Full opinion text
FINDINGS OF FACT AND CONCLUSIONS OF LAW ED KINKEADE, District Judge. This case is a tax dispute between Plaintiff Southgate Master Fund, LLC (“South-gate”) and the United States of America (the “Government”). It is a civil action by the Plaintiff against the United States under 26 U.S.C. § 6226 for readjustment of partnership items. Based on the findings and conclusions set forth today, the Court holds that although Southgate’s claimed capital loss appeared to fall within the literal terms of the statute, the transaction that created the high basis in the stock lacked economic substance and therefore must be disregarded for tax purposes. Consequently, the Internal Revenue Service correctly determined Plaintiffs reported loss was invalid. The Court further holds that because the calculation of taxes was done in good faith and with reasonable cause and the penalties assessed are otherwise inapplicable, the Plaintiff is not liable for the penalties sought by the Government. In December 2008 and January 2009, the Court conducted a fifteen-day bench trial on this matter. The Court additionally asked the parties for extensive post-trial briefing and allowed the parties to file evidence. Thus, the Court, having heard the testimony of witnesses and the argument of counsel, hereby renders the following Findings of Fact and Conclusions of Law as permitted by Federal Rule of Civil Procedure 52(a). I. Findings of Fact A. Andrew Beal and Beal Bank’s Business of Acquiring “Stressed Debt” 1. This case centers around banker D. Andrew Beal (“Beal”), and his participation in a partnership transaction involving Chinese non-performing loans (“NPLs”), by which he claimed $1.1 billion in tax losses on his personal income tax returns across the years 2002-2004 based on an economic loss the Government estimates at about $10 million. Beal is South-gate’s primary United States investor, and the person whose tax liability is ultimately at issue in this action. Beal is the founder, Chief Executive Officer, and 100 percent shareholder of Beal Financial Corporation (“BFC”), a Texas corporation and S-corporation for federal tax purposes, and its subsidiary Beal Bank, which in turn owns Beal Capital Markets, Inc.(collectively the “Bank”). Although Beal is a highly sophisticated and experienced banker, he has no professional or educational background in tax law. Beal is a Texas resident. 2. Beal Bank, a S-corporation, has been operating under the scrutiny of regulators since its inception in 1988. During that time, Beal Bank has been given “exemplary” ratings from its regulators. 3. Over the past twenty years, Beal and the Bank have been highly profitable, and have achieved significant returns on distressed assets originated by other financial institutions. The Bank’s primary business is acquiring “stress debt,” which Beal describes as “debt that has some issue with it ... performing loans that are out of favor ... or where the industries are stressed.” 4. In its 2002 Report of Examination of Beal Bank, the Federal Deposit Insurance Corporation (“FDIC”) confirmed Beal Bank’s success, and the Bank’s primary focus on acquiring distressed loans: “[Beal Bank’s] earnings remain strong and well in excess of peer levels. Management is competent and skilled in the bank’s primary business activity of acquiring distressed loan packages at a discount.” 5. Both before and after founding Beal Bank, Beal individually (as opposed to on behalf of Beal Bank) had a long and, for the most part, successful history investing in distressed assets. 6. In many instances, Beal would purchase these assets based on limited research — including one instance where he acquired over 100,000 loans with a face value of approximately $20 million based on two days of investigation — if “the price was right.” B. Thomas Montgomery and His Experience with Stressed Debt 7. Thomas Montgomery (“Montgomery”) is a certified public accountant with significant experience in venture capital transactions. In 2001, Beal Capital Markets, Inc. hired Montgomery to start a new capital markets group. The group’s specific focus was identifying investment markets and opportunities where there existed a so-called “market disconnect” between the quality of assets and the price at which those assets were trading, as well as opportunities in distressed debt generally. Excluding investments in China, Beal’s companies invested several billion dollars at the recommendation of the Beal Capital Markets group since 2001. 8. Montgomery had been involved in, or had knowledge of, some of Beal’s and the Bank’s investments in distressed assets, especially non-performing loans. Some of these included: (a) domestic investments in a pool of over 100,000 loans sold by the FDIC with a face value of approximately $20 million, purchased for about $1.4 million or roughly seven cents on the dollar; (b) numerous investments in airline bonds following September 11, 2001, totaling several hundred million dollars; (c) investments in distressed hotel and casino bonds; and (d) investments in power company bonds of more than $1 billion following the Enron and Dynegy frauds and the California rolling blackouts. 9. Like Beal, Montgomery worked on deals that would be researched quickly before an offer was made, sometimes in a matter of days or hours. Montgomery stated that his and Beal’s investment philosophy is “to go where nobody else is going and do it quickly” to beat other investors looking for high profit potential “market miseonnects.” 10. When Beal Capital Markets, Inc. hired Montgomery, Beal defined the pursuit of investments in foreign-based nonperforming loans as one of Montgomery’s primary business duties. He increasingly sought such foreign opportunities as Beal’s and the Bank’s potential for “upside returns” on traditional investment targets became more limited within the United States. Beal and Montgomery turned to investing in the “inefficiencies” of foreign markets that allowed greater leverage. Inefficient markets are generally those that have yet to be fully understood by investors at large, leaving opportunities for pioneer investors willing to take some risk of not having complete knowledge of all the pitfalls of that market. 11. Montgomery was involved with and aware of Beal’s and the Bank’s investments (or attempted investments) in foreign-based non-performing loans and other assets, including a $23 million acquisition of approximately 25,000 non-performing loans with a face value of $460 million originated in Jamaica in early 2002, as well as investments in Estonia, Mexico, Slovakia, Nicaragua, and several other countries. 12. In the Jamaica transaction, Beal and Montgomery relied on the due diligence of their loan servicer. For unsecured loans in the Jamaica transaction, there was little review; what review was done was based on a small statistical sample “just to make sure that [the loans] were ... valid, legally enforceable.” Beal Bank ultimately doubled its investment in the Jamaican transaction. Although the Jamaican transaction was not structured for tax benefits, Montgomery realized toward the end of the transaction that, if it had been structured differently, there may have been tax benefits available. 