ICF. ICF then transferred $1 million to St. John, which on the same day transferred the funds to WEA. WEA then transferred the $1 million, plus an additional $547,645 to est, a.e.c.
Thus, at the close of the four phases, WEA had acquired all of est, a.e.c.'s operating assets. (Note 4) It had replaced its short-term loans and owed a total of $15 million, consisting of a $1 million demand loan and a $14 million long- term loan. Both loans were owed to ICF.
Note 4: WEA had also acquired some artwork, an auxiliary sloop, and various recreational vehicles.
WEA paid interest to ICF on both the demand loan and the long-term loan. WEA properly withheld ICF's federal income tax from its payments to ICF and transmitted these amounts to the IRS. In early 1985, WEA paid $1 million, purportedly in repayment of the $1 million demand loan. However, Erhard transferred $550,000 directly to Island Bank rather than to ICF. Island Bank informed ICF that it would not release the $550,000 unless ICF initiated legal action in California to uphold the validity of the $14 million note in Erhard's then-active matrimonial action. Thus, of the $450,000 ICF did receive, it spent approximately $400,000 to defend the $14 million note.
On their returns for the tax years of 1981, 1982, and 1983, Erhard and WEA claimed depreciation and interest deductions based on the transactions described above. The IRS disallowed all the deductions and asserted additions to tax under sections 6653(a)(1), 6653(a)(2), and 6661, as well as increased interest under section 6621(c). Erhard petitioned the tax court for a redetermination of the asserted deficiencies, and the cases were assigned to Special Trial Judge Gussis for hearing. Erhard objected to the assignment on the ground that Judge Gussis was biased against Erhard because he presided over two prior cases involving est, a.e.c. The tax court denied Erhard's motion, and this court denied his petition for mandamus. After a six-week trial, the cases were assigned to Tax Court Judge Scott, who adopted Judge Gussis' opinion. The opinion held that Erhard was not entitled to interest or depreciation deductions because the transactions through which they were generated lacked economic substance, and it sustained the determination and imposition of increased interest under section 6621(c).
On September 3, 1991, Erhard filed a motion for reconsideration. The tax court reaffirmed its conclusions with regard to the disallowance of interest deductions and the determination and imposition of increased interest. The court determined, however, that Erhard was entitled to some depreciation deductions. The court then stated that "decisions will be entered under Rule 155." Erhard v. Commissioner, 1992 Tax Ct. Memo LEXIS 400, 64 T.C.M. (CCH) 10, 15, 1992 T.C. Memo 376 (1992). Erhard and the Commissioner disagreed about the appropriate computations under Tax Rule 155 and this appeal followed.
Erhard raises three issues on appeal: (1) the disallowance of interest deductions; (2) the imposition of increased interest; and (3) the tax court's computations of Erhard's deficiency.
Erhard first argues that this court should remand the case to the tax court, asserting that Judge Scott improperly allowed the special trial judge to make the decision of the tax court.
The chief judge of the tax court may assign a case to be heard by a special trial judge, IRC § 7443A(b)(4); however, the special trial judge has no authority to decide the case. IRC § 7443A(c). Rather, the special trial judge submits a report to the assigned tax court judge, who must "review the work of the special trial judge." Freytag v. Commissioner, 501 U.S. 868, 111 S. Ct. 2631, 2635 n.2, 115 L. Ed. 2d 764 (1991). The litigants do not automatically receive a copy of the report and, therefore, are not routinely allowed to file objections to it.
Once the tax court judge has reviewed the report, she may adopt the Special Trial Judge's report, or may modify it or may reject it in whole or in part, or may direct the filing of additional briefs or may receive further evidence or may direct oral argument, or may recommit the report with instructions.
Tax Court Rule 183(c). Whichever course the tax court judge takes, she must presume that the special trial judge's findings of fact are correct, and she must give "due regard" to the fact "that the Special Trial Judge had the opportunity to evaluate the credibility of witnesses." Id. Here, Judge Scott adopted Special Trial Judge Gussis' report. Erhard was not permitted to file objections to the report prior to Judge Scott's action.
