Otto Candies, LLC v. United States (288 F. Supp. 2d 730, 2003)

FINDINGS OF FACT AND CONCLUSIONS OF LAW

AFRICK, District Judge.

In these consolidated cases, plaintiffs, 0.tto Candies, L.L.C., successor to Otto Candies, Inc., jointly referred to as “OCI,” and Candies Towing Company, L.L.C., successor to Candies Towing Company, Inc., and jointly referred to as “CTI,” seek a refund of accumulated earnings taxes, as well as related penalties and interest, that were assessed against them by the Internal Revenue Service pursuant to 26 U.S.C. § 531. The assessments relate to fiscal years ending April 30, 1991, through April 30, 1996, with respect to OCI, and fiscal years ending April 30, 1991, through April 30,1995, with respect to CTI.

On January 13, 2003, a non-jury trial commenced which concluded on January 17, 2003. Upon consideration of the evidence adduced at trial, including the testimony of the witnesses and the admitted exhibits, the briefs and arguments of counsel, and the law, the Court makes the following findings of fact and conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil Procedure.

I.

Plaintiffs, OCI and CTI, are in the marine transportation business, predominantly serving the offshore oil and gas industry in the Gulf of Mexico. OCI owns and operates powered vessels such as offshore supply vessels (“OSVs”) and tugboats (“tugs”), while CTI owns and operates non-powered vessels such as barges. OCI and CTI are limited liability companies organized and existing under the laws of the State of Louisiana. The companies’ principal place of business is in Des Alle-mands, Louisiana.

The parties dispute whether plaintiffs are due a refund of accumulated earnings taxes, associated penalties and interest paid, plus further interest thereon in accordance with the law. As will be discussed in more detail below, the Internal Revenue Code imposes accumulated earnings taxes on corporations deemed to have accumulated earnings and profits for the purpose of avoiding taxes that might otherwise be imposed if the income was distributed to shareholders. 26 I.R.C. §§ 531, 532(a).

Plaintiffs’ position is that accumulated earnings taxes, as well as associated penalties and interest, should not have been assessed against plaintiffs. Plaintiffs argue that to the extent the companies retained funds, they did so for business purposes and not to avoid taxes. Plaintiffs contend that at the end of each year in question, each company had reasonable identified business needs that exceeded the companies’ available assets for that year. According to the plaintiffs, their business needs included (1) replacing the companies’ aging fleet; (2) investing in particular projects associated with the companies’ core business, but not their day-to-day operations; (3) providing for the companies’ working capital needs; and (4) being prepared, should such need arise, to redeem the stock of one of the companies’ three major shareholders.

Procedural History

For purposes of this lawsuit, the “years in question” are fiscal years 1991 through 1996 for OCI and fiscal years 1991 through 1995 for CTI. During the years in question, OCI and CTI were both corporations organized and existing under the laws of the State of Louisiana and they were taxed pursuant to Subchapter C of the Internal Revenue Code. During these years, the companies timely filed their federal income tax returns and paid all taxes reportedly due.

On January 12, 1995, and then again on October 23, 1998, the Internal Revenue Service (“IRS”) issued notices of deficiency, stating that the companies owed additional amounts, including accumulated earnings taxes and related penalties and interest for each of the years in question. OCI and CTI paid the total amount of the assessed taxes and penalties plus interest. Thereafter, the companies submitted timely claims for refunds, seeking the return of the taxes as well as related penalties and interest paid. Following negotiations with the IRS Office of Appeals, all issues raised in the claims for refunds were resolved except the accumulated earnings tax issue. The remaining amounts in dispute are as follows:

OCI

Fiscal Year Tax Penalty Interest Total

1991 $1,407,768 $ 281,554 $ 541,458 $ 2,230,780

1992 1,164,870 232,974 287,303 1,685,147

1993 1,422,827 284,565 208,278 1,915,670

1994 1,359,988 271,998 779,892 2,411,878

1995 1,889,607 377,921 792,905 3,060,433

1996 676,912 135,383 192,073 1,004,368

TOTAL $7,921,972 $1,584,395 $2,801,909 $12,308,276

CTI

Fiscal Year Penalty Interest Total

1991 $ $ 116,297 $ 223,842 $ 921,624

1992 971,621 194,324 240,230 1,406,175

1993 871,738 174,347 127,640 1,173,725

1994 1,569,390 313,878 898,930 2,782,198

1995 1,054,632 210,926 442,528 1,708,086

TOTAL $5,048,866 $1,009,772 $1,933,170 $7,991,808

History of the Companies

OCI and CTI are family-owned and family-operated businesses founded in 1942 by the late Captain Otto Candies when he agreed to transport Humble Oil personnel on a borrowed boat to and from a location on Bayou Des Allemands where Humble Oil intended to drill an oil rig. He was then hired by Humble Oil to keep the canal leading to that location free from vegetation. Having no money, Captain Candies borrowed $500 to buy a boat in order to provide those services. Thereafter, he was hired to provide additional services to Humble Oil (now ExxonMobil) in connection with the rig’s operation. Over a period of time, the marine transportation services offered by Captain Candies expanded and his companies evolved to become one of the leading providers of marine transportation services in the Gulf of Mexico. The companies’ growth is attributed in large part to Captain Candies’ conservative philosophy of investing earnings back into the companies so that he would have funds to expand the companies and the companies would not have to incur debt.

During the years in question, stock in OCI and CTI was held primarily by Captain Candies’ three sons: Otto Candies, Jr., chairman and chief operating officer of OCI and CTI, Paul Candies, president of OCI and CTI, and Kevin Candies, executive vice president of OCI and CTI. Otto Candies, III, the son of Otto Candies, Jr., was the companies’ secretary and treasurer. Otto Jr., Paul, Kevin, and Otto III (collectively, the “Candies family” or “management”) work together in the same small office building and virtually see each other each day. As such, many management decisions are made informally at work, rather than during formal board meetings. During and prior to the years in question, the companies paid no dividends to their shareholders.

Because OCI and CTI provide transportation services to oil and gas companies, primarily in the Gulf of Mexico, the companies’ economic vitality is largely dependent upon that industry. As the price of oil and gas rises and falls and exploration and production activities in the Gulf of Mexico correspondingly increase and decrease the demand for marine transportation services dramatically fluctuates. In particular, the “day rate,” which is the customary unit of pricing for vessel services, swings widely up and down depending upon market conditions. These swings can occur over very short periods of time and they can be unpredictable. In sum, the companies operate in a highly volatile business environment.