13. In September 2003, Montgomery left Beal’s employment and rejoined his accounting firm, known as Montgomery Coscia Greilich LLP (“MCG”), where he currently is the managing partner. MCG provides accounting services and prepares tax returns for Beal and the companies he owns, including BFC and Beal Bank. C. The Emergence of the Non-Performing Loan Market in China 14. The non-performing loan business has its roots in the United States Government’s response to the savings and loan crisis in the 1980s-1990s. During the crisis, the United States Government established the Resolution Trust Corporation (“RTC”), a government-owned asset management company whose mandate was to liquidate the savings and loans’ non-performing loans and other distressed assets. As the RTC sold off its inventory of nonperforming loans, best practices were established with respect to sales processes, and specialist non-performing loan investors emerged. 15. Other countries drew upon the United States’ RTC model to handle their financial institutions’ distressed assets, and non-performing loan markets emerged worldwide. By the time non-performing loan markets developed in Asia in the wake of the late-1990s financial crisis, nonperforming loan investing operated under a set of generally recognized guidelines. 16. The non-performing loan market started to develop in China in or around 1999-2000. At that time, China was looking to join the World Trade Organization (“WTO”). To do so, the Chinese government sought to reform its State-owned commercial banks (“SOCBs”) and turn them into more modern institutions. Responding to concerns about the continued solvency of its banks, and to prevent financial crises, the Chinese government took several steps to reform its ailing banking system, including (1) reduced government interference in bank operations, (2) recapitalized State banks, and (3) created and transferred NPLs to government-owned Asset Management Companies (“AMCs”). 17. As of 1999, there were four main SOCBs in China: (1) The Industrial and Commercial Bank of China (“ICBC”), (2) The Agricultural Bank of China (“ABC”), (3) The Bank of China (“BOC”), and (4) the China Construction Bank (“CCB”) (collectively, the “Big Four Banks”), which each had specific roles in Chinese lending. These banks were under administrative control by the People’s Bank of China (“PBOC”), which is the central bank of the People’s Republic of China and has power to control monetary policy and regulate financial institutions, and the Chinese government. The PBOC regulated supply and allocation of credit through an annual “credit plan.” 18. Years of inefficient banking policies and procedures, lack of competition due to a state-owned economy, and poor lending decisions to poorly run state-owned enterprises caused the Big Four Banks to generate large numbers of non-performing loans. The Big Four Banks made loans to a variety of Chinese entities, and many of the loans were made without reasonable expectation of repayment to achieve other government purposes without following basic lending principles as practiced in many industrialized economies. 19. In 1999, the Chinese government set up four Asset Management Companies to take on and resolve debt from each of the Big Four Banks. The AMCs were China Great Wall (“Great Wall”), China Orient, China Cinda (“Cinda”), and China Huarong (“Huarong”). Each of the AMCs was established to resolve one of the Big Four Bank’s non-performing loans: BOC/China Orient; CCB/Cinda; ICBC/Huarong, and; ABC/Great Wall. Neither the Chinese government nor the AMCs are subject to taxation in the United States with respect to the non-performing loans. 20. The basic statutory instrument governing the establishment and operation of AMCs was the Regulation on Financial Asset Management Companies promulgated by the State Council in November 2000. The Ministry of Finance, often in conjunction with other Chinese government agencies (such as PBOC, China Banking Regulatory Commission, and State Administration of Foreign Exchange), made numerous regulations, rules and decrees that regulate various aspects of the AMCs operations. The dispositions of NPLs by the AMCs were and are effectively controlled by the Chinese government, as the Ministry of Finance is statutorily empowered to “set the operating targets” for AMCs’ disposition of NPLs and to “assess and supervise” their operations. 21. By establishing the AMCs, the Chinese government essentially bifurcated the Chinese banking system into “good banks” and “bad banks.” The latter — the AMCs — would receive, manage and maintain the SOCBs’ non-performing loans, acting somewhat akin to the United States’ RTC model. This allowed the SOCBs— the “good banks” — to clear thousands of distressed assets from their books. With their improved balance sheets and increased liquidity, the SOCBs could use their resources to expand, to “commence a new lending policy based on a client’s creditworthiness,” and eventually to compete with foreign banks. A parallel goal of the AMCs was to stabilize and rehabilitate China’s debt-ridden State-Owned Enterprises (“SOEs”) through an extensive program of government-mandated debt-equity swaps with state-owned enterprises. 22. In 2000 and 2001, approximately 1.4 trillion Chinese yuan (renminbi or “RMB” is the official name for the currency in China; yuan is the principal unit of that currency) (U.S. $169 billion) of the Big Four Banks’ non-performing loans were transferred to the four AMCs. Primarily, non-performing loans generated pre-1995 were transferred. Pursuant to Article 12 of the Chinese Regulations on Financial Asset Management Companies, the AMCs purchased the non-performing loans from the Big Four Banks at face value (i.e., outstanding principal plus accrued but unpaid interest). 23. The AMCs were bestowed with unique legal and policy-based “super powers” that were intended to facilitate the AMCs’ resolution of non-performing loans. The powers included the ability to restructure debt, pursue litigation against debtors, and toll the statute of limitations. 24. The most important power was that the AMCs were permitted to compromise debt. Historically, the SOCBs were not allowed, except in rare circumstances, to accept anything less than full repayment of loans from borrowers. Consequently, there was no incentive for debtors — even those who may have had the ability to pay off part of their debts — to do anything other than stonewall their lending bank. With the establishment of the AMCs, for the first time a lender was allowed to conduct debt restructuring — it could agree to accept a reduced amount rather than force a debtor into an all-or-nothing choice — thus increasing the likelihood of collecting at least some portion of the amount owed. This change brought renewed value to China’s non-performing loans and created significant investment possibilities for those who acquired an interest in such loans. 25. Other AMC “super powers” included the following: the AMCs could provide notice by publication, rather than have to provide personal notice, to a debtor of the transfer of its debt; the AMCs could suspend the statue of limitations on enforcement through publication notice; and the AMCs could waive the need to re-register a mortgage upon transfer or modification of a mortgage contract. D. Cinda 26. The Chinese NPLs used in the Southgate transaction were from China Cinda Asset Management Company, a state-owned financial institution supervised by various arms of the Chinese government. 