| Commitments and Contingencies | (14) Commitments and Contingencies
(a) Income Tax
Matters
Internal
Revenue Service Audit
Effective
March 31, 2009, we completed the sale of the trust certificate
of NC Residuals Owners Trust (the Trust Certificate). In connection
with the sale of the Trust Certificate, FMD entered into an asset
services agreement (the Asset Services Agreement) pursuant to which
FMD provided various consulting and advisory services to the
purchaser of the Trust Certificate. As a result of the sale of the
Trust Certificate, as well as our operating losses incurred in
fiscal 2009, we recorded an income tax receivable for federal
income taxes paid on taxable income in prior fiscal years. In
fiscal 2010, we received a total of $189.3 million in federal and
state income tax refunds related to our income tax receivables.
Furthermore, we received a federal income tax refund of $45.1
million in October 2010 related to the operating losses in fiscal
2010, which we applied to taxable income from fiscal 2008. In April
2010, the Internal Revenue Service (IRS) commenced an audit of our
tax returns for fiscal 2007 through fiscal 2009, including a review
of the tax treatment of the sale of the Trust Certificate and the
federal tax refund previously received in the amount of $176.6
million. Such audits are required by the Internal Revenue Code. The
IRS also commenced an audit of our fiscal 2010 tax return in light
of the $45.1 million income tax refund that we received in October
2010.
On
September 10, 2013 we received two Notices of Proposed
Adjustment (NOPAs) from the IRS. In the NOPAs, the IRS asserted
that our sale of the Trust Certificate should not be recognized for
federal income tax purposes primarily because we retained the
economic benefits and burdens of the Trust Certificate, including,
among other things, retaining certain repurchase rights and data
rights. The IRS further concluded that the transaction should be
characterized as a financing instead of a sale and asserted that
the sale of the Trust Certificate and the execution of the Asset
Services Agreement had the impact of converting taxable income to
the owner from an accrual basis to a cash basis. As a result, the
NOPAs proposed to disallow the loss that generated the tax refunds
that we previously received as well as require us to include income
from the Trust Certificate from the March 31, 2009 sale date
through June 30, 2011 in our taxable income for such
years.
On
December 18, 2014, the IRS informed us that it is no longer
challenging the federal tax refunds we previously received in the
amounts of $176.6 million and $45.1 million. The IRS has provided
us with its final examination report confirming that the refunds
were correct and we do not owe additional tax. The IRS’s
decision not to challenge these federal tax refunds was subject to
the review of the Joint Committee on Taxation, as is required for
all refunds in excess of $5.0 million. On June 23, 2015, the
IRS informed us that the Joint Committee on Taxation had completed
its consideration of the IRS’s final examination report and
had taken no exception to the conclusions reached by the IRS. As a
result, the IRS’s audit of our tax returns for fiscal 2007
through fiscal 2010 is now complete.
Massachusetts Appellate Tax Board Matters
GATE
Holdings, Inc. Taxable Years Ended June 30, 2004, 2005 and
2006
We are
involved in several matters relating to the Massachusetts tax
treatment of GATE Holdings, Inc. (GATE), a former subsidiary
of FMD. On November 9, 2011, the Massachusetts Appellate
Tax Board (ATB) issued an order (ATB Order) regarding these
proceedings. On January 28, 2015, the Massachusetts Supreme
Judicial Court (SJC) issued its opinion in these proceedings and
affirmed the decision of the ATB. We were not required to make any
payments to the Massachusetts Department of Revenue for
GATE’s taxable years ended June 30, 2004, 2005 and 2006
at that time as we had made a $5.1 million payment to the
Massachusetts Department of Revenue in the third quarter of fiscal
2012 that satisfied our obligations for those tax years. In
affirming the ATB, the SJC’s opinion interpreted the
controlling statute in a manner that is inconsistent with the
ATB’s interpretation, as well as the interpretations
advocated by both GATE and the Massachusetts Commissioner of
Revenue (Commissioner) in their briefs. We believe the SJC’s
statutory analysis is incorrect. On February 11, 2015, we
filed a petition for rehearing on this matter with the SJC, which
was denied by the SJC on March 2, 2015. On May 31, 2015,
we filed a petition for a writ of certiorari with the Supreme Court
of the United States.
Background
We took the
position in these cases that GATE was properly taxable as a
financial institution and not as a business corporation and was
entitled to apportion its income under applicable provisions of
Massachusetts tax law. The Commissioner took alternative positions:
that GATE was properly taxable as a business corporation, or that
GATE was taxable as a financial institution, but was not entitled
to apportionment or was subject to 100% Massachusetts
apportionment.