Erhard first argues that because the parties are not provided an opportunity to object to the special trial judge's report, it is likely that the special trial judge will end up deciding the case. (Note 5) Indeed, permitting the litigants to file objections to the special judge's report might well decrease the danger that the tax court judge will simply endorse the report without review, see Linda J. Silberman, Masters and Magistrates Part II: The American Analogue, 50 N.Y.U. L. Rev. 1297, 1344 n.268 (1975). Yet, absent such a procedure, the tax court judge will not necessarily abdicate her judicial responsibility. The Supreme Court has cautioned specifically that "'rubber stamp' activity" on the part of the tax court judge is not to be assumed. Freytag, 111 S. Ct. at 2653 n.2.
Note 5: Erhard analogizes special trial judges in the tax court to special masters and magistrates in the district court, pointing out that litigants in the district court are permitted to file objections to the special master's report before the district judge acts on it.
Second, Erhard maintains that Judge Scott, in fact, did not adequately review the case. Erhard makes much of several quotes from Judge Scott where she admits that she relied on Special Judge Gussis' findings and did not examine every exhibit nor read the entire transcript. However, these admissions do not lead to the conclusion that Judge Scott's review was inadequate. First of all, Tax Court Rule 183 requires Judge Scott to give "due regard" to Judge Gussis' report on findings of fact and credibility. Further, the record in this case is so voluminous (Note 6) that it was perfectly reasonable for Judge Scott not to read every word. Judge Scott made clear that while she did rely on Judge Gussis' findings, she did not "take them carte blanche."
Note 6: The transcript comprised 27 volumes.
Finally, Erhard maintains that Judge Scott's comments during the reconsideration hearing showed that she misunderstood important facts. Erhard points out that Judge Scott mistakenly believed that ICF and the Harry E. Wright, Jr. Charitable Trust were system entities, and that Erhard owned stock in est, a.e.c. Erhard contends that these mistakes show that Judge Scott did not adequately review the record.
After carefully examining the record and Judge Scott's comments, we are convinced that Judge Scott's review of the case was adequate. Erhard points to isolated mistakes; however, Judge Scott's other comments indicate a satisfactory understanding of the case. Further, we believe that the few errors Judge Scott did make were understandable in light of the case's enormous complexity. Although the Wright Trust was not a system entity, it was a Margolis client, and the Commissioner has claimed that it was effectively controlled by Margolis. Similarly, ICF, though not a system entity, clearly took part in the transactions at Margolis' request and with his direction. Finally, Judge Scott's confusion about Erhard's ownership of est, a.e.c. also is understandable given that everyone seemed to acknowledge that Erhard was the "owner" of the business, and given est, a.e.c's purposefully complicated organization structure. Accordingly, we see no reason to remand.
Erhard next challenges the tax court's finding of sham. The tax court's determination that a transaction is lacking in economic substance is a factual determination that this court reviews for clear error. Karme v. Commissioner, 673 F.2d 1062, 1065 (9th Cir. 1980). (Note 7)
Note 7: Contrary to Erhard's contention, Casebeer v. Commissioner, 909 F.2d 1360, 1362 (9th Cir. 1990) does not set forth a de novo standard for review of sham transactions.
At issue here are interest deductions that Erhard claimed for the ICF loans and the Terla B.V. loans. Section 163(a) of the Internal Revenue Code provides for an income tax deduction for "interest paid or accrued within the taxable year on indebtedness." In order to be deductible, however, interest must be paid on genuine indebtedness, an indebtedness in substance and not merely in form. Knetsch v. United States, 364 U.S. 361, 5 L. Ed. 2d 128, 81 S. Ct. 132 (1960). The burden is on the taxpayer to show that the borrowing scheme was a bona fide arrangement entered into for economic purposes, rather than merely a tax avoidance scheme. Valley Title Co. v. Commissioner, 559 F.2d 1139, 1141 (9th Cir. 1977).
The tax court found that the transactions at issue here were without economic substance; that they were merely circular money movements that "began and ended with system entities, with no change in the economic position of the system viewed as a whole." 62 T.C.M. (CCH) 1, 26 (1991).