27. Cinda was the first Chinese AMC to be established, on April 20, 1999. It was, and is, a state-owned institution, but maintains an independent legal identity and different supervision than CCB. Cinda and the other three AMCs are all Chinese state-owned companies. Each AMC has registered capital that was allocated by the Chinese Ministry of Finance. The AMCs’ business operation and management are conducted by its president and vice-presidents, all appointed by the Chinese State Council (the executive branch of China’s central government). There is no independent board of directors for the AMCs. 28. In the relevant time frame, China Construction Bank dealt primarily with Cinda. CCB’s personnel were divided between Cinda and CCB, with loan collection personnel going to Cinda and loan origination personnel staying with CCB. Cinda’s and CCB’s headquarters and branch offices were separate, and Cinda established and maintained offices in most of the regions where CCB originated its non-performing loans. 29. The Articles of Incorporation of Cinda state that Cinda shall be subject to the supervision and management by the People’s Bank of China, the Ministry of Finance, and the China Securities Regulatory Commission. The Articles of Incorporation of Cinda were examined and approved by the PBOC on May 24, 2001, pursuant to and in accordance with the provision of the Company Law of China and the Rules on Financial Asset Management Companies and other relevant law and regulations. 30. In 2001 and 2002, CCB was regulated by the PBOC, Ministry of Finance, the Chinese Insurance Regulatory Commission, and the China Securities Regulatory Commission. In 2001 and 2002, Cinda was regulated by the PBOC, the Ministry of Finance, State Economic and Trade Commission, and the China Securities Regulatory Commission. 31. Cinda, as later with the other AMCs, was required by Chinese law to purchase CCB’s non-performing loans for their full face value, including accrued but unpaid interest. Cinda acquired those non-performing loans, including the loans ultimately contributed to Southgate, by paying CCB cash, bonds or other negotiated instruments for the face amount of each debt instrument plus accrued, but unpaid, interest. By the end of 2000, Cinda had acquired approximately RMB 373 billion (USD $45 billion) of non-performing loans from CCB. The Ministry of Finance and/or the PBOC, both of which are government agencies, at least implicitly guaranteed the bonds that Cinda issued to acquire the NPLs from CCB. The exchange rate in 2002 was approximately 8.3 RMB to 1 USD. 32. At the time of its transactions with Southgate in August 2002, Cinda was a corporation duly organized and validly existing under the laws of the People’s Republic of China. 33. As with the other AMCs, Cinda’s trade or business from its inception through the time of the Southgate transaction in 2002 was to receive, manage, and resolve the nonperforming loans of CCB and the other SOCBs, thus allowing the SOCBs to clear thousands of distressed assets from their books, improve their balance sheets, and increase their lending based on creditworthiness. Cinda also engaged in thousands of government mandated debt-for-equity swaps, taking on bad debt in exchange for equity in state-owned enterprises, that were aimed at stabilizing China’s many SOEs. For comparison, U.S. entities like Amtrak, the Federal Deposit Insurance Corporation, and the Tennessee Valley Authority are domestic state-owned enterprises. Also, AIG and General Motors arguably are government-owned entities as of the date of this opinion. 34. During 1999 and 2000, Cinda signed debt-to-equity swap contracts with 168 Chinese SOEs involving NPLs with RMB 154.5 billion face amount. In 2001, Cinda signed debt-to-equity swap contracts with sixteen SOEs involving NPLs with a RMB 12.7 billion face amount. 35. In 2000, Cinda disposed of NPLs with RMB 38 billion face amount. These dispositions involved approximately 3,748 NPLs and were in addition to Cinda’s debt-to-equity swaps and auctions during 2000. The 2000 dispositions consisted of reductions in loan balances from Cinda’s collection efforts. In 2001, Cinda disposed of NPLs with RMB 29.9 billion face amount. These dispositions involved approximately 3,192 NPLs and were in addition to Cinda’s debt-to-equity swaps and auctions during 2001. The 2001 dispositions included collections and transfers to joint ventures. 36. In May 2001, Cinda formed a joint venture with Deutsche Bank, the world’s second-largest commercial bank and Germany’s largest bank, for the purpose of managing and liquidating part of Cinda’s NPL portfolio. Deutsche Bank acted as a middleman and sourcing agent of Cinda’s non-performing assets. 37. In selling or otherwise disposing of Chinese NPLs, Cinda has carried out investment banking activities. To this end, Cinda became a member of the Shanghai Stock Exchange and Shenzhen Stock Exchange. Cinda also acted as a sponsor or underwriter for stock listings by a number of enterprises as part of Cinda’s NPL dispositions through debt-for-equity swaps and asset restructuring. The Government has failed to establish that these actions occurred during the relevant period of 1999-2001. 38. Because the People’s Republic of China wholly owned and controlled both the state-owned banks and the AMCs, there was little economic consequences as a result of these transactions because the PRC government effectively shifted nonperforming loans from one state-owned entity to another state-owned entity. Cinda thus acquired NPLs with built-in losses for a price that it may not have paid in an arms-length negotiated deal for the NPLs. 39. Cinda disposed of at least 13 percent of its existing balance of NPLs in each year from 1999 to 2001. When properly excluding non-sales transactions, the Court finds Cinda had not “sold, transferred, or exchanged” more than 5 percent of the total basis of all loans it had acquired each year. 40. Southgate’s attorneys recognized that the IRS might try to label Cinda’s debt-to-equity swaps “sales” for purposes of the mark-to-market (“MTM”) rules in Section 475. This does not indicate, however, that Southgate’s attorneys considered Cinda a dealer at the time; rather, it indicates an early awareness of potential Government arguments in this ease. E. Development of China’s Non-Performing Loan Market 41. Generally, the environment in China between 2000 to 2002 was strongly pro-business and pro-foreign investment as the country sought entry into the WTO. In that time period, the Chinese government actively sought Western technology, ideas, and capital in an effort to become a greater force in the global economy. Concomitantly, many Western companies developed presences in and/or a strategic approach to business dealings in China. 42. After finding success elsewhere in Asia, foreign non-performing loan investors saw great possibility in the China market; the belief was that the non-performing loan market in China was potentially larger than in any other country in Asia. Reports of early profits earned by foreign investors stoked this enthusiasm. 43. Huarong’s November 2001 auction of a non-performing loan portfolio was the first non-performing loan auction in China run under internationally-recognized guidelines. Sixteen bidders, including experienced foreign investors such as Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers, registered for the auction. Huarong sold seven nonperforming loan portfolios to two investor groups: Goldman Sachs acquired two portfolios with a face value of $241 million, and a consortium led by Morgan Stanley acquired five portfolios with an aggregate face value of $1.3 billion. It is unclear from the evidence at trial what the bidders paid for the portfolios, although South-gate’s expert, Ted Osborn (“Osborn”), estimated they sold for about ten cents on the dollar. 