Nevertheless, OCI and CTI, despite the volatility of the oil and gas industry, have succeeded. Unlike many of their competitors, the companies funded their operations internally whenever possible, a strategy that, as previously stated, had its origin in the conservative business philosophy of the late Captain Otto Candies. As a result, the companies, in part because they were debt free, have been able to successfully weather rough periods in the oil and gas industry.

OCI and CTI have always had a good reputation in their industry. As Captain Robert J. Underhill, defendant’s expert in the Gulf of Mexico marine industry, himself acknowledged, “[T]hey were very frugal, a well-run company, closely held, nothing but good.... They understood and knew the business ... in my estimation, better than anyone.” Likewise, Sid Mizell, senior vice president of sales and marketing for Halter Marine, Inc., a local shipyard, testified:

The Candies have always been an organization that has over the years in my opinion ran their business very — I’m not sure if ‘frugal’ is a proper term, but they pay attention .to their business, they don’t get flamboyant with their lifestyles. They obviously reinvest in their fleet renewal programs, and as their equipment gets older, they continue to replace the older equipment with new equipment. And in my opinion, they have been one of the more successful operators.

The years in question followed the roughest downturn in the history of the oil and gas industry. After an oil price peak in 1981, the oil and gas industry suffered a severe recession that lasted at least until 1988. During that recession, many of OCI’s and CTI’s competitors went bankrupt and/or were forced out of business. OCI and CTI also suffered steep declines in revenue during that time, but their conservative approach of reinvesting earnings into the companies and avoiding debt by self-funding most operations enabled them to survive. As defendant’s expert, Captain Underhill stated, “[m]any companies went out of business, lost their shirts, but not the Candies. They were in pretty good shape. They were always' — the old Candies, there was just — he wasn’t a guy to spend money foolishly. They just didn’t do it.”

In 1991 and the years that followed, the companies’ management was acutely aware of the recession of the 1980s, and management proceeded with an extra measure of caution despite some increase in oil prices from 1988 to 1991. As Kevin Candies testified, “we were very, very cautious, wanting to move forward, but cautiously.... We had just experienced the depression of the ’80s like none of us had ever seen before and it was a very scary thing....” Throughout the difficult years in question, the companies and their peers were hopeful that the industry would rebound at any moment. As such, the Candies wanted to remain in a position of financial strength so that when the market did rebound, the companies had the resources to expand and become more competitive. However, in the early 1990s, oil prices declined again, further emphasizing the need for prudence.

Fleet Replacement

The companies’ business centers around their respective fleets. During the years on question, the companies’ fleet was growing old. After years of little capital investment during the industry wide depression of the 1980s, many of the companies’ vessels were beyond their optimum life expectancies. In 1991, OCI’s fleet included the following vessels:

16 OSVs: 1 vessel 23 years old

4 vessels 19 years old

1 vessel 17 years old

1 vessel 16 years old

1 vessel 13 years old

5 vessels 12 years old

3 vessels 8 years old

10 tugs: 6 vessels 10 years old

1 vessel 9 years old

1 vessel 6 years old

1 vessel 5 years old

1 vessel new

During times of expansion, OCI’s practice was to replace its OSVs and tugs approximately every 12 years. Even when the market did not support a 12 year replacement cycle, OSVs and tugs were generally not expected to be used for more than 15 years or, at the very latest, 20 years. In the early 1990s, the average age of OSVs and tugs retired from the marine transportation service industry was 15 years. As the above chart demonstrates, as of 1991 almost all of OCI’s OSVs were nearly due or past due for replacement and some of the tugs were approaching the same status.

With respect to CTI, its fleet in 1991 including the following vessels:

25 barges: 3 vessels 21 years old

6 vessels 18 years old

2 vessels 15 years old

1 vessel 14 years old

2 vessels 12 years old

2 vessels 11 years old

7 vessels 10 years old

2 vessels 9 years old

The life expectancy of barges is approximately 20 years. Therefore, approximately one third of CTI’s barges were nearly due or past due for replacement in 1991.

In addition to the growing age of its fleet, management was keenly aware that changes in technology and customer demands dictated a need for new vessels. As oil exploration moved further offshore into the Gulf, new OSVs and tugs with deep water capability were required. Regardless of their condition, the older vessels in OCI’s fleet could not meet these requirements.

Plaintiffs’ fleet replacement need was undisputed at trial. In fact, even defendant’s own expert in the marine industry, Captain Underhill, emphatically agreed that the Candies needed to modernize their fleet in order to stay in business.

Given the aged and outdated state of the existing fleet, it was management’s intent to make substantial new vessel expenditures as soon as the market provided a reasonable return on its investment. Each year, management expected and hoped that the following year would bring conditions ripe for fleet replacement. After the downturn of the 1980s, the companies’ management was reluctant to make major vessel expenditures until it seemed clear that the prevailing day rates would justify the investment, particularly since new vessel technologies made boat building more expensive. Management’s reluctance was shared by many of the companies’ competitors. In fact, during the years in question, new vessel construction decreased significantly with respect to offshore operations conducting business in the Gulf of Mexico.

According to the testimony of Candies family members, the companies’ management discussed fleet replacement needs regularly during the years in question, both formally at board meetings reflected in several of the companies’ minutes and informally during day-to-day interactions with each other. OCI intended to build 12 OSVs, ranging in size from 180 feet to 220 feet at a cost of between $3,500,000 and $5,000,000 each, and 6 tugs, approximately 9,000 horsepower each at a cost of approximately $3,000,000 each. CTI intended to replace at least twelve of its barges at a cost of approximately $3,000,000 each. The details concerning OCI’s plans were recorded in interview notes written by IRS Agent Cyrus Fanguy in December, 1992, during the very beginning of his audit, when he met with Paul Candies and discussed OCI’s fleet replacement plans.

