Structuring Defined Value Clauses in Trust Transfers: Formula Allocations and Price Adjustment Clauses

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Structuring Defined Value Clauses in Trust Transfers: Formula Allocations and Price Adjustment Clauses TUESDAY, JULY 18, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Paige K. Ben-Yaacov, Partner, Baker Botts, Houston Patrick J. Duffey, Attorney, Holland & Knight, Tampa, Fla. Jonathan J. Rikoon, Partner, Loeb & Loeb, New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.

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5 Background Why Use a Formula Clause? Client wants to transfer hard-to-value assets to beneficiaries Assets selected for growth potential compared to current appraised value Some of that is due to real business potential but with a trade-off in volatility and risk But some of it may be due to a depressed valuation: Market conditions Special risks and exposures regulatory, tax environment. Closely held business interest with no control or marketability 5

6 The Problem What If the IRS Disagrees on Value? A plain gift may generate unexpected gift tax cost A GRAT avoids the gift tax risk but - Mortality risk: all in estate if grantor does not survive term Liquidity risk: GRAT has rigid formula for paying annuity Inter-generational gifting: Not readily available for generation-skipping planning A leveraged (installment) sale to a grantor trust can reduce gift tax cost without the mortality or liquidity risk of a GRAT. - But the risk of additional gift tax remains unchanged (same as a gift) and unaffected by the leverage of the installment note. Exception to the extent use of the note saves gift tax exemption to be available as an audit cushion 6

7 Solution Can a Formula Save the Day? We know formulas work in some contexts: - Marital deduction/credit shelter legacies - GST exemption legacies - Disclaimers - Size of annuity/unitrust amount for charitable split interest trusts (CLATs, CLUTs, CRATs, CRUTs) Why not just give (or sell) so much of the asset as is worth $X (e.g., gift tax exemption), whatever percentage that turns out to be? Alternative: formula allocation clause transfer entire asset but allocate the transfer between completed-gift transferee (by gift or sale) and non-taxable transferee. Or, sell the asset (or X% of it) for a price equal to its fair market value, whatever that turns out to be? 7

8 No Surprise IRS Hates Formula Clauses in Gifts or Sales Public Policy (takes away incentive to audit, requires courts to decide moot cases) Technical arguments (condition subsequent: gift is already complete by the time clause kicks in) Potential for gamesmanship or collusion Encourages overly aggressive appraisals no down side? IRS won some early cases but has been losing lately as practitioners learn lessons 8

9 The First Clause (it didn t work) Procter (4 th Cir. 1944) Trust document said that if a court later determines that any part of this transfer is subject to gift tax, then that portion shall automatically be deemed not to be included in the conveyance... and shall remain the sole property of the transferor. Court: that s a condition subsequent and the gift was already made and taxable before we rule, too late to reverse gift. Violates public policy; trifling with the judicial process. Discourages collection of tax. Decision of court would deprive the court of jurisdiction: once the final judgment fixes the gift tax liability, the gift (and the tax) disappears. End-run around the prohibition on declaratory judgments for tax cases. 9

10 Proctor s Progeny Proctor Was Followed (for a while at least) Ward (TC 1986) Gift of 25 shares of closely held stock, with the number of shares of the gift to be adjusted if the finally determined fair market value is other than $2,000/sh, such that each gift turns out to be $50,000. Donors argued they intended to give $50,000 worth of stock and the 25 shares was just representative of the value. But that s not what the documents said. 2 of 3 Proctor public policy arguments still applied: no incentive for IRS to challenge valuation, and the donor cannot be compelled to reclaim a portion of the property which would thus escape gift and estate taxation. Distinguishes King (below) as an arms-length sale, no donative intent; plus in King the clause operated to insure that no unintended gift was made while here the agreement purports to retroactively alter the amount of an otherwise completed gift. Q: Does that mean if the gift had indeed been so much stock as is worth $50,000 it would have been OK? Form over substance but a critical drafting point. 10