44. Huarong announced these transactions publicly in December 2001 (the “Huarong I” transactions). Almost immediately thereafter, the strong market buzz was that the deals were making tremendous returns. Goldman Sachs was reported to have found a proverbial “nugget” — a real property within the portfolio that was undervalued when Goldman acquired it and then sold for its true market value, which was many multiples of its acquisition price. Collections were reportedly so strong on the Morgan Stanley portfolio that Morgan Stanley never had to reach into its own pocket to pay the full acquisition price. Notably, Huarong — like Cinda, an AMC — served as interim servicer for the Morgan Stanley portfolios during this period of reported early success. 45. The reported success of the Huarong I investors had a powerful impact on the Chinese non-performing loan market. Foreign investors seeking to emulate Morgan Stanley and Goldman Sachs regularly incorporated particular elements of the Huarong I transactions into later non-performing loan deals — including transferring loans to an offshore entity and including the selling AMC either as a joint venture partner or in the post-transaction servicing or collection process. 46. Huarong I was not the only widely-reported transaction in late 2001 that stoked foreign investors’ interest in the China non-performing loan market. Also in December 2001, China Orient sold a $217 million portfolio to United States investors. The deal drew a great amount of attention because that NPL transaction was the first involving a foreign investor to close with full government approval, as it was completed around the same time the Huarong I deals were signed but not yet closed. F. Southgate Acquires an Interest in Chinese NPLs 47. It was against this backdrop that Montgomery began to investigate potential investment opportunities in the Chinese non-performing loan market. Montgomery was well aware that Goldman Sachs, Morgan Stanley and other foreign entities were investing in China in 2001. China’s non-performing loan market was far from a known quantity in 2002, however, as less than a handful of non-performing loan deals preceded Southgate’s. 48. Montgomery identified the Chinese non-performing loan market as a potential investment opportunity in February or March 2002. Through extensive research and conversations with several contacts at investment banks, Montgomery ascertained that, although it was in its nascent stages in 2002, the Chinese non-performing loan market was one of the largest in Asia. 49. In contrast to earlier investments on which he worked with Beal, Montgomery sought to determine if a distressed-debt transaction could be structured to provide tax benefits. Montgomery believed the earlier transactions, such as the one in Jamaica, were “missing something” in regard to their potential tax benefits. 50. Deutsche Bank introduced Montgomery to the law firm of De Castro, West, Chodorow, Glickfeld & Nass, Inc. (“De Castro”), which suggested a structure using a network of U.S. limited liability companies. After Deutsche Bank introduced Montgomery to the De Castro firm, Montgomery and Beal sought and received tax advice, including several memoranda, on how to structure such a transaction. In addition to providing tax advice, De Castro attorneys drafted tax opinion letters for Montgomery and Beal, drafted most of the transaction agreements, and helped negotiate and structure the Southgate transaction on Montgomery’s and Beal’s behalf. 51. Beal first spoke with De Castro attorneys in July 2002. On July 18, 2002, Beal and Montgomery had a telephone conference call with the De Castro attorneys. During that conference call, Beal, Montgomery, and the attorneys discussed Montgomery’s investigation in China to date, the pricing of Chinese NPLs, the proposed transaction structure, and as shown below, the tax implications of the proposed Chinese NPL investment. On the call, they discussed the size of a potential investment in Chinese NPLs held by Cinda — whether Beal would acquire Chinese NPLs with a face amount (including accrued interest) of $1 billion or $500 million. 52. De Castro attorneys prepared several memoranda on the tax implications of the Southgate transaction, covering topics including (1) how the transaction would be reported on Beal’s returns; (2) the partnership’s preference of foreign rather than U.S. domestic debt; (3) the size and timing of tax losses; and (4) building Beal’s outside basis in Southgate. The memoranda reflect Beal and Montgomery’s caution in light of the extremely high likelihood of an IRS audit. 53. The Government notes that this discussion of the relative “value” of a foreign versus domestic investment did not mention any non-tax economic profitability considerations. The Court does not find this fact surprising because the De Castro attorneys were hired as tax advisors, and Montgomery and Beal were businessmen capable of evaluating the economic potential of the Southgate deal. 54. One memorandum to Montgomery reveals that a reason for choosing foreign (such as Chinese) debt instead of domestic debt was the greater likelihood of finding “tax value” at a lower price from a foreign source because holders of U.S. debt would generally desire to take the benefit for themselves or extract a higher price for this “tax value.” The memo also stated: You expressed a concern that an active search for U.S. debt with favorable tax characteristics could expose the strategy to numerous people with potential contact with tax authorities. Also, holders of U.S. debt will have their own U.S. tax reporting obligation and could take inconsistent positions (despite representations that may be made). This also could provide a trail to you. Foreign debt is preferable because it would preserve a lower profile on these matters. 55. Despite the tenor of this tax-specific memorandum, Montgomery and Beal evaluated the contemplated transaction both for its non-tax economic profitability potential and the domestic tax benefits that could result. 56. Montgomery made several trips to China during the summer of 2002 to investigate Chinese non-performing loan investment opportunities. 57. Montgomery’s interest in pursuing investments in China dated back to his employment at the Arthur Andersen accounting firm in the 1980s, during which time he participated in a task force concerning Chinese markets. Montgomery cited a number of specific reasons for believing that China presented significant investment opportunities in 2002, including: China was seeking to join the WTO and thus was receptive to foreign investment; China’s currency was undervalued, giving investors an opportunity to earn a profit on the anticipated rise in China’s currency; and the improved performance of once-struggling companies swept up in the “rising tide” of the rapidly growing Chinese economy would significantly impact the potential value of non-performing loan portfolios. 