The companies also discussed their fleet replacement needs with management personnel at a number of shipyards during the years in question. In particular, Otto Candies, Jr. spoke regularly, as often as two or three times per month, with representatives of Bender Shipyards and Halter Marine. During his conversations with shipyard representatives, Otto Candies, Jr. would discuss details of new vessel construction such as the type of equipment the vessels would require, pricing, horsepower, etc. These conversations were not idle chatter. As Frank Terrell, vice president of sales for Bender Shipyard, testified:

Otto Candies told me that he would buy some boats, that I just needed to stick with them, that they were serious, and that when the time was right they would be a buyer. They had a fleet to replace and they were going to replace it. I took that to be a very serious statement, so that’s what we did. We stuck there and kept talking, and eventually conditions changed to where it made it worth their while to build new vessels.

Similarly, Halter Marine, Inc.’s Sid Mi-zell testified:

The Candies, like I said, they have always said that they are in the business to stay and to keep their fleet so that they’re competitive.... [A] lot of people ... go out and shop and kick the tires, but when they came to us with a project, I always took them seriously, that it — at least if we didn’t get the job, someone would.

Plaintiffs expert witness, Dr. Colin Blaydon, provided his expert opinion as to the amount of financial resources he would have recommended that plaintiffs have available to meet fleet replacement needs during the years in question. Dr. Blaydon is Dean Emeritus of the Amos Tuck School of Business at Dartmouth College and a director of the economics and finance consulting firm of LECG. His involvement with LECG primarily has been in the fields of quantitative analysis, financial economics, and corporate governance. He has served on the board of directors of 26 corporations, including nine closely held companies and four family-owned companies. He is recognized as an expert in finance, managerial economics and, in particular, the assessment of the strategic options available to a company, the impact of alternative strategies for retention of resources upon a company’s long-term prospects for survival, and the analysis of the reasonable needs of a company for financial resources.

Dr. Blaydon had numerous meetings with plaintiffs’ management and investigated the details of their fleet replacement plans. Analyzing such information, including data about the age of vessels in plaintiffs’ fleet and anticipated costs of vessel replacement, Dr. Blaydon concluded that he would have advised OCI and CTI to retain the following amounts for fleet replacement at the end of each of the years in question:

1991 1992 1993 1994 1995 1996

OCI $39,800,000 42,900,000 48,400,000 49,000,000 57,400,000 37,200,000

CTI $11,900,000 12,200,000 12,600,000 15,100,000 16,500,000

These figures represent amounts needed merely to maintain, not expand, the existing fleet capacity. The year-by-year totals are less than the fleet replacement costs the companies’ management actually planned ($60,000,000 to $78,000,000 for OCI and $36,000,000 for CTI). These totals are also considerably less than the $100,000,000 that defendant’s expert, Captain Underhill, testified would have been required for plaintiffs to replace their aging fleet. It is plaintiffs’ position that the amounts quantified by Dr. Blaydon are the minimum amounts the companies should have retained during the years in question for fleet replacement.

OCI ultimately did make major fleet replacement expenditures. From 1991 through 2001, OCI spent or committed to spend a total of $173,697,000 on new vessels, including 14 OSVs and 7 tugs. After subtracting approximately $84,559,000 from the sale of old vessels and approximately $40,000,000 in financing commitments, OCI has made or has committed to make a net outlay of approximately $50,000,000 of its own resources on fleet replacement.

CTI has only just begun construction because its business remains depressed. In 2002, CTI committed to purchase a $15,000,000 barge. Management still intends for CTI to engage in major fleet replacement as soon as market conditions so warrant.

Defendant offered no direct evidence disputing OCT’s and CTI’s fleet replacement plans or activity. To the contrary, as stated above, defendant’s own expert, Captain Underhill, agreed that the companies needed to retain approximately $100,000,000 to replace their fleet. His only contention was that the companies should have invested in fleet replacement earlier in the 1990s. Notwithstanding that assertion, however, Captain Underhill readily admitted that reasonable business minds could differ as to the appropriate time for fleet replacement. Specifically, Captain Underhill testified:

THE COURT: Captain, in all your experience that you’ve had and notwithstanding the regard which you have, from your testimony, for some of the things that the Candies do and their reputation in the industry, is it reasonable for me to assume that knowledgeable persons in the field such as yourself, such as the Candies, could have different business judgments as far as when it was necessary to replace a fleet?

THE WITNESS: Why, certainly. Certainly.

Project Needs

The companies are frequently presented with opportunities to engage in various projects that are related to their business, but that are outside of their day-to-day operations of vessel chartering and brokering. These projects include opportunities to bid on large jobs and submit proposals to purchase, refit, or construct vessels for unique undertakings. The projects also include opportunities to finance the operations of the companies’ customers and suppliers. Certain of the projects provide the companies with a means of diversifying their business outside the gas and oil industry in order to ensure economic survival.

During the years in question, the companies were presented with numerous opportunities to engage in a variety of such projects. The flow of projects was continuous. Some projects required extensive consideration and development before coming to conclusion, while others were addressed more quickly. The projects took a variety of forms.

At trial, plaintiffs identified a number of projects for which they anticipated business needs during the years in question. The projects relied upon by plaintiffs were all viable and outstanding as of the end of one or more of the years in question and, according to plaintiffs, gave rise to a reasonably anticipated business need susceptible of quantification.

Plaintiffs’ counsel retained Michael C. Odom, a certified public accountant formerly employed by Arthur Andersen LLP, to provide his expert opinion regarding the various projects considered by OCI and CTI during the taxable years at issue. Mr. Odom has served as the “engagement partner” for numerous publicly and privately held oil and gas and oilfield services companies and he has over 30 years of experience in conducting audits and due diligence investigations for clients and lenders engaged in the oil and gas industry. Mr. Odom was asked to testify regarding management’s level of consideration of identified projects and to determine the amount of funds that would have been required to develop those projects, outstanding as of the end of any of the years in question, to which management gave serious and extensive consideration. Mr. Odom reviewed extensive documentary files regarding the projects and met several times with the companies’ management to discuss the projects.

In conducting his analysis, Mr. Odom reviewed approximately one- hundred potential projects and considered (1) the amount of time and resources committed by management for development of the project; (2) whether documents and other available information indicated that management gave the project serious consideration; (3) management’s own indications of the consideration given to the pursuit and development of the project; (4) the degree to which project specifications and management’s responsibilities with respect to the project were established; and (5) the commitment of the companies’ funds for the development of the project. Based on such criteria, Mr. Odom concluded that seventeen of the approximately one hundred identified projects were the subject of serious and extensive consideration by the companies’ management and were under consideration as of the end of a' taxable year. Mr. Odom’s opinion was corroborated by the testimony of the companies’ management and third-party witnesses. It is only these projects, as set forth below, and their associated quantified needs, upon which plaintiffs rely in asserting the companies’ reasonable business needs.