11 Proctor s Progeny Proctor Was Followed (for a while at least) McLendon (TC 1993) Private annuity sale agreement in closely held business provided for adjustment of fixed dollar purchase price if final gift tax valuation differs from appraisal. Analysis closely follows Ward. Formula stated that if value "changed through a settlement process with the Internal Revenue Service, or a final decision of the United States Tax Court, the purchase price hereunder shall be adjusted accordingly." Q: If the sale price had been a King-style whatever the fair market value is formula rather than a fixed dollar price to be subsequently adjusted, would that have been OK? 11

12 Turning the Corner What About a Price Adjustment Clause? King (10 th Circuit 1976): Sale price of closely held stock to family trust used formula of similar sales to stock option plan. Ordinary course of business. Sale agreement provided: "if the fair market value... as of the date of... [the agreement] is ever determined by the Internal Revenue Service to be greater than the fair market value determined in the... manner described above, the purchase price shall be adjusted to the fair market value determined by the Internal Revenue Service." Trial court had found that the parties really intended to pay FMV but they recognized that it was difficult to ascertain. Actual price adjustment had real financial effect. No donative intent. Distinguished Proctor based on these facts. Plus: no diminution of seller s estate Unlike clauses where a contingency would alter, change, or destroy the nature of the transaction. 12

13 A New Contender Formula Allocation Clauses Used to limit gift or estate tax liability by: transferring a fixed or "defined" value portion of the asset to one or more taxable donees, and allocating the rest of the asset to one or more non-taxable donees Examples of non-taxable donees include charities, marital trust, etc. If the value going to the taxable donee is a fixed or "defined" amount, then: an increase in the value of the asset on audit does not change the value passing to the taxable donee only the value transferred to the non-taxable donee is adjusted, meaning no additional gift or estate tax should be due. 13

14 A New Contender Formula Allocation Clauses Two different types of formula allocation clauses McCord/Hendrix style clause: McCord (5th Cir. 2006) Hendrix (Tax Ct. 2011) Petter/Christiansen style clause: Petter (Tax Ct. 2009; 9th Cir. 2011) Christiansen (Tax Ct. 2008; 8th Cir. 2009) Best illustrated by an example; the following pages show 4 stages of a hypothetical transfer using a formula allocation clause, as follows: Stage 1: the Transfer by donor to a taxable donee and a non-taxable donee Stage 2: the Division of the Interest between the donees Stage 3: the Audit Stage 4: Adjustments because of Audit (?) 14

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16 Formula Allocation Clauses Example Stage 1 The Transfer Daddy Warbucks ("DW") has a 99% LP interest in a FLP that he thinks is worth $10 million DW transfers the entire 99% LP interest to a trust for his daughter, Annie, and Orphan World Relief, a public charity ("OWR") DW states in the transfer document that the 99% LP Interest will be allocated between the trust and OWR as follows: first, that portion of the 99% LP interest having a fair market value, as of the date of the transfer, equal to $9.9 million is allocated to the trust; second, any remaining portion of the interest is allocated to OWR. 16

17 Formula Allocation Clauses Example Stage 2 The Division of the Interest Between the Donees Hypothetical example (Stage 2- the division of the interest by the donees): The trustee of Annie's trust and OWR each hire an appraiser to determine the fair market value of the 99% LP Interest After consulting with the appraisers, the trustee and OWR agree, in a written document, as follows: the 99% LP interest was worth $10 million on the date of the transfer; 99% (i.e., $9.9 million out of $10 million) of the 99% LP Interest (i.e., a 98% LP interest) is allocated to the trustee; and the remaining portion of the 99% LP Interest (i.e., a 1% LP interest) is allocated to OWR).! DW took no part in the negotiations between the trustee and OWR, nor was DW a party to the agreement between the trustee and OWR by which the 99% LP interest was allocated between the donees. 17