58. The testimony of Osborn confirmed that Montgomery’s optimism about the Chinese economy in 2002 and about the Chinese nonperforming loan market in particular was widely shared by investors at the major brokerage houses and other investors worldwide. Osborn, a partner with the Hong KongUhina firm of PriceWaterhouseCoopers (“PwC”), is the leading authority on the China non-performing loan market. The Government’s expert, Professor Theodore Barnhill (“Barnhill”), met with Osborn twice in connection with his work on this case to learn more about the Chinese non-performing loan market. Osborn leads PwC’s Business Recovery Services division, which specializes in advising on debt restructurings, insolvencies, distressed M & A and China non-performing loans. He worked on nearly a dozen non-performing loan-related transactions in the 2001 to 2002 time frame — and more than three dozen overall in the past eight years — on behalf of both foreign investors looking to purchase non-performing loan portfolios in China as well as AMCs seeking to resolve them. Starting in 2000, Osborn met with Chinese AMCs to educate them on best practices for them to use in their non-performing loan resolutions. Through 2007, Osborn was the primary author of Industry Watch and NPL Asia — the premier publications on the Asian non-performing loan market; Osborn’s particular focus for these publications was China’s non-performing loan market. G. The Bank Rejects the Chinese NPL Investment 59.In the spring of 2002, Montgomery consulted with Beal regarding an opportunity to invest in Chinese non-performing loans. The Bank paid for Montgomery to travel to China in July 2002 to conduct preliminary research on opportunities that he had identified there. Initially, Montgomery was trying to identify secured Chinese non-performing loans trading somewhere between 10-20 percent of face value. Yet based on his initial due diligence on the Chinese legal system, which raised concerns over the ability to perfect and enforce security interests, Montgomery changed investment strategies. He began to research unsecured investments in highly distressed Chinese non-performing loans at a less expensive price, which was below 5 percent of face value. 60. Montgomery presented the general results of his initial due diligence to Beal. Montgomery did not propose any formal investment opportunity to Beal; he only recommended that they pursue lower-quality non-performing loans that were trading at 5 percent or below of face value instead of those trading at 10 to 20 percent of face value as was initially contemplated. Due to the Bank’s recent acquisition of a Jamaican loan portfolio and the expectation that regulators would not allow the Bank to leverage its acquisition of an interest in these Chinese non-performing loans, Beal informed Montgomery that the Bank would not do this deal. 61. Because Montgomery believed in the potential of the Chinese non-performing loan market, he sought to be released from his obligations to the Bank so he could pursue the opportunity independently. Beal agreed to release Montgomery, with the understanding that Montgomery would keep Beal reasonably informed of further activities in the Chinese non-performing loan market. 62. Hearing how strongly Montgomery believed in the profit potential of the investment opportunity after his trip to China, Beal in July 2002 advised Montgomery that Beal personally might be interested in making the investment outside of the Bank, but that he did not want to commit time or money to the prospect until Montgomery had secured a specific deal that Beal could consider. 63. Montgomery hoped, but could not be certain, that Beal would invest in the Chinese non-performing loans if Montgomery was able to put a deal together. In the event Beal declined to invest, Montgomery was confident he could find another investor who would invest. 64. Montgomery formed Montgomery Capital Advisers, LLC (“MCA”), a Delaware limited liability company, on or about July 18, 2002 for the purpose of pursuing an investment in the Chinese non-performing loan market. Montgomery was and is the sole member and manager of MCA. Beth Montgomery is not included as a member of MCA on any of the formation documents, but is shown as a member on MCA’s federal income tax returns. At this time, Beth Montgomery was an employee and advisor of Beal Capital Markets. 65. As is routine among experienced investors, Montgomery set up a limited liability company through which to pursue this investment to shield himself from personal liability. 66. Cinda had formed China’s first joint venture designed specifically to manage delinquent assets with Deutsche Bank in May 2001. Montgomery used his contacts at Deutsche Bank, which acted as the exclusive sourcing agent for Cinda’s nonperforming loans, to arrange introductions to Cinda. 67. Montgomery met with Cinda for the first time in July 2002. Ma Wen, an executive director of Cinda, was Montgomery’s primary contact. 68. Beal’s typical investment practice in non-performing loans involves a rigorous due diligence process before entering a transaction. Beal Bank Executive Policies and Procedures (“BBEPP”) is a policy manual for Beal Bank. The BBEPP includes a section listing various factors that Beal Bank considers to evaluate a potential investment in either a domestic or foreign loan portfolio. The BBEPP also sets forth guidelines for retaining appraisers to value collateral. 69. In pursuing this investment, Montgomery did not follow Beal Bank’s policies for evaluating loan portfolios, primarily because the loans in which he sought to invest were largely unsecured. Beal Bank’s policies do not apply to unsecured nonperforming loans. 70. Beal has purchased secured and unsecured assets based on limited research, even in as little as two days, if “the price was right.” H. Identification of a NPL Portfolio for Investment Purposes 71. In July 2002, Montgomery spent a significant amount of time and money performing due diligence on loans held by Cinda. Montgomery went to China to meet with Cinda and explore potential NPL portfolios. 72. As a part of his due diligence, Montgomery identified a portfolio of approximately 24,000 “Category 4” — severely distressed and uncollateralized — loans held by Cinda, but that Cinda had not previously worked (the “NPLs”). 73. The NPLs had a face amount, including accrued but unpaid “balance sheet” interest at the time of Cinda’s purchase of the NPLs, of RMB 9,473,111,857, which was equivalent at the time to USD $1,145,479,064. 74. By e-mail message dated July 15, 2002, a De Castro attorney advised Montgomery that the pricing of the Chinese NPLs held by Cinda, including a fee to Deutsche Bank for arranging the transaction, “is the best pricing we have ever seen” and that “[rjegardless of possible tax benefits, due diligence should show possibility of a profit on the investment (including fees).” 75. Montgomery acquired a diskette listing the NPLs in an effort to “tie down” the portfolio. At closing, Montgomery asked Deutsche Bank to confirm that the NPL portfolio Cinda contributed to the partnership was the same portfolio he has previously reviewed. 76. Consistent with his and Beal’s experience with severely distressed nonperforming unsecured loans in the United States, Montgomery believed the NPLs would be worth at least 1-3 percent of their face value, with the bulk of profits being generated by finding “golden nuggets” in the pool. 77. Montgomery met with Ma Wen approximately six to ten times in Beijing to discuss a potential transaction relating to the portfolio. 