Marine Spill Response Corporation

After the Exxon Valdez oil spill, Congress directed U.S. oil companies to adopt oil spill cleanup procedures to minimize the effects of future oil spills from oil tankers. The oil industry’s response was to create the Marine Spill Response Corporation- (“MSRC”), a private company funded by the oh industry. In late 1990 and early 1991, the MRSC sought bids for the construction and charter of up to sixteen vessels to respond to marine spills. On April 29, 1991, OCI submitted a four-volume bid to MSRC. Pursuant to that bid, OCI proposed to supply nine newly constructed oil spill response vessels for charter to the MSRC. The vessels would be designed and constructed by Halter Marine at a cost of $11,600,000 to $12,100,000 each, for a total of approximately $105,000,000. The bid provided that OCI and CTI would finance the vessels, build the vessels, and be repaid through charter hire.

In connection with this project, the companies solicited and received blueprints and other design drawings relating to vessel construction which would be submitted as part of their bid to the MSEC. The companies performed considerable research with respect to this project. According to Admiral John D. Costello, president of the MRSC, the MRSC considered the companies’ proposal to be a serious bid and he believed that the companies had the financial resources to support their proposal.

OCI’s bid remained outstanding at the end of the companies’ 1991 fiscal year. However, in the summer of 1991, MSRC rejected OCI’s bid, opting instead to have the vessels built at its own cost.

Freeport New Discovery Sulphur

The companies had a long-standing relationship with Freeport McMoRan (“Free-port”), a firm engaged in sulphur mining and other natural resources production. In March, 1991, Freeport contacted the Candies regarding ,the movement of sul-phur from Port Sulphur, Louisiana, to Tampa, Florida. By letter dated April 5, 1991, OCI presented Freeport three proposed options for moving sulphur from the designated locations: (1) converting the Louisiana Brimstone, a vessel owned by Freeport, at an estimated cost of $31,000,000; (2) building a large tug-barge unit at an estimated cost of $30,250,000; and (3) building two smaller tug-barge units at a cost of $41,000,000. One of Freeport’s objectives with respect to this project was to have the vessel operator, rather than Freeport, invest the capital necessary to convert the Louisiana Brimstone or build the new vessels required to move the sulphur.

The testimony of the witnesses, together with the corporate minutes of OCI and CTI, indicate that management committed significant time and resources to work with Freeport in developing the vessel specifications and related cost estimates, in coordinating vessel design specifications with engineers, and in confirming vessel delivery dates with the vessel contractor. As of the fiscal year ending April 30, 1991, management anticipated investing at least $30,250,000 in this project. This amount represents the least expensive of the options set forth in the April 5, 1991, proposal to Freeport.

Given the large nature of this venture, the companies expected to co-venture this project, allocating to CTI the non-powered vessel costs which were not to exceed the amount of CTI’s available assets. The remaining costs will be allocated to OCI. As of April 30,1991, CTI had approximately $15,400,000 of available assets and, therefore, it would not have had the necessary available assets to make the full $20,250,000 barge investment contemplated. OCI had approximately $41,100,000 of available assets as of the 1991 fiscal year end. Accordingly, the anticipated investment for this project allocated $15,400,000 to CTI and the remainder, i.e., $14,850,000, to OCI.

Foster Duncan, senior vice-president for Freeporh-McMoRan Business Enterprises, testified by deposition that Freeport viewed its discussions with the companies as serious and that he believed the companies were seriously interested in the project and had the funds necessary to invest in same. Ultimately, however, Freeport awarded the project to one of the companies’ competitors.

Hallr-Houston

During the years in question, Hall-Houston was an independent oil and gas exploration and development company that operated in the Gulf of Mexico. In late 1990, OCI began soliciting Hall-Houston for marine transportation work. At or around that same time, Hall-Houston was experiencing cash flow difficulties and it proposed that OCI purchase Hall-Houston preferred stock in exchange for its business. On or about January, 1991, Gary Hall, chairman and CEO of Hall-Houston, met with Paul Candies to discuss the purchase of the stock. By April 30, 1991, OCI had made a commitment to make a $5,000,000 investment in Hall-Houston in return for Hall-Houston agreeing to make OCI its sole provider of marine transportation services. Consistent with that agreement, on August 5, 1991, OCI purchased 50,000 shares of Hall-Houston preferred stock for $5,000,000.

In early 1995, Hall-Houston contacted management regarding a proposed issuance of Hall-Houston subordinated notes. By April 30, 1995, OCI had again committed to invest an additional $4,000,000 in Hall-Houston subordinated notes. Consistent with that commitment, OCI subscribed on May 11, 1995 and on May 24, 1995, respectively, to make two separate purchases of two $2,000,000 Hall-Houston subordinated notes.

Finally, in April 1996, OCI committed to provide $4,950,000 in financing to Hall-Houston. As of April 30, 1996, OCI had advanced $1,093,703 of that amount.

Paul Candies testified that OCI made these investments in Hall-Houston based upon management’s judgment that it was important to make the investments to maintain OCI’s business relationship with Hall-Houston. Mr. Candies’ testimony was corroborated by that of Gary Hall, chairman and CEO of Hall-Houston, who acknowledged that if OCI had not made the investments, OCI would have lost some of the Hall-Houston marine transportation business to a competitor who was prepared to make an investment in Hall-Houston. Each of the 1991, 1995, and 1996 financ-ings provided Hall-Houston with the funds needed to engage in new activity that ultimately generated more business for the companies.

The companies’ gross receipts from sales to Hall-Houston for the 1990 to 1997 fiscal years were as follows:

1990 $ 37,859

1991 0

1992 2,542,872

1993 4,490,543

1994 1,474,666

1995 2,081,793

1996 2,023,225

1997 2,084,981

OCI and CTI continue to provide marine transportation services to Hall-Houston’ successor, Energy Partners Ltd.