18 Formula Allocation Clauses Example Stage 3 The Audit On audit, the IRS asserts that the 99% LP interest was worth $15 million; rather than $10 million DW explains to the IRS that any increase in the value of the 99% LP interest does not result in any additional gift tax because, regardless of the overall value of the 99% LP interest, he transferred only $9.9 million to the trust for Annie. If the 99% LP interest is worth $10 million, OWR received an interest worth $100,000; if the LP interest is worth $15 million, OWR received an interest worth $5.1 million. If OWR actually received something worth $5.1 million (as opposed to $100,000), DW has a bigger charitable deduction. DW and the IRS settle at a $12 million value for the LP Interest; DW pays no additional gift tax 18

19 Formula Allocation Clauses Example Stage 4 Adjustment as a Result of Audit (?) There are two types of formula allocation clauses one type results in changes to the percentages owned by the donees if value is adjusted on audit (Petter/Christiansen) the other type does not result in any changes to the percentages owned, even if values are adjusted on audit (McCord/Hendrix) Petter/Christiansen: division of the LP Interest between the donees is based on values as finally determined for federal gift/estate taxes In our example, the value of the 99% LP Interest was adjusted from $10 million to $12 million on audit If DW used a Petter/Christiansen style formula, the trustee's interest would decrease from 98% to 81.7% ($9.9 mill. out of $12 million, multiplied by 99%), and OWR's interest would increase from 1% to 17.3%. Huge Difference! McCord/Hendrix: division of the LP Interest is based on agreement between the donees - increase in value on audit does not change the ownership split! 19

20 McCord v. Petter Drafting Comparison McCord* The Assigned Shares shall be allocated among the Assignees in the following order: (a) that portion of the Assigned Shares having a fair market value as of the Effective Date equal to $, is assigned the Trust; and (b) then, any remaining portion of the Assigned Shares is assigned to the Foundation. For purposes of this paragraph, the fair market value of the Assigned Shares as of the Effective Date shall be the price at which the Assigned Shares would change hands as of the Effective Date between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts for purposes of Chapter 12 of the Internal Revenue Code of 1986, as amended. * Note: underlined language is unique to clause Petter* The Assigned Shares shall be allocated among the Assignees in the following order: (a) that portion of the Assigned Shares having a fair market value as of the Effective Date equal to $, as such value is finally determined for federal gift tax purposes, is assigned the Trust; and (b) then, any remaining portion of the Assigned Shares is assigned to the GRAT. 20

21 McCord v. Petter Division of Transferred Asset For both McCord and Petter, division of the transferred asset initially is based on negotiations between donees very important to have a good feel for value of asset on date of transfer requires "whisper number" from appraiser, which can be hard to obtain for operating entities For Petter but not McCord the division agreed upon by the donees would be altered if the value of the transferred asset is adjusted on audit The IRS essentially gets to have a hand in how much goes to the taxable donee v. the non-taxable donee Adjustment on audit can make a big difference in ownership percentages Assume FLP holds $15.6 mill. in assets; if a combined 35% discount applies to a 99% LP interest, that interest is valued at approx. $10 mill. If discount is reduced to 20% on audit, the 99% LP interest is valued at approx. $12 mill. In our example, this changed the charity's ownership from 1% to 17.3% Adjustments to ownership of entity can result in need to amend income tax returns, true-up distributions, etc. 21

22 McCord v. Petter Non-Taxable Donee Because the division of the transferred asset in a McCord-style formula is not based on values as finally determined for federal gift or estate tax purposes, the non-taxable donee must be completely independent from the donor and the other donee for the transaction to work public charity (e.g., donor-advised fund) is a good choice There must be no collusion between the donor and the non-taxable donee in McCord, it was important that there was no evidence of any agreement-not so much as an implicit, wink-wink understanding-between the Taxpayers and any of the donees regarding the percentage interest to which each donee was entitled" non-taxable donee should have its own attorney and its own appraiser document the back-and-forth between the donees regarding value By contrast, in a Petter-style formula, there is less pressure on the independence of the non-taxable donee could be a marital trust could be a GRAT (this will not completely protect from gift tax exposure, but will minimize it) 22