78. In Montgomery’s initial discussions with Cinda concerning a potential acquisition of an interest in the NPLs, Cinda proposed an acquisition price equal to 3-3.5 percent of the face value of the portfolio. Montgomery ultimately negotiated the price down to 1.7 percent of face value. After these negotiations with Cinda and due diligence, Cinda agreed to contribute the NPLs to Southgate. I. Eastgate’s Formation 79. Eastgate was formed as a Delaware LLC on July 31, 2002. Cinda was the sole member of Eastgate upon its formation. 80. Eastgate was formed primarily to act as Cinda’s United States investment vehicle for the NPLs. Eastgate was a 100 percent-owned subsidiary of Cinda. Southgate believed this domestic LLC structure was preferable because it was organized under and thus controlled by U.S. and Delaware law. 81. Cinda contributed the NPLs to Eastgate on August 1, 2002. 82. On August 1, 2002, a Contribution Agreement was entered into by Eastgate, MCA, and Southgate (the “Contribution Agreement”), in which Eastgate represented it had not: (1) written any debt instrument comprising the NPLs down or off; (2) made provision for bad debts with respect to the NPLs for tax or financial accounting purposes; or (3) made a determination that all, or any specific one, of the NPLs was worthless or partially worthless. 83. The outstanding balance of the loans, including accrued interest, that Cinda contributed to Eastgate on or about August 1, 2002, when converted was approximately $1,145,479,064. 84. Cinda’s tax basis in the NPLs immediately prior to their contribution to Eastgate was equal to Cinda’s purchase price of $1,144,801,161 plus accrued but unpaid interest of $234,979,225 for a total of $1,379,780,386. 85. Upon Cinda’s contribution of the NPLs to Eastgate, Eastgate’s tax basis in the NPLs was equal to Cinda’s tax basis in the NPLs. J. Southgate’s Formation 86. Southgate was formed as a Delaware limited liability company on or about July 31, 2002. Upon its formation, South-gate’s members were Eastgate (99 percent) and MCA (1 percent). MCA was the manager of Southgate. 87. Pursuant to the Contribution Agreement, Eastgate contributed the NPLs to Southgate in exchange for a 99 percent membership interest in Southgate; and was credited with an initial capital account balance of $19,420,000. The NPLs transferred by Eastgate to Southgate, at or about the time of Southgate’s formation, comprised approximately 19,000 obligors and approximately 24,000 loans. 88. Southgate’s initial tax basis in the NPLs was equal to Eastgate’s tax basis in the NPLs immediately prior to their contribution to Southgate. 89. MCA transferred $100,000 in cash and a promissory note for the principal amount of $96,162 to Southgate in exchange for its 1 percent membership interest. 90. On August 1, 2002, MCA appointed Deutsche Bank as its exclusive agent for the Cinda NPLs and agreed to pay an initial placement fee of $50,000; in addition, MCA agreed to pay Deutsche Bank additional transaction fees based on the face amounts of the NPLs purchased, which amounted to $8,500,000. Montgomery anticipated that Beal or another investor would cover this fee. 91. The Deutsche Bank fee was a cost of doing business in China. Montgomery had been rebuffed in efforts to go directly through Cinda. Deutsche Bank acted as an intermediary for Cinda and had obtained exclusive brokerage rights. This meant MCA had to pay the 1.7 percent price plus the Deutsche Bank fee of $50,000, the other transaction fees of $8.5 million, and any future fees to obtain the NPLs. 92. The Southgate Operating Agreement was entered into by MCA and East-gate on August 1, 2002. Under the South-gate Operating Agreement, MCA was paid $1,000 per month and was entitled to 10 percent of Southgate’s net profits at such time, if ever, that the members recovered their initial capital contributions plus a 6 percent interest factor. No built-in losses from the NPLs were allocated to either MCA or Montgomery. 93. Under the Southgate Operating Agreement, the members of Southgate could not withdraw from the company within the first three years following admission. K. Southgate Partners with Cinda 94. After its formation and funding on August 1, 2002, Southgate, as owner of the NPLs, entered into a three-year loan servicing agreement with Cinda (the “LSA”) to service the NPLs. Under the Cinda-Southgate LSA, Cinda was to service the NPLs and was entitled to a fee equal to 25 percent of net collections after expenses. 95. Montgomery learned that Cinda had to pay 99 percent of any proceeds from the acquisition price of the NPLs to service the bonds used to finance its acquisition of those loans from CCB, whereas Cinda was able to keep servicing fees for its ongoing operations. Montgomery thus negotiated a servicing fee of 25 percent of gross collections in exchange for a reduction in the acquisition price of the NPLs from the 3 percent of face value that Cinda originally requested to the 1.7 percent ultimately agreed upon amount to be paid. In doing so, Montgomery incentivized Cinda’s collections efforts and provided Cinda with working capital. 96. The LSA provided that Cinda was to service the loan pool “with reasonable care and efforts in accordance with the terms of the [LSA].” Cinda was also to service the assets “in accordance with customary and usual procedures employed by parties engaging in the business of servicing loan contracts and, to the extent more exacting, in accordance with the procedures used by [Cinda] to service and administer similar contracts owned by [Cinda].... ” Cinda was also prohibited under the LSA from taking “any action ... which would diminish or impair ... [Southgate’s] rights under [the LSA] or ... [Southgate’s] rights with respect to the Assets.” The LSA did not forfeit Southgate’s rights as owner of the loans or Southgate’s ability to determine which loans Cinda could service. 97. For a number of reasons, Montgomery believed that Cinda was the best choice to service the NPLs. First, it was a large, organized, and regulated entity “with controls, processes and procedures throughout [China].” Second, Montgomery believed that an effective servicer of the NPLs, which were spread geographically throughout China, must have branches “in all the areas where the loans were.” Cinda, with twenty-eight different branch locations throughout China, satisfied that requirement. Montgomery did not learn until September 2004 that Cinda’s headquarters failed to pay its branches for their collection work on the NPLs. Third, Montgomery’s understanding was that Cinda was “aggressively” pursuing its own collections of its high-quality non-performing loans, including by filing thousands of lawsuits. Fourth, Montgomery believed that Cinda was incentivized to become an effective servicing agency so that it could continue to work portfolios in the future. Fifth, as with all AMCs, Cinda possessed certain “super powers” with respect to collections, most notably the ability to compromise or restructure debt. Finally, Montgomery believed that the only alternatives to Cinda would have been “very small one- and two-man collection type firms,” which would not have been capable of servicing such a large, geographically-diffuse portfolio of loans as Southgate’s. 98. Montgomery’s approach was consistent with Chinese non-performing loan market practice in 2001-2002, as it was typical for foreign investors to retain the selling AMC post-closing in a loan servicing capacity. Southgate’s expert Osborn, who has been involved with servicing pools of Chinese non-performing loans, found Southgate’s servicing arrangements with Cinda, including the 25 percent servicing fee, to be reasonable. 