Tug for Gardinier Sulphur Barge

Gardinier was a subsidiary of Cargill, Inc. In November, 1990, Gardinier/Cargill hired OCI to tow a sulphur barge from Tampa, Florida to Mexico. Initially, OCI towed the sulphur barge with an existing tug which had to be modified to be compatible with the barge. In January, 1991, OCI’s board of directors began discussing the possibility of building a new tug specifically dedicated to this charter. The board estimated that the new tug would cost between, $4,500,000 to $5,500,OOO. On February 6, 1991, OCI and Cargill amended their November 29, 1990, contract and agreed that OCI would build a new tug to tow the sulphur barge. At a March 28, 1991, OCI board of directors meeting, Otto Candies, Jr. announced that OCI had contracted with Halter Marine, Inc. for the construction of a new tug. The board estimated that the tug would cost approximately $3,000,000 and that the new tug’s linkage system, engines and deck machinery would cost an additional $1,000,000 to $2,000,000 over the contract price with Halter Marine, at a total projected cost of approximately $5,000,000.

In fiscal year 1993, Halter Marine delivered the new tug, the Kelly Candies. The capitalized cost of the vessel was $3,600,000. The difference between that amount and the originally projected $5,000,000 cost was due to the fact that used equipment, rather than new equipment, was utilized. However, according to the testimony of Otto Candies, Jr., as of April 30, 1991, neither management nor Halter Marine expected the use of used equipment. Therefore, as of the end of fiscal year 1991, management reasonably estimated that the projected expense for the construction of the Kelly Candies tug body, engines, linkage system and deck machinery would be approximately $5,000,000.

Offshore Pipelines, International Tugs

In April, 1991, OCI was considering purchasing two tugs from Offshore Pipelines, International (“OPI”) which had been previously owned by OCI. The minutes of the April 19,1991, board of directors meeting indicate that OCI was willing to trade services and forgive accounts receivable in exchange for the tugs. Paul Candies explained that by selling the two vessels, OPI “wanted to free up capital to do other things and have someone else do their marine transportation work.” OCI management concluded that pm-chasing the vessels would provide OCI with a valuable opportunity to work with OPI in West Africa. Accordingly, as of the end of the 1991 fiscal year, management anticipated purchasing the vessels for up to $1,500,000 each.

On October 5, 1991, OPI sent OCI a draft purchase agreement for the two tugs stating a total purchase price of $3,800,000. OPI’s offer was more than OCI was willing to pay for the tugs and, consequently, OCI decided against purchasing the vessels. Another buyer ultimately purchased them for $3,800,000.

Freeport Sulphur Tankers

In April 1992, Sonny Launey of Free-port contacted Otto Candies, Jr. to inquire about the companies’ interest in a ten-year contract to move sulphur from a new discovery site to Port Sulphur, Louisiana. The companies’ minutes from their April 20, 1992, board of directors meetings, as well as management’s notes regarding the project, indicate that it was estimated that this venture would require a $10,000,000 investment. In order to satisfy its obligations under the contract, management planned to use existing tugs and build two new barges. The Candies met with representatives of Freeport on numerous occasions to discuss the details of the project. According to the testimony of both the Candies and Foster Duncan, senior vice-president of Freeport, Freeport viewed its discussions with the companies as serious and told the companies that they were a strong candidate for the project. As of April 80, 1992, management was committed to going forward with the project if the companies were awarded the project. However, ultimately, Freeport decided not to pursue the project with OCI, opting instead to build two of its own barges for this project.

Lykes Brothers Steamship Company Joint Venture

In early 1990, Lykes Brothers Steamship Company (“Lykes Brothers”), a company that owned and operated cargo ships, was considering converting some of its cargo ships into barges in order to render them more profitable. Beginning in early October, 1991, Lykes Brothers began discussions with OCI about a joint venture under which OCI would provide new or converted tugs to transport these barges. The joint venture that was envisioned by OCI management, after considerable research on the available options, involved the construction of tugboats using integrated tug-barge systems with special linkage rather than conventional towing systems. The cost of these vessels was estimated to be approximately $5,000,000 each.

By the end of fiscal year 1992, OCI’s management expected that at least two vessels would be constructed and that a minimum investment of $10,000,000 was anticipated. Through its discussions with Lykes, management further believed, as of the end of fiscal year 1992, that OCI had a good chance of doing the project with Lykes. Ultimately, however, Lykes did convert two of its vessels into barges but the joint venture between OCI and Lykes was not established.

American Gulf Shipping

Beginning in the late 1980s, the companies began pursuing a business relationship with American Gulf Shipping, Inc. (“AGS”). AGS owned and operated several vessels that transported grain, commodities, and other bulk cargo. The companies were interested in a relationship with AGS because they wanted to expand their bulk cargo transportation business in order to mitigate their dependence on the oil and gas industry. Management was aware that AGS was approximately $5,000,000 in debt to other creditors. Therefore, in an effort to build a lasting business relationship with AGS, OCI’s management agreed that AGS would not pay for towing services performed by OCI and that AGS would accrue a significant accounts payable balance to OCI. As Paul Candies explained, “This way, they could take the revenues they were generating from the work we were doing at that time and pay off [their] debt.”

As of April 30, 1992, management was committed to providing AGS with accounts receivable funding up to $5,000,000 for the next fiscal year, while AGS used its revenues to pay off other pre-existing debts. In March 1993, OCI had accrued receivables from AGS of over $5,000,000. OCI transferred that balance to CTI. On March 26, 1993, AGS issued a promissory note to CTI for $5,698,292 which was secured by first mortgages on six AGS vessels.

The relationship between the companies and AGS continued through the 1993 tax year and OCI’s business with AGS increased. Because the companies and AGS were involved in a continuing and growing business and because management believed that the grain business had tremendous potential, OCI again committed as of April 30, 1993, to extend accounts receivable financing for an additional $5,000,000 during the 1994 tax year. As of April 30, 1994, OCI’s AGS receivable balance was $5,087,121. CTI’s note receivable balance was $4,736,246. Eventually, OCI, CTI and AGS entered into a series of transactions which resulted in OCI foreclosing on AGS’s vessels in order to receive payment on the companies’ outstanding accounts receivable balances.