23 McCord v. Petter Enforceability McCord transfer to non-taxable donee was not contingent on value adjustment having a charity as the non-taxable donee is helpful because of the strong public policy in favor of charities McCord-style formula is particularly strong in the 5th circuit Petter has the additional argument that valuation is not a moot issue because an adjustment to the value of the asset changes the percentage interests held by the donees For McCord-style transactions, should a small portion (say, 5%) of the non-taxable portion also pass to the taxable gift, to give the IRS an audit incentive and deal with one of the Proctor arguments? 23

24 A Different Kind of Clause Wandry (Tax Ct. 2012) Background Taxpayers were Albert & Joanne Wandry Gift Tax deficiency for 2004 year based on gifts of LLC interests to children and grandchildren LLC was Norseman Capital Structure: Mr. & Mrs. Wandry Gift of LLC units equal to $1 million exemption split among children and grandchildren Kenneth $261,000 Cynthia $261,000 Jason $261,000 Jared $261,000 5 grandchildren $11,000 each - Norseman was formed by TPs and their children in Court characterized Norseman as part of a family business - Gifts were in dollars (not units/percentages/shares, etc.) 24

25 Wandry Clauses Evidence of Transfer In Wandry-style clauses, consistency is key establishing that the transfer actually occurred as documented. Evidence of the Transfer in Wandry -Capital Account Ledger: reflected a downward adjustment of the TP s capital accounts and an upward adjustment of the children s and grandchildren s capital accounts. the adjustments did not reconcile with TP s claimed gift amounts Partnership Tax Return (Form 1065 and K-1s): reflected capital adjustments, generally did not itemize adjustments that were attributable to the gifts Gift Tax Return: described the gifts as percentage interests, not dollar amounts Less-than-ideal (return was prepared by CPAs, not planners) 25

26 Wandry Clauses Structure 26

27 Wandry Clauses Tax Court Analysis IRS ARGUMENTS (1) Gift Tax Descriptions are Admissions TAX COURT RESPONSE Gift Tax descriptions are admissions, but the percentage interests were derived from and consistent with the Gift documents. (2) Capital Accounts are Controlling (3) DVC is Ineffective Capital Accounts are reflective of ownership, not dispositive. They are frequently subject to adjustment in other contexts. King (10th Cir.) not on point, Petter (9th Cir.) controls. Petter Test: Donees always entitled to receive a predefined number of units Passes Formula had one unknown, which was a constant (value of an LLC unit) Pre-audit, donees were legally entitled to receive same number of units The audit only ensured that donees would receive the units to which they were always entitled. 27

28 Asset What Went Right - old and cold (2001) - operating business Drafting Wandry Clauses Key Take-Aways - clear and well-drafted documents Consistency - Consistently characterized gift as pecuniary amount on the 709, during audit, and at trial Jurisdiction - 10 th Circuit (King) Best Practices Precise descriptions of the gift on the 709 Use an attachment or continuation sheet to describe the transfer. Record-Keeping Entity records (especially capital accounts) should accurately reflect the transfer Income Tax Reporting Ensure that the entity s income tax reporting is accurate and consistent w/ the transfer (likely Form 1065 and K-1) Forum Shopping The Tax Court is relatively friendly to formula clauses, but Wandry was just a TC Memo. 5 th, 8 th, 9 th, and 10 th Circuits all have favorable (but perhaps not dispositive) law. 28

29 Wandry Clauses On Audit The Service strongly dislikes Wandry -On November 13, 2012 the IRS announced its non-acquiescence to Wandry -A Wandry clause is, anecdotally, an audit flag Q: does operation of a Wandry-style clause always benefit the client? Consider: (a) IRS sensitivity to DVC clauses; and (b) Potential appreciation of the underlying asset(s). A DVC will partially undo the estate tax freeze aspect of such a transfer (gift or sale) The IRS may be willing to trade operation of the DVC in exchange for a better valuation discount Timing is also important: gift tax audit or estate tax audit? Audit Example: the IRS hates Wandry, until it doesn t 29