99. It was reasonable for Southgate to retain Cinda as servicer, and to believe that Cinda’s fee and the fact that Cinda retained a direct interest in the NPLs would ineentivize Cinda to pursue collections aggressively. 100. Government witnesses Barnhill and Jiawen Yang (‘Tang”) opined that Southgate should have foreseen a purported conflict between Cinda’s contractual obligations as Southgate’s loan servicer and its duty to help reform China’s SOEs, as mandated by the Chinese government. The evidence partially contravenes this assertion. At the time of the Southgate transaction, the Chinese government was desperately trying to attract foreign investors to the non-performing loan market. AMCs had sued SOE debtors and had utilized other aggressive collection methods for the benefit of their foreign investor clients. And it was widely reported that Huarong’s performance as servicer for the portfolios acquired in Huarong I was strong. 101. Barnhill and Yang contend that Southgate should have been aware of the fact that profits earned by early foreign investors had embarrassed Chinese political officials, who subsequently attempted to stifle returns. These facts illustrating this phenomenon did not largely manifest themselves until after the transaction was completed in 2002 — i.e., late 2003 or early 2004 — and were not known to Southgate at the time of its transaction. Even if, with the benefit of hindsight, Southgate might have selected a different servicer, that does not necessarily make the selection of Cinda suspect at the time because it could not reasonably have known about the changing political winds in China. 102. Notwithstanding the opinions of Government witnesses, the weight of the evidence shows that from Southgate’s perspective in 2002, the LSA with Cinda was a legitimate and reasonable agreement. L. Montgomery’s Due Diligence Efforts 103. After Southgate was formed on or about August 1, 2002, MCA continued its legal and financial due diligence on the NPLs. MCA engaged Chinese legal counsel, Haiwen & Partners (“Haiwen”), and a Chinese valuation firm, Zhongyu Assets Valuation Co., Ltd. (“Zhongyu”), to conduct legal and asset due diligence with respect to NPL investment opportunities that MCA had identified. 104. To facilitate the due diligence, all loan files in relation to the NPLs (which were held by Cinda’s twenty-eight branches throughout China) were sent to Cinda’s headquarters in Beijing. Zhongyu and Haiwen conducted their own due diligence at Cinda’s headquarters. Both Montgomery and De Castro attorney Andre Bernknopf (“Bernknopf”), who were in Beijing negotiating with Cinda at the time, observed the amassed loan files during this due diligence process. Zhongyu and Haiwen each examined a small sample of the NPLs destined for the Southgate portfolio. i. Zhongyu Valuation 105. Montgomery engaged Zhongyu, a valuation firm based in China, to provide a valuation analysis of the NPLs. 106. Zhongyu carried out its due diligence over twenty working days, from July 22, 2002, to August 16, 2002, and reported its findings to MCA on August 16, 2002. The valuation report regarding the NPLs was prepared by Zhongyu at the request of Haiwen on Southgate’s behalf. For purposes of determining the value of the NPLs, Southgate relied on, among other things, Zhongyu’s report. 107. Due to the size of the NPL portfolio and other factors, Zhongyu performed its services based on the top two-hundred loans in terms of face value, plus a statistically valid sample of the portfolio. The total face value accrued interest of the NPLs in the sample was about 35 percent of the total portfolio. Zhongyu’s sample reflected the characteristics of the whole portfolio. 108. Given the pennies-on-the-dollar purchase price of the NPLs and their generally poor documentation, site visits and in-depth analysis of the loans would not have been cost effective. The cost and time investment of thoroughly investigating some 19,000 borrowers spread across the country of China would have undermined the profit potential of the deal. Hence, a “sampling” of the portfolio was reasonable. 109. Zhongyu estimated that the value of the NPLs was between 3.90 percent and 9.76 percent of face value, or between $44,673,683 and $111,798,757, based on a sampling of borrowers. The Zhongyu report did not state a valuation standard by which it measured the Chinese NPLs that ultimately went into the Southgate portfolio.The value overestimated Southgate’s actual recovery. 110. Given the typical market practice in China in 2001, the Court finds that Southgate reasonably relied on Zhongyu’s analysis. Zhongyu’s analysis was consistent with Cinda’s own 5 percent target recovery rate for “category 4” loans. The Zhongyu valuation, when compared to Southgate’s 1.7 percent acquisition price, showed a reasonable possibility of profit. 111. As a part of its valuation analysis, Zhongyu graded certain loans in its sample as “A,” “B,” or “C” category loans. Category A and B loans were both categories of loans in which Zhongyu identified either “good quality assets” or “relatively good quality assets” available to support collections. 112. Based on his investigation of Zhongyu before he retained the firm, Montgomery reasonably believed that Zhongyu did not have any conflict of interest. Montgomery specifically asked whether Zhongyu had previously done work for Cinda. He was told that Zhongyu had not. 113. As early as October 2002, three months after the Southgate transaction closed, Tony Chen (“Chen”), who worked for MCA, wrote a memorandum stating that the information gathered by Zhongyu was “not complete and not enough.” Chen’s memorandum also indicated that the NPLs in the Southgate portfolio were “classified as ‘lowest priority loan’ before, which generally means there is only little hope to get the loans paid back.” Montgomery admitted that Chen’s criticisms of the Zhongyu appraisal were accurate. 114. In discovery in this case, it became known that Zhongyu undertook a simultaneous valuation study for Cinda on NPLs drawn apparently from the same pool, contradicting Zhongyu’s assertion that it had no conflict of interest. In the Cinda valuation, Zhongyu reached a valuation (1.18 percent and 1.56 percent) that supported Cinda’s decision to sell the loans to Southgate for 1.67 percent of the face value. In the Southgate valuation, Zhongyu reached a valuation (3.90 percent to 9.76 percent) which is used to support Southgate’s contention that there was an expectation of making a profit on the transaction. ii. Haiwen Opinion 115. MCA engaged Haiwen, a Chinese law firm, to conduct legal due diligence on Cinda and the NPLs, i.e., were the loans legally enforceable? Due to the size of the NPL portfolio, among other factors, Haiwen conducted its due diligence on a sampling basis representing all regions and industries of the obligors. 116. Haiwen reviewed 1,900 of the NPLs in preparing its due diligence report. Only one was found to be unenforceable, and less than 1 percent of the loans in the portfolio were to obligors in bankruptcy. Haiwen also reviewed approximately two-hundred of the NPLs with the highest principal amounts, and found documentation to support each one. 117. On or about August 30, 2002, Haiwen issued both a legal opinion and a Due Diligence Report to MCA. 118. Haiwen’s legal opinion included the following representations: (1) the transfer of the NPLs by Cinda to Eastgate was valid under the laws in China; (2) the NPLs were legally binding obligations under the laws in China, were genuine indebtedness, and had not been discharged; (3) Cinda was the sole legal and beneficial owner of the NPLs; and (4) Haiwen had not found any evidence that any NPLs had been written off as worthless or written down for financial or tax accounting purposes by Cinda. 