Bills / Cases / IRS

Wine Education Council v. Arizona Rangers; No. 2:29-cv-02235

Wine Education Council, Plaintiff, v.

Arizona Rangers, Defendant.

IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF ARIZONA

ORDER

Pending before the Court are two motions for summary judgment ("MSJs"), one filed by Plaintiff Wine Educations Council ("WEC"), and one filed by Arizona Rangers ("AZR"). The MSJs pertain to AZR's illegality defense to the enforcement of a contract between the parties and both are fully briefed. (See Docs. 244; 245; 246; 252; 253; 254; 255; 257; 258.) WEC requested oral argument, (Doc. 254 at 1), but the Court declines to hold oral argument, finding that it is unnecessary. See LRCiv 7.2(f). The Court has considered the pleadings, evidence, and relevant law, and will now grant WEC's MSJ, (Doc. 244), and deny AZR's MSJ, (Doc. 246), for the reasons explained below.

I. BACKGROUND

The following facts are undisputed. AZR is a non-profit law enforcement auxiliary, which is comprised of a total of 22 companies. (Doc. 245 ¶ 2.) According to AZR's Bylaws, "a 'Company' is '[a]n operating entity of persons (Rangers) chartered by the Corporation to do business.'" (Id. ¶ 3 (alteration original).) In December of 2016, Grant Winthrop became a "probationary" member of AZR, and on March 7, 2017, formally joined the organization as an associate member of the East Valley Company. (Id. ¶ 4.) Between November 30, 2016 and October 3, 2017, AZR accepted six grants (the "Grants") from the American Endowment Foundation ("AEF"), totaling $175,000. (Id. ¶ 10.) All Grant checks were made payable to AZR and were deposited into AZR's Chase bank account, which used AZR's tax identification number. (Id. ¶¶ 31—32.) The IRS recognizes AZR as a tax-exempt entity. (Id. ¶ 34.) The parties agree that the Grants "explicitly required AZR, by accepting the Grants, to certify that the funds were to be used 'exclusively for charitable purposes,'" and not to "confer a personal benefit upon any individual who is not an appropriate beneficiary of [AZR's] charitable programs." (Id. ¶ 36.)

The remainder of the facts are largely disputed by the parties. WEC contends that the evidence shows that AZR authorized Mr. Winthrop to spend the grants in accordance with their terms and conditions. (Id. ¶ 14.) WEC argues that, according to AZR's own internal accounting, "it (and thus, Winthrop), spent the funds in accordance with the Grants' terms and conditions." (Id. ¶ 15.) WEC further argues that, after an internal investigation, AZR itself concluded that "all fund expenditures had been used to the benefit of the Arizona Rangers and in accordance with restrictions imposed by the donor organizations" and that "no evidence was found that would indicate the existence of a misappropriation of Arizona Rangers assets." (Id. ¶ 20.)

Conversely, AZR argues that Mr. Winthrop drafted and submitted each of the six grant recommendations on behalf of AZR that resulted in the issuing of the Grants from AEF to AZR. (Doc. 253 ¶ 8.) It contends that Mr. Winthrop — between July 2017 and October 2017 — charged $70,807.56 to an American Express card which he opened in AZR's name for dozens of inappropriate purchases purportedly on behalf of AZR. (Id. ¶ 4.) AZR scolds Mr. Winthrop for spending large sums of money on a private charter flight from Phoenix to Los Angeles, expensive dinners, expensive cowboy hats, and other large, allegedly inappropriate charges with the Grant funds. (Id. ¶¶ 6—13.) Additionally, AZR contends that an entity called the "East Valley Troop" is not recognized by the bylaws or policies and procedures of AZR. (Id. ¶ 16.)

AZR attempts to bring an illegality defense to WEC's breach of contract claim, arguing that the Grants were illegal because they were subject to taxes under three sections of the Internal Revenue Code ("IRC"): §§ 4966, 4967, 4958.