CSX

This was a joint project for CTI and OCI. In the early 1990s, the rail transport company, CSX, in order to eliminate various inefficiencies associated with the land route alternatives, considered transporting rail cars via the Gulf of Mexico, from Mobile and/or New Orleans to a port in Vera Cruz, Mexico. The rail cars would be transferred using a combination of tugs and barges or self-contained vessels. Under either scenario, the barges or vessels would be specially designed to transport rail cars. CSX, via its consultants, Leo Richardson, Sr., and his son, Leo Richardson, II, contacted the Candies about possible participation in this project. CSX initially wanted OCI and CTI to provide towing or other operating services for the barges or vessels, but OCI and CTI proposed participation in the project on an equity investment basis in that they would build, own, and operate all of the vessels involved. CSX became interested in the companies’ proposal.

The minutes from the OCI and CTI board of directors meetings, as well as the various correspondence exchanged between the parties, show that negotiations between management and CSX began around October, 1992, and lasted through February, 1995. Proposals for the transportation of the rail cars ranged from the construction and chartering of one tug-barge vessel to the construction and chartering of as many as four or five tug-barge vessels.

In connection with this project, the companies invested significant time and money in researching all aspects of the construction of the vessels, including obtaining specifications and design drawings, meeting with representatives of CSX both in the United States and Mexico, and contacting financial institutions to discuss the possibility of borrowing funds in excess of the companies available assets. CSX took the companies’ proposal to finance, build, and operate the vessels seriously and considered OCI and CTI to be good candidates for the project. As Andrew J. West-hoff, finance director of CSX assigned to the CSX project during the relevant time period, testified:

It truly was a very interesting project but throughout it all the Candies proposals were, in fact still some of the best proposals that we had available. The capacity, their speed seemed to be just what we were looking for.

* * * * * *

[M]y personal conclusion was that they were definitely a viable candidate, yes. They had the expertise we were looking for. They could stand behind these letters they were sending to us. They seemed to be a very reputable company.

As of fiscal years ending April 30, 1993, and April 30, 1994, management expected the full project to involve five tug-barge units or other rail carrier units, each costing approximately $20,000,000. Therefore, as of April 30, 1993, and April 30, 1994, management anticipated a total investment of $100,000,000 and it was fully committed to using as much of the companies’ available assets as reasonably possible to make that investment.

According to management, funding for the tug vessels would have been provided by OCI, while funding for the barges would have been provided by CTI. However, since such a project contemplated a very large capital investment, the companies would have exhausted the bulk of their jointly available resources and they would have then had to borrow funds. The anticipated investments for this project were, therefore, allocated proportionately between OCI and CTI based upon the relative available assets of each company during the relevant years. The companies anticipated that they would have to borrow over and above the companies’ available assets.

The CSX rail-barge project was never completed. CSX abandoned its consideration of the project in February, 1995, because of the devaluation of the Mexican peso.

Seamar Join Venture

In late 1992, OCI considered a possible joint venture with Seamar, a competitor of OCI, for the possible acquisition of Sea-mar’s fleet of vessels. The minutes of an OCI’s board of directors meeting held on November 24, 1992, show that in order for the joint venture or acquisition to proceed, the board estimated that OCI would have to invest $9,800,000 to pay off Seamar’s outstanding debt. The evidence presented at trial showed that the project was considered from at least November, 1992 through July, 1993. During that time, OCI loaned Seamar a total of $2,250,000 secured by first mortgages on Seamar vessels. According to Paul Candies, these loans were unrelated to the $9,800,000 investment, but they were made in an effort to further OCI’s joint venture/acquisition opportunity with Seamar. As of April 30, 1992, OCI’s management was still pursuing the $9,800,000 joint venture/acquisition opportunity and this continued for several months thereafter. Ultimately, the parties were unable to come to terms and Seamar was purchased by another company.

Exxon Land Purchase

This project related to OCI’s purchase of 19,000 acres of land located in La-fourche Parish, Louisiana, from Exxon, the companies’ first customer. Exxon was still a major client and OCI’s management believed that the purchase of the property would further its business relationship with Exxon. As Paul Candies stated, although management did not believe that Exxon would cease doing business with the companies if OCI did not purchase the land, the transaction was nevertheless viewed as an opportunity to “continue to negotiate with Exxon to further enhance our relationship.... [I]t just gave us a better opportunity to work with people that we were already good vendors with.”

The testimony of the witnesses, along with the minutes of OCI’s board of directors meetings and correspondence between OCI and Exxon, evidence that negotiations between the companies spanned the course of two years beginning in November, 1992, when OCI commissioned an independent appraiser to appraise the land. On January 15, 1993, OCI submitted a bid for $1,700,000. OCI’s board of directors was aware that Exxon had appraised the land for $2,400,000 and, at its April 12, 1993 meeting, the board authorized up to $2,400,000 for the purchase of the land. In May, 1994, OCI made an offer to Exxon of $2,300,000. The offer was ultimately accepted and the transaction was consummated in December, 1994. Based on the evidence, the Court finds that as of April 30, 1993, and April 30, 1994, management was committed to spending as much as $2,400,000 to purchase the Exxon land.

KAP Resources Investment

KAP Resources, Ltd. (“KAP Resources”) was a Canadian company developing a Chilean copper mine. On April 28, 1994, OCI entered into a private placement subscription agreement to purchase 1,100,-261 common shares and 833,531 common shares purchase warrants of KAP Resources for $994,666. It was management’s hope and belief that the relationship arising from this investment could lead KAP Resources to charter OCI vessels to transport copper from Chile to the United States. As Paul Candies testified:

Mr. Plant came to us and said he understood that KAP Resources was going to open a Chilean copper mine, was looking for some investment to facilitate that mine, thought that we could — if we became one of the investors in KAP Resources or one of the bigger investors in KAP Resources, we could expand our ocean freight business to transport the copper from either Chile to Canada where they had a processing facility or Chile to the United States where the copper would be processed.

On May 6, 1994, OCI purchased the KAP Resources shares and warrants as outlined in the April 28, 1994, subscription agreement.

Candies-Mott International

On August 10, 1995, OCI and Allen Mott established Candies-Mott International, L.L.C. (“Candies Mott”), of which 60 percent was owned by Mott and 40 percent was owned by OCI. Candies-Mott was established to engage in the vessel brokerage business in Paraguay and, potentially, in other countries. The operating agreement dated October 10, 1995, required OCI to make monthly loans of $30,000 to Candies-Mott for the first twelve months of its operation. According to the terms of the operating agreement, Candies-Mott was to issue a promissory note for each advance and repay the notes with interest at the end of the calendar year. For each subsequent year of Candies-Mott’s existence, OCI was to finance Candies-Mott based upon Candies-Mott’s expenses for the preceding year.