In
September 2007, we filed a petition with the ATB seeking a
refund of state taxes paid for our taxable year ended June 30,
2004, all of which taxes had previously been paid as if GATE
were a business corporation. In December 2009, the
Commissioner made additional assessments of taxes, along with
accrued interest, of approximately $11.9 million for GATE’s
taxable years ended June 30, 2004, 2005 and 2006, and
approximately $8.1 million for our taxable years ended
June 30, 2005 and 2006. For the 2005 and 2006 taxable
years, only one of the two assessments made by the Commissioner
would ultimately be allowed. In March 2010, we filed petitions
with the ATB contesting the additional assessments against GATE and
us.
On
November 9, 2011, the ATB issued the ATB Order regarding these
proceedings. The ATB Order reflected the following rulings and
findings:
•
GATE was properly taxable as a financial institution, rather
than a business corporation, for each of the tax years at
issue;
•
GATE was entitled to apportion its income under applicable
provisions of Massachusetts tax law for each of the tax years at
issue;
•
GATE properly calculated one of the two applicable
apportionment factors used to calculate GATE’s financial
institution excise tax;
•
GATE incorrectly calculated the other apportionment factor,
which we refer to as the Property Factor, by excluding all income
from trust-owned education loans outside of Massachusetts rather
than including such income for the purposes of GATE’s
Massachusetts state tax returns; and
•
All penalties assessed to FMD and GATE were abated.
On
April 17, 2013, the ATB issued its opinion confirming the
rulings and findings included in the ATB Order. On July 22,
2013, we filed an appeal of the ATB’s findings with regard to
the Property Factor in the Massachusetts Appeals Court. On
December 18, 2013, the SJC notified us that it had elected to
hear our appeal of the ATB’s findings and heard arguments on
the appeal on October 7, 2014. On January 28, 2015, the
SJC issued its opinion affirming the decision of the
ATB.
GATE’s Taxable Years Ended June 30, 2008 and
2009
On
August 6, 2013, the Massachusetts Department of Revenue
delivered a notice of assessment for our taxable years ended
June 30, 2008 and 2009, which included an assessment for
penalties of $4.1 million. We have not accrued for the penalties as
we believe that it is more likely than not that the penalties will
ultimately be abated, which is consistent with the Massachusetts
Department of Revenue’s treatment of GATE’s taxable
years ended June 30, 2004, 2005 and 2006. On August 26,
2013, we filed an application to have the assessed amounts abated
in full. On March 26, 2014, the Massachusetts Department of
Revenue denied our application. While we have filed an appeal on
this matter with the ATB, it is on hold pending resolution of the
petition for a writ of certiorari we filed with the Supreme Court
of the United States on May 31, 2015 related to GATE’s
taxable years ended June 30, 2004, 2005 and 2006. The
SJC’s opinion in the cases related to GATE’s taxable
years ended June 30, 2004, 2005 and 2006 may influence the
outcome of our appeal for the taxable years ended June 30,
2008 and 2009.
We plan to
vigorously pursue the litigation pending before the ATB in the
cases pertaining to GATE’s taxable years ended June 30,
2008 and 2009. If we are unsuccessful in this litigation, we could
be required to make additional tax payments, including interest,
for GATE’s taxable years ended June 30, 2008 and 2009,
which could materially adversely affect our liquidity position. As
of June 30, 2015, we had accrued a total income tax liability
of $26.6 million, including interest, related to GATE’s tax
returns for the taxable years ended June 30, 2008 and 2009,
which amount was included in income taxes payable on our
consolidated balance sheet. We cannot predict the outcome of this
matter or the timing of such payments, if any, at this
time.
It is
reasonably possible that our liability for this uncertain tax
benefit may change within the next 12 months depending on the
outcome of the litigation pending before the ATB in the cases
pertaining to GATE’s taxable years ended June 30, 2008
and 2009. As of June 30, 2015, the range of potential change
in our liability, excluding an assessment for penalties, was $0 to
$26.6 million.
(b) NC Residuals Owners
Trust Litigation
On
April 2, 2014, FMD filed a complaint in the Delaware Court of
Chancery (Chancery Court) against NC Residuals Owners Trust (NC
Residuals) and The Wilmington Trust Company in its capacity as
owner trustee (the Owner Trustee) of certain of the securitization
trusts that we previously facilitated (the GATE Trusts). The action
is entitled The
First Marblehead Corporation v. NC Residuals Owners Trust, et.
al.
GATE, a
former subsidiary of FMD, was the owner of certain beneficial
interests in the GATE Trusts as well as certain beneficial
interests in certain of the other securitization trusts that we
previously facilitated (the NCSLT Trusts). GATE assigned and
transferred all of its interests in the GATE Trusts to FMD pursuant
to a transfer and assignment agreement. As part of that agreement,
GATE agreed to, among other things, execute and deliver all
documents that might be necessary to transfer, assign and deliver
to and vest in FMD ownership of the GATE Trusts on the records of
the Owner Trustee. After the transfer of its interests in the GATE
Trusts to FMD, GATE’s remaining assets consisted of its
interests in the NCSLT Trusts and it was statutorily converted into
NC Residuals and, immediately thereafter, the Trust Certificate was
sold.