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31 Woelbing The Service s Continued Attack on Wandry Woelbing v. Comm r. (actually two companion cases) is not a reported case The taxpayer and the IRS settled before the IRS filed a response (on January 12, 2016) Woelbing involved the sale of all of the taxpayer s non-voting stock in a closely-held business (Carma Laboratories) to grantor trusts in exchange for promissory notes. It involved a number of issues: (1) asset valuation dispute, (2) consideration valuation dispute (2702), and (3) gross estate inclusion (2036 & 2038). (1) transfer of a significant asset (TP valued at $59M); (2) lack of collateral (personal guaranties for 10% of note value from two trust beneficiaries); (3) below-market promissory notes (interest-only, AFR), (4) defined value clause in sales agreement (Wandry-style). 31

32 Woelbing The Value Adjustment Clause The IRS did not have a chance to respond, but in the Tax Court Petition the Taxpayer outlined the key provisions of the Wandry-style clause used to transfer the non-voting shares. The Instalment Sale Agreement apparently included the following provisions: 1. Sale of the taxpayer s non-voting stock to the Trust for $59M 2. The number of shares and the value of those shares were determined on the transfer date (2/28/06), but the buyer and seller acknowledged that the exact number of shares purchased depends on the FMV of each share of stock. Based on the appraisal, approximately 1.1M shares of stock were transferred 3. In the event that the value of a share of stock is determined to be higher or lower than that set forth in the appraisal whether by the IRS or a court then the purchase price shall remain the same, but the number of shares of stock purchased shall automatically adjust so that the fair market value of the stock purchased equals the purchase price. 32

33 Practicalities Simpler Formula Transfer Clauses Stated value transfer clause (transfer of so many units as equals $X as determined for gift tax purposes) (Wandry). Can be a sale or a gift. Not a condition subsequent, does not take back any property just defines how much is transferred, balance not in the transfer at all. Forgoes the charitable gift public policy argument Puts pressure on independence and fiduciary duties of transferee to fight for full valuation. Alternative: gift of $X worth of assets and sale of excess for a note. Alternative: gift with a donee disclaimer of excess above $X worth. 33

34 Practicalities Simpler Formula Transfer Clauses Stated price sale clause (transfer of X units, for whatever the fair market value is) (King). Not a condition subsequent; does not alter the amount of property transferred just defines purchase price for what is transferred. Forgoes the charitable gift public policy argument Puts pressure on independence and fiduciary duties of transferee to fight for full valuation. 34

35 Example of Price Adjustment Clause Recitals A. Transferor wishes to sell the Transferred Interest to Transferee, and Transferee wishes to purchase the Transferred Interest, for the fair market value of the Transferred Interest as of the date of this Agreement. B. Based on the parties estimate of the fair market value of the Transferred Interest as of the date of this Agreement, Transferee will deliver to Transferor the consideration set forth in paragraph 1 below. C. If the fair market value of the Transferred Interest is determined to be higher or lower than the Estimated Price or the Appraisal Price, determined as provided in this Agreement, then Transferor and Transferee will adjust the Purchase Price of the Transferred Interest as provided in this Agreement so that the Purchase Price is equal to the fair market value, as so determined 35