119. Haiwen’s Due Diligence Report, based on its review of some 1,900 of the NPLs, included the following representations: (1) a People’s Republic of China (“PRC”) court had declared that one NPL loan contract was invalid; (2) four borrowers were bankrupt and the bankruptcy procedures for these four borrowers were closed and finalized; (3) thirteen borrowers were bankrupt and the bankruptcy proceedings were ongoing; (4) five borrowers were deregistered; (5) sixteen borrowers were in process of being dissolved; (6) there existed a PRC court order indicating that one borrower and the creditor (that is, CCB or Cinda) had reached a settlement; and (7) fifty-one borrowers had their business licenses revoked and they could not legally continue to trade. iii. Sinobridge Opinion 120. On or about August 30, 2002, MCA received an additional legal opinion from Sinobridge, a Chinese law firm that represented Cinda in connection with the Southgate negotiations, concerning the transfer of the NPLs to Eastgate and Southgate. 121. Sinobridge’s opinion included the following representations: (1) Cinda was a valid corporation and had the power and authority to execute the Contribution Agreement and the Southgate Operating Agreement in respect of Eastgate, and the LSA; (2) Cinda was required by government directive to acquire the NPLs by paying CCB cash with respect to the face amount and cash, bonds or other negotiable instruments with respect to accrued interest; (3) Cinda was the owner of the NPLs; (4) the transfer of the NPLs by Cinda to Eastgate was valid under Chinese law; and (5) the NPLs were legally binding obligations under Chinese law. The Court finds it was reasonable for Montgomery to rely on the opinions of Haiwen and Sinobridge. M. Southgate’s Due Diligence was Reasonable 122. The due diligence done by South-gate was consistent with what other investors were doing in the same time period. Montgomery took the pre-transaction steps necessary to put Southgate in a position to succeed. His efforts, and those of the professionals retained by and on behalf of Southgate, evidence Southgate’s genuine expectation of making some profit on this transaction. 123. Montgomery testified that he considered the difficulties that could be faced by an investor seeking to enforce judgments in Chinese courts, which led him to target a lower quality — and less expensive — loan portfolio. Despite the practical and legal difficulties in China’s system, various witnesses confirmed that these issues did not preclude successful collections efforts on non-performing loans. 124. The professionals retained by Southgate or on Southgate’s behalf appropriately evaluated the NPL portfolio. They considered, among other things, whether the NPLs were legally enforceable, what industries and geographical regions were involved, and whether Cinda had previously worked the loans. 125. Southgate’s due diligence efforts went beyond what is often done in this type of transaction. When a high net-worth investor invests in a pool of loans for which he is paying pennies on the dollar, due diligence is not necessarily cost-effective. Such an investor normally invests in the loans for a small percentage of their face value in the hopes of finding “nuggets” or “gems” — the relatively small number of recoverable loans — that will make the purchase profitable. In such circumstances, due diligence is often not worth the expense. 126. Southgate’s experts, Osborn and accountant Cosimo Borrelli (“Borrelli”), who themselves have conducted due diligence on pools of non-performing loans in China, found Southgate’s due diligence, and the work of Zhongyu and Haiwen, reasonable. The Court agrees. 127. Borrelli works in Hong Kong as managing director of an insolvency restructuring firm, akin to a bankruptcy trustee in the United States, and has significant hands-on experience with due-diligence and analysis of non-performing loans generally and the Chinese non-performing loan market specifically. Borrelli has more than twenty years of experience dealing with non-performing loan servicing and due diligence, and since 1999 he has worked extensively in the Chinese and Asian non-performing loan markets. Borrelli has advised investors in and done due diligence on pools of Chinese non-performing loans of a size and quality similar to Southgate’s. In addition, Borrelli has repeatedly been appointed by courts in Hong Kong and elsewhere as a trustee, liquidator, and receiver. In that work, Borrelli has had experience with, among other things, resolving legal disputes and claims with mainland Chinese creditors, including AMCs, and implementing a restructuring with the Chinese Ministry of Finance. 128. Zhongyu’s sampling methodology and approach to evaluating the NPLs was both reasonable, appropriate, and “typical of what [one] would expect to see,” in light of the size, scope and quality of the portfolio. 129. Likewise, the legal due diligence conducted by Haiwen was reasonable and typical. 130. Barnhill and Yang contend that Southgate failed to conduct adequate due diligence prior to acquiring the NPLs and that Southgate’s failure to do further investigation undermined the credibility of, and any hope for a successful return on, its investment. Barnhill and Yang were unaware of either the specific due diligence efforts undertaken by any other foreign non-performing loan investor or the typical due diligence practices of Chinese nonperforming loan investors at the time of the Southgate transaction. Barnhill and Yang’s testimony regarding Southgate’s due diligence therefore does not change the Court’s analysis. 131. Barnhill and Yang argued that Zhongyu relied on information from Cinda’s loan files that could have been biased or incomplete. Because Barnhill and Yang do not actually know what was in the files that Zhongyu reviewed, they have no information that the sample of loans studied by Zhongyu was biased. Moreover, the information in Cinda’s loan files was typical of what was seen in AMC loan files in 2002, and Barnhill and Yang have no evidence to the contrary. 132. Barnhill and Yang also testified that Zhongyu’s valuation did not account for the efficiency of the Chinese legal system, a factor that could affect Southgate’s return on its investment. Barnhill and Yang did not know whether or not Zhongyu factored the efficiency of the Chinese legal system into its analysis because there was no specific analysis or line item in Zhongyu’s valuation to reflect it. 133. Barnhill offered an “alternative” valuation in the form of a completely theoretical model. This hypothetical model has little probative value about the real Southgate transaction. Barnhill concedes that his model is not any kind of industry standard, and cannot point to a single instance where his theoretical model has been used to value a non-performing loan portfolio, in China or elsewhere. The model cannot be used to determine the value of the NPLs, because it requires gathering multiple data points and applying the model to each