From August, 1995, to April, 1996, OCI loaned Candies-Mott a total of $270,000 pursuant to the August 10, 1995, operating agreement. Candies-Mott later repaid this amount to OCI. As of April 30, 1996, OCI management expected to fund Candies-Mott for at least another year at the rate of $30,000 per month for a total of $360,000. Otto Candies, III, testified:

At that point in time they had several good projects working. We thought the company was going to continue on at least for another year minimum at that point in time, so we managed to fund it — at least the $30,000 a month — for another year at that point in time.

In fact, after April 30, 1996, OCI funded Candies-Mott for eighteen more months at $30,000 per month. Candies-Mott, however, did not repay any of these additional amounts and, therefore, OCI made no further advances to Candies-Mott.

Paraguay LPG Transportation

This was a joint project for OCI and CTI. In 1995, the companies pursued an opportunity, through Allen Mott of Candies-Mott, to construct, prepare, and operate a towboat and two barges to transport liquefied petroleum gas (“LPG”) in Paraguay for Petropar, the government-owned oil company of Paraguay. The project was intended to move LPG from the coast upriver to consumers as Paraguay had no pipeline distribution system.

Project development and discussions between the companies began as early as early as March 10, 1995. In April, 1995, representatives of OCI and CTI traveled to Paraguay and met with Paraguayan cabinet-level officials with whom they discussed this project. They also met with the President of Paraguay. On April 21, 1995, Allen Mott sent a letter to a Paraguayan governmental official on behalf of Otto Candies, Jr. and Otto Candies, III, discussing the details of the project. The April 27, 1995, minutes of the OCI board of directors indicate that the company was pursuing a project for “an LPG barge for Paraguay and additional towboats/barges to work in the Paraguay and Parana river systems.”

On May 3, 1995, Men Mott sent the companies a worksheet setting forth rate calculations and a $10,145,000 capital budget for this project, consisting of $4,000,000 for each of the two new barges, $1,500,000 for one towboat, and $645,000 in transportation costs. According to management, the companies expected to co-venture this project. The $10,145,000 capital budget referred to in the May 3, 1995, worksheet was to be allocated between OCI and CTI so that OCI paid for the towboat ($1,500,000) and half of the transportation expenses ($322,500) and CTI paid for the remainder.

Otto Candies, Jr. testified that the figures in the May 3, 1995, worksheet were consistent with the figures that management estimated as of April 30, 1995, just three days earlier. As Otto Candies, Jr. stated:

Q. Mr. Candies, that stipulation of the parties indicates that on May 3, 1995, Mr. Men Mott sent the companies a worksheet setting forth rate calculations and a $10,145,000 capital budget for this project. Is that consistent with your recollection?

A. It is.

Q. Specifically, the stipulation says the capital budget consists of $4 million for each of two barges, $1.5 million for one towboat, and $645,000 in transportation costs. Is that, sir, consistent with your recollection?

A. It is.

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Q. Can you tell the Court, to the best of your recollection whether those were the numbers the company had in mind as of April 30, some three days earlier?

A. Yes, it is.

Q. Is it consistent with your recollection that those are the numbers that you then had in mind for the Paraguay LPG Transportation Project?

Q. It is.

Otto Candies, Jr.’s testimony was corroborated by that of his son, Otto Candies, III, who similarly testified that as of April 30, 1995, the companies planned to make the $10,145,000 equipment investments detailed on the May 3, 1995, worksheet. To this end, the companies solicited and received blueprints and other design drawings relating to construction of the proposed vessels and the companies spent significant time and effort developing the details of the project. Ultimately, the companies’ bid was not accepted as the project was awarded to a South American competitor.

Morrison-Knudsen Tunnel Project

The minutes of a January 16, 1991, CTI board of directors meeting indicate that Morrison-Knudsen Co. (“Morrison-Knudsen”) contacted CTI about possibly providing a barge for a tunnel construction project known as the Boston Harbor Tunnel Project. Morrison-Knudsen was interested in hiring CTI for this project because it owned the only available U.S.flagged submersible barge, the OC-350, and because it had experience in underwater tunnel construction. However, given that there was no dry dock at Boston Harbor, it was necessary to modify the OC-350 in order to perform the work required by Morrison-Knudsen. Specifically, the OC-350’s deck space needed to be increased to allow it to lower as many pre-connected tunnel sections as possible into the water at one time. There was also a possibility that stability columns would have to be added to the barge.

The board minutes show that the board planned to offer Morrison-Knudsen the option of either modifying the OC-350 or building a new one for the project and that the board estimated that modifying the existing barge would cost $1,000,000, while building a new barge would cost between $8,000,000 to $10,000,000. CTI made such an offer to Morrison-Knudsen. The project remained under consideration through April 30, 1991, and for several months thereafter.

At a November 26, 1991, board of directors meeting, the board discussed the status of the Morrison-Knudsen project. The minutes indicate that Morrison-Knudsen requested a quote for adding a 50-foot mid-body section to the OC-350 and that management planned to obtain a quote from Trinity Marine in order to respond to Morrison-Knudsen’s inquiry. Negotiations continued for several months following and including April 30,1992.

As of April 30, 1992, CTI was considering various options for lengthening the OC-350 to gain more deck space. Depending upon the option ultimately selected, management still estimated that the modifications would cost as much as $1,000,000. The $1,000,000 option included adding an extra hull and deck section to lengthen the barge and adding stability columns.

On June 1, 1992, CTI and Bethship-Sparrow Point Yard entered into a contract for the OC-350 to haul tunnel sections for the Morrison-Knudsen Boston tunnel project. Immediately thereafter, CTI put the OC-350 in Bollinger shipyard. On September 4, 1992, Bollinger Machine Shop sent OCI a $435,722 invoice for modifications to the OC-350. According to management, the conversion of the OC-350 that was ultimately completed at a cost of $435,722 included less deck space and it was, therefore, less costly than that which was originally contemplated as of April 30, 1991 and April 30, 1992. In fact, it was not until the OC-350 had been sent to the Bollinger Shipyard in June, 1992, that it was decided that the barge would undergo less extensive modifications. As Paul Candies testified:

Q. If the actual invoice from Bollinger Shipyard came in September of 1992, could you tell the Court how long before that a decision was made as to what modifications would be done and how much they would cost, sir?