36 Example of Price Adjustment Clause Operative Language (a) Sale and Purchase. Upon the terms and subject to the conditions set forth in this Agreement, Transferor hereby sells, assigns and transfers to Transferee all of Transferor s right, title and interest in and to the Transferred Interest for an amount equal to the fair market value of the Transferred Interest as of the date of this Agreement ( Purchase Price ). (b) Payment. The parties have engaged [NAME OF APPRAISER] to prepare an appraisal ( Appraisal ) of the Transferred Interest to determine the Purchase Price. Upon execution and delivery of this Agreement, Transferee shall deliver to Transferor a payment on account of the Purchase Price in the amount of ($ ) ( Estimated Price ), payable $ in cash, receipt of which by Transferor is hereby acknowledged, and the balance of which is payable in accordance with the terms of a note dated the same day as this Agreement in the face amount equal to the balance of the Estimated Price ( Note ). [COLLATERAL] (c) Post-Appraisal Adjustment. If the fair market value of the Transferred Interest set forth in the Appraisal ( Appraisal Price ) is greater or less than the Estimated Price, the difference shall be delivered as follows: (i) if the Estimated Price is less than the Appraisal Price, Transferee shall deliver to Transferor an amount equal to the excess ( Additional Payment Amount ) of the Appraisal Price over the Estimated Price; or (ii) if the Estimated Price is greater than the Appraisal Price, Transferor shall deliver to Transferee an amount equal to the excess ( Return Amount ) of the Estimated Price over the Appraisal Price. [MECHANICS] (d) Subsequent Adjustment of Price. If at any time any governmental agency or a court of competent jurisdiction finally determines that the fair market value of the Transferred Interest as of the date of this Agreement ( Finally Determined Price ) is greater or less than the Appraisal Price, then such portion of the difference shall be delivered as follows: (i) if the Appraisal Price is less than the Finally Determined Price, Transferee shall deliver to Transferor an amount equal to the excess ( Final Additional Payment Amount ) of the Finally Determined Price over the Appraisal Price; or (ii) if the Appraisal Price is greater than the Finally Determined Price, Transferor shall deliver to Transferee an amount ( Final Return Amount ) equal to the excess of the Appraisal Price over the Finally Determined Price. [MECHANICS] 36

37 Example of Formula Allocation Clause Recitals A. Transferor intends to sell to Dynasty Trust the Sale Fraction of the Transferred Interest in Company for its fair market value, and to give to GRAT as a gift the Gift Fraction of the Transferred Interest in Company. B. Dynasty Trust intends to purchase the Sale Fraction from Transferor for its fair market value, and GRAT intends to accept as a gift the Gift Fraction from Transferor. C. Based on the parties estimate of the fair market value of the Transferred Interest as of the date of this Agreement ( Estimated Price ), Dynasty Trust will deliver to Transferor the consideration set forth in Section 1 below. D. If the fair market value of the Transferred Interest is determined to be different from the Estimated Price or the Appraisal Value of the Transferred Interest, determined as provided in this Agreement, then Dynasty Trust and GRAT will adjust the Sale Fraction of the Transferred Interest and the Gift Fraction of the Transferred Interest as provided in this Agreement so that the Purchase Price is equal to the fair market value of the Sale Fraction of the Transferred Interest, as so determined. 37

38 Example of Formula Allocation Clause Definitions E. The term Gift Tax Value of the Transferred Interest shall be the Transferred Interest s value on the date of this Agreement, as finally determined for federal gift tax purposes or by a court of competent jurisdiction. F. The term Sale Fraction shall be a fraction, not to exceed one, the numerator of which is equal to the Appraisal Value, and the denominator of which is equal to the Gift Tax Value of the Transferred Interest. The Gift Fraction shall be a fraction of the Transferred Interest, the numerator (which in no event shall be less than zero) of which is the Gift Tax Value less the numerator of the Sale Fraction, and the denominator of which is the Gift Tax Value. To illustrate the operation of this section, assume that the Appraisal Value of the Transferred Interest is $1,000,000, and the Gift Tax Value is $1,500,000. As of the date of this Agreement, the Sale Fraction is one ($1,000,000 + $0/$1,000,000), the portion of the Transferred Interest sold to Dynasty Trust is 100%, the Gift Fraction is zero, and the portion of the Transferred Interest transferred to GRAT as a gift is 0%.. As a result of the increase in the value of the Transferred Interest from $1,000,000 to $1,500,000, the Sale Fraction is 2/3 ($1,000,000/ $1,500,000) and the Gift Fraction is 1/3 ([$1,500,000 - $1,000,000] / $1,500,000). The portion of the Transferred Interest sold to Dynasty Trust is adjusted to 2/3 of the Transferred Interest, and the portion of the Transferred Interest transferred to GRAT as a gift is adjusted to 1/3 of the Transferred Interest. 38