II. LEGAL STANDARD

Summary judgment is appropriate when "there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). A material fact is any factual issue that might affect the outcome of the case under the governing substantive law. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). A dispute about a fact is "genuine" if the evidence is such that a reasonable jury could return a verdict for the non-moving party. Id. "A party asserting that a fact cannot be or is genuinely disputed must support the assertion by . . . citing to particular parts of materials in the record" or by "showing that materials cited do not establish the absence or presence of a genuine dispute, or that an adverse party cannot produce admissible evidence to support the fact." Fed. R. Civ. P. 56(c)(1)(A), (B). The court need only consider the cited materials, but it may also consider any other materials in the record. Id. 56(c)(3). Summary judgment may also be entered "against a party who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial." Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986).

Initially, the movant bears the burden of demonstrating to the Court the basis for the motion and "identifying those portions of [the record] which it believes demonstrate the absence of a genuine issue of material fact." Id. at 323. If the movant fails to carry its initial burden, the non-movant need not produce anything. Nissan Fire & Marine Ins. Co. v. Fritz Cos., 210 F.3d 1099, 1102—03 (9th Cir. 2000). If the movant meets its initial responsibility, the burden then shifts to the non-movant to establish the existence of a genuine issue of material fact. Id. at 1103. The non-movant need not establish a material issue of fact conclusively in its favor, but it "must do more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). The non-movant's bare assertions, standing alone, are insufficient to create a material issue of fact and defeat a motion for summary judgment. Liberty Lobby, 477 U.S. at 247—48. "If the evidence is merely colorable, or is not significantly probative, summary judgment may be granted." Id. at 249—50 (citations omitted). However, in the summary judgment context, the Court believes the non-movant's evidence, id. at 255, and construes all disputed facts in the light most favorable to the non-moving party, Ellison v. Robertson, 357 F.3d 1072, 1075 (9th Cir. 2004). If "the evidence yields conflicting inferences [regarding material facts], summary judgment is improper, and the action must proceed to trial." O'Connor v. Boeing N. Am., Inc., 311 F.3d 1139, 1150 (9th Cir. 2002).

"[T]he party who asserts the illegality of a contract bears the burden of proof on that point." Rock River Commc'ns, Inc. v. Universal Music Grp., Inc., 745 F.3d 343, 350 (9th Cir. 2014).

III. DISCUSSION

AZR's MSJ argues that it is entitled to an illegality defense to WEC's breach of contract claim because "even if the turnover clause were enforceable, WEC, via its assignment from AEF, is not entitled to enforce any turnover clause because the grants initially made, and subsequently spent, were in violation of IRS Statutes and Regulations." (Doc. 246 at 8.) Moreover, AZR contends that "the East Valley Company (or any "troop"), standing alone, was not qualified to receive a charitable grant from a donor advised fund." (Id.)

WEC's MSJ argues that the Grants at issue are not illegal because the legislature did not intend for the IRC to invalidate private contracts as punishment and assessing a tax is not a punishment for illegal conduct. (Doc. 244 at 7.) WEC also contends that AZR misreads the relevant IRC provisions, and that the provisions do not provide a legal basis for AZR to assert illegality as an affirmative defense. (Id. at 11.) Additionally, WEC argues that the grants are for completely legal purposes, and therefore the contracts cannot be illegal. (Id. at 16.)

A. AZR's Standing

As an initial matter, the Court finds that AZR has standing to bring its illegality defense. AZR is not attempting to raise the affirmative defense on behalf of AEF in raising its illegality defense to WEC's breach of contract claim. WEC fails to properly explain how the defense is owned by AEF or why AZR is without standing to raise it. (See Doc. 244 at 11—12.)