A. We put the barge in June, so immediately upon decisions being made we put the barge in and put the barge on charter to Morrison-Rnudsen and the modification was done there.

Q. As of April 30, 1991, had a decision already been made that only $435,000 in modifications would be done?

A. No.

Q. As of April 30, 1992, had such a decision been made?

A. No.

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Q. As of April 30, 1991 and April 30, 1992, what was the amount that was estimated by management of CTI that would have to be expended to complete the project?

A. $1 million for the barge.

Freeport Phosphoric Acid Barge

In 1992, Freeport McMoBan (“Free-port”) contracted with OCI to build and operate a new barge to transport phosphoric acid between Tampa, Florida, and Taft, Louisiana. At an April 20; 1992, meeting, OCT’s and CTI’s board of directors approved a $7,500,000 budget, consisting of $5,100,000 to build a new barge and the remainder to modify existing equipment for Freeport’s phosphoric acid transportation needs. As of April 30, 1992, management anticipated making a total investment of $7,500,000 in the Free-port project.

On May 18, 1992, OCI and McDermott entered into a contract for the construction of a new barge for the price of $5,131,043. OCI began making barge construction progress payments on May 19, 1992, and by the end of October, 1992, OCI had paid McDermott a total of approximately $1,800,000.

After McDermott began building the barge, a dispute arose between McDer-mott and CTI concerning the progress of construction. Because of the dispute, McDermott stopped work on the barge, OCI stopped making progress payments, and the Freeport contract was cancelled.

On January 14, 1993, McDermott filed a petition for declaratory judgment against OCI in the 16th Judicial District Court, Parish of St. Mary, Louisiana. McDer-mott sought $4,900,000 in damages. As of April 30, 1993, OCI’s financial statements reflect that management estimated that it might need to pay a $4,900,000 judgment in the McDermott litigation. As of April 30, 1994, OCI’s financial statements reflect that management estimated that it might need to pay a $5,454,000 judgment in the McDermott litigation. On January 8, 1996, the lawsuit was finally settled with CTI paying McDermott $6,750,000. From April 30, 1994, through the settlement of the lawsuit, management believed that it was necessary to retain assets to satisfy any judgment rendered against OCI.

Cargill Ammonia Barge

In late 1992 or early 1993, Cargill contacted the companies to charter a barge to move ammonia from Tampa, Florida, to ports in New Orleans, Louisiana, Port of Spain, Trinidad, and Coatzacoalcas, Mexico. The March 1, 1993, board of directors minutes of OCI and CTI mentioned Cargill’s interest in chartering an ammonia barge and further discussed the possibility of converting or building such a barge. In connection with this project, CTI engaged in numerous discussions with Design Associates, Inc., Trinity Marine Group, and Northstar Marine Services to develop a design and specifications for the ammonia barge. It also solicited architectural drawings and operating cost estimates relating to the barge construction which estimates were submitted as part of its bid. On March 18, 1993, Otto Candies, Jr. sent a fax to Cargill attaching assumptions relating to the barge characteristics and estimating that such a barge would cost $13,000,000 According to the testimony of Otto Candies, Jr., CTI’s bid of March 18, 1993, was outstanding as of April 30, 1993, and discussions with Cargill continued for several months thereafter. The project, however, was ultimately not awarded to CTI.

Project Summary

Based on his review of documents and information related to dozens of potential projects that were considered for investment by OCI and CTI, as well as his discussions with management of the companies regarding those projects, Mr. Odom determined that each of the above-described projects involved real business opportunities that the companies pursued with serious interest and attention and that all of them were viable and outstanding as of the end of one or more years in question. Consideration of the projects generally required a significant time commitment by management and in some instances the investment of funds for vessel specifications and marine architectural drawings. The potential projects are summarized as follows, together with the amount of investment that would have been required to complete each such project:

Significantly, defendant offered no direct evidence at trial which would contradict evidence offered by plaintiffs that they had legitimate business reasons to invest in the projects previously identified. Furthermore, defendant did not contradict plaintiffs’ evidence regarding their plans to use their accumulated funds to invest in those projects.

Working Capital

The companies also required working capital which would be used in day-to-day operations. As Dr. Blaydon explained, working capital is used to cover the time lag between when a company’s expenses must be paid and when the company receives payment from its customers for the goods or services provided. According to management, having sufficient working capital is important for the companies given that both OCI and CTI sometimes use their billing cycle as a competitive tool, offering customers the ability to defer payments. During the years in question, management believed that the companies needed, on a combined basis, between $12,000,000 and $20,000,000 for both working capital and unanticipated special projects that might arise during the coming year.

At the request of plaintiffs’ counsel, Dr. Blaydon calculated the amount of working capital that he would have recommended each of the companies have available at the end of each year at issue. Dr. Blaydon used historical data to calculate the number of days needed to turn over both accounts receivable and accounts payable, subtracting the payables cycle from the receivables cycle, and multiplying the resulting total operating cycle by annual operating expenses. By adding one standard deviation to the relevant expenses, this annual amount was adjusted to account for industry volatility. This formula resulted in the following projected working capital needs:

1991 1992 1993 1994 1995 1996

OCI $4,000,000 .$4,500,000 $5,200,000 $7,200,000 $7,000,000 $7,100,000

CTI $ 400,000 $ 800,000 $1,000,000 $1,300,000 $1,500,000

Defendant did present direct evidence in opposition to plaintiffs’ working capital claim. That evidence, however, demonstrates that in some fiscal years, the differences between the plaintiffs’ and the defendant’s amount of required working capital are relatively insignificant. Defendant concedes that the companies had a reasonable business need to retain the following amounts for working capital:

1991 1992 1993 1994 1995 1996

OCI $3,951,000 $4,218,000 $4,647,000 $6,285,000 $6,596,000 $5,824,000

CTI $ 285,000 $ 143,000 $ 153,000 $ 208,000 $ 259,000

The above figures represent amounts identified by defendant’s expert witness, Dr. Raymond Ball, wh