After conducting a detailed examination of each of the phases, the court concluded the following: In phases one and two, most of the borrowed money simply circled out of the system, through WEA, and back into the system. However, WEA retained approximately $3 million purportedly to use for operating expenses. In phase three, the entire $14 million loan circled through the system in one day. Id. After recounting the convoluted series of transactions involved in phase three, the court concluded that the "loans which had originated from system funds (directly or indirectly) in phases one and two were repaid with system funds in phase three, and the total amount of such repayments were returned, directly or indirectly, to the system." Id.
The court found that the $1 million loan in phase four followed a similar pattern. "Again, the funds originated in a money movement from the Margolis system through the Harry E. Wright, Jr., Charitable Trust, to Island Bank, Ltd., to Intercultural Cooperation Foundation to St. John Fundacion to WEA and from WEA to est, a.e.c." Id. Consequently, the tax court concluded that "the $14,000,000 and $1,000,000 loans purportedly obtained by petitioner to finance the acquisitions were sham transactions completely lacking in economic substance." Id. at 27.
The court's findings of sham are based on its conclusion that the complex est, a.e.c. organizational structure was simply a means of shielding "the true ownership of assets that in reality belonged to the Werner Erhard operation." Id. at 28. The court concluded that the entire series of transactions "merely represented the so- called 'clean-up' phase in which the structure created by Margolis for Werner Erhard in 1975 was shed as a prelude to a new structure." Id. at 27. The court, noting that no "effort was made in the system accounting to differentiate between Werner Erhard and the entities (Erhard Seminars Training, Inc., and est, a.e.c.) which were used to conduct the Erhard business over the years," found that the system accounting simply served to reflect a client's cash position within the system. Id. Thus, when est, a.e.c. was to be dismantled in favor of a new structure, Erhard needed to balance accounts with the system and to remove the assets which, in reality were his, but which had been acquired in the name of various system entities.
This was accomplished in the transactions which took place for the most part in phases one through four in 1981. Werner Erhard or (WEA) obtained all the business assets needed to continue his operations. Personal loans owed by Werner Erhard in substantial amounts were paid. He also acquired possession of art work valued at some $765,038 which had been held in the name of a system entity, the auxiliary sloop Sirona valued at $225,000 which had also been held in the name of a system entity and certain motor vehicles. It also appears that some $3,000,000 remained with Erhard (or WEA) as a result of the circular money movements in phases one and two.
Thus, the court concluded: "We believe that est, a.e.c. was in effect terminated as originally contemplated in 1975, a financial accounting was rendered for Werner Erhard covering some 10 years of close involvement with the system and its entities, and the assets transferred to Werner Erhard in an artificial series of transactions that produced . . . interest expense deductions." Id. at 28.
Although Erhard valiantly attempts to discredit these findings, we are more than satisfied that the tax court committed no clear error in finding that the transactions lacked economic substance.
Erhard first points out that est, a.e.c. was a multi-million dollar business before the asset purchase, as was WEA after the purchase. This, however, is beside the point. The tax court found the asset acquisition to be a sham, not because est, a.e.c. itself was a sham, but because Erhard never really bought est, a.e.c.
Second, Erhard maintains that the court's conclusions about circular money movements are contradicted by the court's own finding that WEA retained a portion of the borrowed funds. However, the court was fully aware that not all the money circulated. Indeed, the court found that the funds that Erhard retained constituted est, a.e.c.'s excess cash balances that needed to be transferred to Erhard in order to square the accounts. This conclusion is supported by the evidence. In a May 20, 1981 memorandum, Margolis indicated that when all the contemplated transactions were concluded, the cash position of est, a.e.c. would be reduced by $2,950,000 while the cash holdings of WEA would increase by that amount. (Note 8)
Note 8: Erhard also argues that the tax court erred as a matter of law by admitting inaccurate IRS charts as evidence of circular money movements. Erhard's claim is meritless, however. Erhard is correct that the charts do not include certain transactions, but it is clear from the court's opinion that the court was aware of and considered these transactions in making its determination.