B. Illegality Defense in Arizona

Because WEC's breach of contract claim and AZR's illegality defense are based on Arizona law, the Court must apply Arizona law to determine whether AZR has stated a valid illegality defense. See Mason & Dixon Intermodal, Inc. v. Lapmaster Int'l LLC, 632 F.3d 1056, 1060 (9th Cir. 2011) ("When a district court sits in diversity, or hears state law claims based on supplemental jurisdiction, the court applies state substantive law to the state law claims.").

"In Arizona, parties may enter into contracts as they desire, provided only that the contract is not for an illegal purpose or against public policy." Trap-Zap Env't Sys. Inc. v. FacilitySource Ne. Servs. LLC, No. 1 CA-CV 18-0278, 2019 WL 3798488, at *3 (Ariz. Ct. App. Aug. 13, 2019) (citing Gaertner v. Sommer, 714 P.2d 1316, 1318 (Ariz. Ct. App. 1986)). "Only 'if the acts to be performed under the contract are themselves illegal or contrary to public policy, or if the legislature has clearly demonstrated its intent to prohibit maintenance of a cause of action' should recovery be denied." Id. (quoting Mountain States Bolt, Nut & Screw Co. v. Best-Way Trans., 568 P.2d 430, 431 (Ariz. Ct. App. 1977)). "A contract that cannot be performed without violating applicable law is illegal and void." Id. (citing Ruelas v. Ruelas, 436 P.2d 490, 493 (Ariz. Ct. App. 1968)) (emphasis original).

C. Winthrop's Subsequent Control Over the Grant Funds

AZR first argues that a donor advisor, such as Mr. Winthrop, is prohibited from controlling funds donated from the donor advised fund he advises "because any direct or indirect benefit to the donor advisor from the donor advised fund is an excess benefit transaction subject to sanctions." (Doc. 246 at 8.) Next, AZR argues that "a donor, by law, is prohibited from directing the donated funds to a specific charity and controlling how the money is spent or used." (Id.) AZR also argues that "that donor is also prohibited from directing those same dollars elsewhere if he stops belonging to the organization." (Id.) Additionally, AZR contends that WEC's position on the turnover clause poses a problem under 26 U.S.C. § 4958. (Id. at 9.)

The Court is unpersuaded by AZR's arguments. Examining the agreement, the Court finds that they were not made for an illegal purpose or against public policy. See Trap-Zap, No. 1 CA-CV 18-0278, 2019 WL 3798488, at *3. Instead, the purpose of the grants was to provide a charitable donation to the AZR, specifically to the East Valley Company. The grants provided AZR funds for, among other things body armor, Sunshine Acres (a children's home), badges, Westlaw access, search and rescue equipment, and fundraising expenses. (Doc. 255 ¶ 45; Doc. 109-9 at 4; Doc. 109-16 at 7—8.) AZR, by their own admission, admits that the grants required AZR to certify that the funds were to be used "exclusively for charitable purposes." (See Doc. 245 ¶ 36; Doc. 253 ¶ 36.) Providing charitable grants to a non-profit for such purposes is certainly not an act that is illegal or against public policy.

The Internal Revenue Code provisions cited by AZR do little to change the Court's analysis. Notably, none of the Internal Revenue Code provisions cited by AZR impose a sanction or penalty for the transactions they describe, instead imposing taxes on a charitable donation in certain situations. See generally 26 U.S.C. §§ 4958, 4966, 4945 (imposing taxes). The imposition of taxes on a charitable donation does not, without more, mean that the underlying agreement is for an illegal purpose or against public policy.

The Arizona cases are clear that, in determining whether acts to be performed under a contract are illegal, courts should examine the legislature's intent. Here, Congress did not clearly intend to the prohibit the type of agreements at issue. Instead, they merely subject such transactions to taxes. Furthermore, AZR cites no authority from the Arizona legislature or Congress that declares such an agreement as the one at issue void or implies that such an agreement is illegal or against public policy. Without such authority, the Court cannot conclude that Congress or the Arizona legislature intended to prohibit charitable grants in such situations as those described in the relevant IRC provisions.