39 Example of Formula Allocation Clause Operative Language (transfer and initial payment) 1.1 Transfer. Upon the terms and subject to the conditions set forth in this Agreement, Transferor (i) hereby sells, assigns and transfers to Dynasty Trust the Sale Fraction of the Transferred Interest for an amount equal to the fair market value of the Sale Fraction of the Transferred Interest as of the date of this Agreement ( Purchase Price ), and (ii) transfers to GRAT by gift the Gift Fraction of the Transferred Interest. As of the date of this Agreement, but subject to the terms of this Agreement, Dynasty Trust and GRAT agree that the following interests in the Transferred Interest have been transferred to Dynasty Trust and GRAT, respectively: (a) Dynasty Trust: 100% (b) GRAT: 0% 1.2 Payment. Based on the parties good faith estimate of the fair market value of the Transferred Interest as of the date of this Agreement, upon execution and delivery of this Agreement, Dynasty Trust shall deliver to Transferor a payment on account of the Purchase Price the Estimated Price of Dollars ($ ), payable with a note dated the same day as this Agreement in the face amount equal to the Purchase Price ( Note ). The Note (as well as any additional Note delivered pursuant to subsection 1.3 or subsection 1.4 of this Section 1) has the benefit of the security agreement dated the same day as this Agreement between Transferor and Dynasty Trust ( Security Agreement ). 39

40 Example of Formula Allocation Clause Operative Language (two-stage adjustment) 1.3 Post-Appraisal Adjustment. The parties have engaged to prepare an appraisal ( Appraisal ) of the Transferred Interest to determine the Purchase Price. If the fair market value of the Transferred Interest set forth in the Appraisal ( Appraisal Value ) is greater or less than the Estimated Price, then the difference shall be delivered as follows: (i) if the Estimated Price is less than the Appraisal Value, Dynasty Trust shall deliver to Transferor an amount equal to the excess ( Additional Payment Amount ) of the Appraisal Value over the Estimated Price; or (ii) if the Estimated Price is greater than the Appraisal Value, Transferor shall deliver to Dynasty Trust an amount equal to the excess ( Return Amount ) of the Estimated Price over the Appraisal Value. The Additional Payment Amount shall be delivered by Dynasty Trust to Transferor in immediately available funds or, at the sole discretion of Dynasty Trust, pursuant to an additional note substantially in the form of the Note, dated as of the same date as this Agreement and bearing interest at the applicable federal rate set forth in the Note. 1.4 Subsequent Adjustment. If at any time any governmental agency or court of competent jurisdiction finally determines that the Gift Tax Value of the Transferred Interest as of the date of this Agreement ( Finally Determined Value ) is greater than the Appraisal Value, then Dynasty Trust and GRAT will adjust the percentage of the Transferred Interest sold to Dynasty Trust and transferred to GRAT by gift to reflect the Sale Fraction and the Gift Fraction of the Transferred Interest, as so determined. Dynasty Trust will transfer to GRAT the percentage of the Transferred Interest equal to the Gift Fraction. 1.5 Distribution Adjustment. Dynasty Trust and GRAT agree that if subsection 1.3 or 1.4 of this Section is applicable, all distributions made from Company since the date of this Agreement shall be adjusted between Dynasty Trust and GRAT, so that Dynasty Trust and GRAT receive the distributions that they would have received had the ownership of the Transferred Interest been as determined in subsection 1.3 or 1.4 as of the date of transfer. All amounts payable shall bear interest at the applicable federal rate to the date that the distributions are adjusted. 40

41 Thank You Jonathan J. Rikoon Partner, Loeb & Loeb LLP (212) Paige K. Ben-Yaacov Partner, Baker Botts L.L.P. (713) Patrick J. Duffey Attorney, Holland & Knight (813)