From 2009
until late 2013, FMD received regular cash distributions as the
beneficial owner of the GATE Trusts and has continually reflected
the GATE Trusts on its consolidated balance sheets. As of July
2013, the Owner Trustee had not received documentation required to
transfer ownership on the records of the Owner Trustee of the GATE
Trusts to FMD and the Owner Trustee’s books and records still
reflected that GATE was the beneficial owner of the GATE Trusts.
FMD requested that NC Residuals, as successor to GATE, execute
certain documents necessary to cause FMD to become properly
reflected as the GATE Trusts’ registered owner in the Owner
Trustee’s books and records, in accordance with NC
Residuals’ obligations under the transfer and assignment
agreement. NC Residuals refused to comply with FMD’s request
and claimed ownership of the GATE Trusts and also demanded that FMD
deliver to it trust certificates reflecting ownership of the GATE
Trusts and all cash distributions received on or after
March 31, 2009 related to the GATE Trusts.
FMD and NC
Residuals agreed to submit this matter to non-binding mediation,
and the Chancery Court entered an order at the parties’
request staying the litigation pending completion of the mediation.
On May 21, 2015, FMD and NC Residuals entered into a
settlement agreement. As part of the settlement, FMD paid NC
Residuals $5.0 million and NC Residuals released any and all claims
of ownership of the GATE Trusts, including any and all claims to
the cash distributions from the GATE Trusts, and agreed to
cooperate with FMD to transfer ownership on the records of the
Owner Trustee of the GATE Trusts to FMD, including executing any
documents necessary to cause FMD to become properly reflected as
the GATE Trusts’ registered owner in the Owner
Trustee’s books and records. In addition, as part of the
settlement, cash distributions of $4.2 million from the GATE Trusts
that had previously been withheld, were paid to FMD. On
July 10, 2015, the Chancery Court dismissed this matter with
prejudice.
(c) Operating
Leases
We lease
office space and equipment under non-cancelable operating leases
expiring at various times through March 2017. Rent expense under
operating leases from continuing operations for fiscal 2015, fiscal
2014 and fiscal 2013 was approximately $3.6 million, $4.2 million
and $4.2 million, respectively.
The future
minimum office space lease payments required under operating leases
for each of the succeeding fiscal years subsequent to June 30,
2015 are as follows:
Fiscal
years ending June 30, Lease
obligations
(dollars in thousands)
2016 $ 2,620
2017 1,916
2018 and
thereafter —
Total minimum lease
payments $ 4,536
We are
entitled to receive approximately $605 thousand under
non-cancelable subleases of office space through fiscal
2017.
(d) TMS Guarantee
Payments
TMS is
subject to guarantee arrangements with certain educational
institutions for a portion of eligible monthly education payment
plans. We record a liability for those guarantee arrangements,
which is included in other liabilities on the June 30, 2015
consolidated balance sheet. The liability pertaining to the
guarantee arrangement was approximately $210 thousand at
June 30, 2015. We also record a bad debt expense if it is
probable that a loss will result and the amount of the loss can be
reasonably estimated, which is included as a miscellaneous expense
in general and administrative expenses on the fiscal 2015
consolidated statement of operations. We recorded approximately $85
thousand in bad debt expense related to the guarantee arrangements
for fiscal 2015. Although we believe that our estimate related to
TMS’ guarantee arrangements are reasonable, we cannot make
any assurances with regard to the accuracy of our estimates, and
actual results could differ materially.
(e) Cology LLC
Contingent Liability
Under certain
of Cology LLC’s loan origination agreements, it has agreed to
indemnify those lender clients for certain claims and damages in
connection with its performance under such agreements. As of
June 30, 2015, we recorded a liability of $350 thousand, which
is included in other liabilities on our consolidated balance sheet,
with a corresponding contingent loss included in general and
administrative expenses on our consolidated statement of
operations. Based on the information obtained, combined with
management’s judgment regarding all of the facts and
circumstances of the matter, we determined that a contingent loss
is probable and that the amount of such loss can be estimated,
ranging from approximately $13 thousand to $420 thousand. In
determining the range and amount of the contingent loss, we took
into consideration advice received from our external counsel, who
has extensive experience in the specific matter, as well as other
factors. Should the judgments and estimates made by management be
incorrect, we may need to record additional contingent losses that
could materially adversely impact our results of operations.
Alternatively, if the judgments and estimates made by management
are incorrect and the contingent loss does not occur, the
contingent loss recorded would be reversed thereby favorably
impacting our results of operations. |