WEC argues that AZR does not have factual support for its defense and mischaracterizes evidence in order to attempt to use the defense. (Doc. 254 at 7.) However, the Court need not examine each piece of evidence with a fine-tooth comb in this instance. Even assuming the facts are as AZR contends and Mr. Winthrop brazenly spent grant funds on an expensive charter flight, fancy dinners, and other questionable items, its illegality defense still fails. The purpose of the Grants, when made, were simply not for an illegal purpose or contrary to public policy. The fact that Mr. Winthrop or AEF may have incurred tax liability under the relevant IRC provisions is irrelevant to the purpose for which the grants were made. Clearly the intent of giving the Grants was charitable in nature. Finding absolutely no support in the law for AZR's illegality defense, the Court must reject it.

D. East Valley Company's Eligibility to Receive the Grants

AZR next argues that:

based on Code Section 4966(c) and the Treasury Regulations promulgated thereunder, the East Valley Company (or any "troop"), standing alone, was not qualified to receive a charitable grant from a donor advised fund because it is not recognized as a public charity under Code Sections 501(c)(3) and 170(b)(1)(A) and the sponsoring organization (AEF, here) did not exercise 'expenditure responsibility' with respect to the grant in accordance with Code Section 4945(h), making the grant a taxable expenditure subject to penalties.

(Doc. 246 at 10.)

This argument defies logic and fails for similar reasons that AZR's first argument failed. Notably, contrary to AZR's argument, the IRC provision purportedly violated by the Grant, 26 U.S.C. § 4966, describes the tax it proffers as a just that — a tax — not a penalty or sanction.1 Simply put, even assuming a tax did need to be assessed on the Grant funds, the fact that a tax needs to be paid on a charitable donation does not render the underlying contract as one for an illegal purpose or against public policy. Furthermore, AZR's argument that the East Valley Company is not a public charity is nonsensical. Despite how the Grant letters described the East Valley Company, the East Valley Company is clearly a part of AZR, a non-profit organization. Simply because the Grant letters defined the East Valley Company differently does not render the Grants as being for an illegal purpose or against public policy. Accordingly, AZR's illegality defense fails as a matter of law.2 Accordingly, the Court will deny AZR's MSJ and grant WEC's MSJ.

E. AZR's Attempt at Summary Judgment on WEC's Breach of Contract Claim

WEC argues that AZR makes an improper request for summary judgment on WEC's breach of contract claim. (See Doc. 246 at 2; Doc. 254 at 11; Doc. 257 at 8.) As WEC correctly points out, the Court extended the deadline for the limited purpose of discovery regarding the illegality defense, and dispositive motions were to be filed only on that issue. (See Doc. 254-1 at 6: 18—25.) AZR, in its Reply, argues that because its illegality defense prevails, summary judgment is proper on WEC's breach of contract claim. Because the Court has found that AZR's illegality defense fails and summary judgment on the defense is appropriate in favor of WEC and against AZR, this issue is irrelevant.

IV. CONCLUSION

Accordingly,

IT IS ORDERED granting WEC's MSJ on AZR's illegality defense. (Doc. 244.)

IT IS FURTHER ORDERED denying AZR's MSJ on their illegality defense. (Doc. 246.)

Dated this 18th day of July, 2022.

Honorable Susan M. Brnovich

United States District Judge

FOOTNOTES

1. "There is hereby imposed on each taxable distribution a tax equal to 20 percent of the amount thereof. The tax imposed by this paragraph shall be paid by the sponsoring organization with respect to the donor advised fund." 26 U.S.C. § 4966(a)(1) (emphasis added); see also id. at (a)(2), (c) (describing the imposition of taxes on the fund management and describing a "taxable distribution").

2. Having ruled that AZR's illegality defense fails as a matter of law, the Court finds it unnecessary to address WEC's argument regarding judicial estoppel. (Doc. 244 at 13—15.)