Third, Erhard maintains that he had a clear business purpose for engaging in the transactions because he desired to terminate his relationship with Margolis. (Note 9) However, even if Erhard had a legitimate business purpose for terminating his relationship with Margolis, that did not give him a business purpose for engaging in the specific transactions at issue here. The fact that he may have had a good business reason for separating from Margolis does not necessarily justify resorting to circular money movements (that just happened to create tax benefits) to effectuate that separation.
Note 9: Erhard also claims that the court applied the wrong test for business purpose. Erhard claims that because the court rejected his asserted business purpose argument on the ground that it was not "convincing," the court erroneously applied an objective test rather than a subjective test. 62 T.C.M. (CCH) 1, 28 (1991). However, Erhard seems to be arguing that unless the court blindly accepts Erhard's assertions, then it is applying an objective test. The text of the opinion shows that the court was not substituting its opinion for Erhard's. Rather, the court was merely stating that, based on the evidence, it did not believe Erhard's assertions.
Finally, Erhard points out that even though the $14 million loan in phase three and the $1 million loan in phase four came from system entities and were immediately returned to system entities, Erhard nonetheless paid over $2 million in interest on the loans over the next several years. He also repaid the $1 million demand loan in 1985. These payments, according to Erhard, are evidence that he was genuinely indebted; after all, he would not have made any payments if the loans had been shams.
We agree that such payments would ordinarily indicate genuine indebtedness; however, the facts of this case immediately dispel such a suggestion. The evidence shows the following: Margolis created the amazingly complicated est, a.e.c. organizational structure, with its numerous offshore entities, in order that money could be "paid offshore in a deductible fashion, and then the money would find its way onshore in a non-income fashion." Reporter's Transcript, volume 22 at 102. Though nominally just an employee of est, a.e.c., Erhard was understood to be its owner. So, when Erhard decided to transform est, a.e.c. into a sole proprietorship, the assets that were ostensibly the property of est, a.e.c. were transferred to Erhard in exchange for payments that were really just circular money movements. Thus, during phases one and two, even though it appeared as though Erhard transferred millions of dollars to est, a.e.c. in exchange for assets, the system was the source not only for the purchase money but also for the additional $3 million that represented est, a.e.c.'s cash reserves.
Further, the convoluted, circular path of the two ICF loans in phases three and four simply makes it hard to believe that these loans were bona fide. The funds began with the system, went through two nonsystem entities in order to provide the transaction with legitimacy, and then went back to the system. Margolis was intimately involved in all these transfers. He arranged for the loans between BEC, ICF, and St. John, and he helped prepare the agreements between the parties. None of these parties knew each other before the transactions, nor did they conduct any of the investigations that are customary in an arms-length transaction. Given this evidence, the fact that Erhard made some subsequent payments to ICF does not lead to the conclusion that the tax court committed clear error in its finding of sham. Indeed, these payments to ICF can be explained in any number of ways (Note 10) that are wholly in keeping with the tax court's conclusion that the transactions lacked economic substance.
Note 10: For example, the payments could very well have been rendered as a part of the final accounting between Erhard and the system. That is, the transactions that occurred during the four phases may have been calculated to take account of Erhard's subsequent payments to ICF.
Erhard next contends that the tax court erred in imposing increased interest. This court reviews the tax court's imposition of increased interest pursuant to section 6621 for clear error. Wolf v. Commissioner, 4 F.3d 709, 715 (9th Cir. 1993).
Before its repeal, IRC section 6621(c) imposed increased interest on an understatement of tax to the extent that the understatement was a "substantial underpayment attributable to tax motivated transactions." Prior to 1986, the section defined "tax motivated transactions" as including only four specific types of transactions. (Note 11) The Tax Reform Act of 1986, Pub. L. 99- 514, 100 Stat. 2750, amended section 6621(c) to add "any sham or fraudulent transaction" to the list of tax motivated transactions. The Commissioner imposed increased interest on Erhard on the basis of this last category.
Note 11: They were (1) any valuation overstatement; (2) any loss disallowed under the at-risk investment credit provisions; (3) any straddle transaction; or (4) any use of an accounting method that created distortion.
Erhard maintains that the legislative history indicates that a transaction does not come within the "sham or fraudulent transaction" category unless the transaction is a fraudulent version of one of the specific types of transactions that were originally defined to be tax motivated transactions. (Note 12) However, Erhard's argument is not supported by language of the section or by precedent. See Hildebrand v. Commissioner, 967 F.2d 350, 353 (9th Cir. 1992). See also Estate of Carberry, 933 F.2d 1124, 1129-30 (2d Cir. 1991). The section, on its face, applies to any sham or fraudulent transaction. Thus, we reject the limitation Erhard urges as not plausible in light of the statute's clear language.
Note 12: Erhard argues that Congress added the "sham" category in order to reverse a line of tax court cases that refused to impose increased interest to a fraudulent straddle because fraudulent straddles are not really straddles.
Finally, Erhard challenges the tax court's computations under Tax Court Rule 155. Computations under Rule 155 are reviewed for an abuse of discretion. Kelley v. Commissioner, 877 F.2d 756, 760 (9th Cir. 1989). Erhard alleges that the tax court abused its discretion (1) by refusing to accept his computations as to the useful lives of the depreciable assets, and (2) by refusing to credit him for amounts that he withheld from his payments to ICF.
Upon reconsideration, the tax court held that Erhard was entitled to depreciation deductions for certain assets that WEA acquired from est, a.e.c. The court directed that decisions would be entered under Tax Court Rule 155. The parties could not agree on the useful lines of those assets; therefore, each party submitted its own computation under Rule 155.
The Commissioner computed the useful lives of the assets by using the class life guidelines contained in the tables in Rev. Proc. 77-10, 1977-1 C.B. 548. Under this method, the Commissioner allowed Erhard to depreciate the assets from the date that est, a.e.c. transferred the assets to WEA. Erhard maintains, by contrast, that the useful lives of the assets should be computed from the earlier date the assets were acquired by est, a.e.c. in the amount identified from the est, a.e.c. tax returns that had been admitted into evidence.
A computation under Rule 155 must be made solely from the evidence in the record and the opinion of the tax court; it cannot be used to reopen the evidence or raise a new issue. Tax Court Rule 155(c). See also Paccar, Inc. v. Commissioner, 849 F.2d 393, 399- 400 (9th Cir. 1988). Here, the tax court found that Erhard's computation was an accounting opinion that raised a new issue of fact. Erhard disagrees, contending that, because the record already included est, a.e.c. tax returns, the remaining useful lives could be calculated "by simple mathematical computations from those returns."
The tax court did not abuse its discretion in refusing to accept Erhard's calculations. The record does not disclose the useful life of each of the assets which remained at the time of the asset acquisition. Rather, Erhard's computations are based on information from est, a.e.c. tax returns. Though the returns are in the record, they were not stipulated to for accuracy or truth, and the Commissioner had no opportunity to contest the accuracy of particular items on the returns. Thus, we agree with the district court that determining the accuracy of Erhard's computations would require reopening the record to permit opinion testimony from both Erhard's accountant and the Commissioner's expert.
WEA withheld amounts from its purported interest payments to ICF and properly remitted the withheld amounts to the IRS on ICF's behalf. Erhard now claims that since the Commissioner has determined that he never really had an obligation to pay interest to ICF, then he was not a bona fide withholding agent and thus must have made the payments to the IRS for his own account.
We are not persuaded by Erhard's argument. The amounts Erhard remitted to the IRS were withheld from payments to ICF and thus were in payment of ICF's tax, not Erhard's tax. Section 1464 provides that a refund or credit of an overpayment of tax which has actually been withheld at the source shall be made to the taxpayer from whose income the amount of such tax was in fact withheld. I.R.C. § 1464; Treas. Reg. § 1.1464-1(a); Bank of America v. Anglim, 138 F.2d 7, 8 (9th Cir. 1943). Thus, the IRS may refund any overpaid amount only to ICF, the taxpayer from whose income the tax was withheld. That the IRS deemed the loans shams does not transform payments made on behalf of ICF into payments made on behalf of Erhard. Erhard withheld that money on ICF's behalf regardless of the underlying purpose of the payments.
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Index - The Mary Polaski L Series
Preface and Summary