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L6256X
Professor Chirelstein
IF YOU ARE A CANDIDATE FOR GRADUATION IN FEBRUARY, 1996, WRITE ON THE COVER
OF YOUR FIRST ANSWER BOOK (OR, IF TYPEWRITTEN, AT THE TOP OF YOUR FIRST PAGE),
"CANDIDATE FOR GRADUATION IN FEBRUARY, 1996."
INSTRUCTIONS:
This is a limited open-book examination. You may bring with you to the examination your Code
and Regulations volume, but nothing else.
Answer each of the following questions - - there are four - - in sufficient detail to convey your
reasoning as well as your conclusions, but please use no more space than is really necessary. And do,
please, write legibly.
_________________________________
Question I
Walgreen Co., a drugstore chain, has for some years operated a pharmacy in the Northpark Mall
outside Milwaukee. Under the terms of Walgreen's lease (which still has six years to run), the Mall owner,
Sara Creek Property, Inc., promised not to lease space in the Mall to any other store that operates a
pharmacy. In 1994, concerned that its main tenant (K-Mart) was about to close up and move, Sara Creek
informed Walgreen that it planned to replace that tenant with a large store operated by Phar-Mor Corp., a
deep-discount chain, that would in fact contain a pharmacy. Walgreen promptly brought suit against Sara
Creek in State court seeking specific performance of the lease restriction mentioned above. The suit was
successful: the State court entered a permanent injunction prohibiting Sara Creek from renting space to
Immediately after the court's decision, Walgreen offered to terminate the lease restriction (in effect,
release Sara Creek from the injunction) for a cash consideration of $250,000. Sara Creek is unable to pay
so large a sum but Phar-Mor, which anticipates good business at the Mall despite the continued presence of
the Walgreen pharmacy, has stated that it is prepared to accept Walgreen's offer and pay the $250,000 in
All three parties - - Walgreen, Sara Creek, and Phar-Mor - - now ask you to analyze the federal
Question II
Early this year the New York City Fire Department promulgated a new set of physical fitness
regulations which apply to all firemen who are engaged in daily fire-fighting activity. Under the new
regulations, any fireman who is more than 25 pounds overweight on December 15 (based on Tables
published by a well-known health insurance company) will be subject to demotion in grade or even
dismissal. Jones, Smith and Brown were all well over their respective weight limits at the time the new
regulations were issued. Each responded to the regulations in a different way, to-wit:
Jones joined a physical training program and hired a personal nutritionist to help him lose weight.
He succeeded in getting his weight down to the required level by the deadline date and, hence, has been
able to keep his regular job on the fire truck. The cost of the training program and the nutritionist's
Smith brought a legal action against the Fire Department seeking to enjoin enforcement of the new
fitness regulations on the ground that those regulations were arbitrary and capricious. He lost in the trial
court but has taken an appeal, pending the outcome of which he has been permitted to remain at his usual
Brown reacted by signing up for a six-month course in "accounting and management" at Pace
College. The course enabled him to pass an exam for, and actually obtain, an administrative post within the
Fire Department. The fitness regulations apply only to active-duty fire-fighters but not to administrators
and other office personnel. The salary Brown now receives as an administrator (clerk) is slightly less than
the salary he got as a regular fireman. The Pace College course cost him $1,500.
Jones, Smith and Brown all want to know whether they can deduct their $1,500 outlays. What is
Question III
In his campaign for the Republican presidential nomination this year, Senator Richard Lugar of
Indiana has proposed that we scrap the present federal income tax and substitute for it a national sales tax.
Such a sales tax (like our State and City sales taxes) would apply to the purchase at retail of all goods and
services (maybe with various limited exemptions, e.g., medical care). Certainly one advantage of the Lugar
proposal (others are claimed) is simplification -- no more individual income tax returns, no more audits by
Despite the simplification benefit, one learned commentator, interviewed on the evening news, has
characterized -- and by implication denounced -- the Lugar proposal as "nothing more or less than a tax on
wages". A friend of yours, having heard the interview, admits to being puzzled by the quoted statement.
Why is a sales tax, she wonders, equivalent to "a tax on wages"? Accordingly, she now asks you to try to
explain that statement to her and to say whether you think the statement is accurate.
Your friend is in a hurry to keep an appointment, so she hopes you can enlighten her in not more
Question IV
Howard, an investment banker, enjoyed some very high income years back in the mid-1980's and in
1985 bought a vacation home in the Hamptons for $1,150,000. Howard paid $100,000 out of his own
resources and borrowed the balance, $1,050,000, on a 10-year mortgage from the Long Island Savings Bank
(the Bank). The vacation home was the securing property, of course, and Howard, like almost all residence
Howard's income has declined sharply during the past few years and he now finds himself unable to
meet the monthly mortgage payments when due; indeed, he is several months behind at present. As a
result, the Bank has announced that it intends to foreclose. To make matters worse, the Hampton vacation
home has plummeted in value and is now appraised at only $400,000. The unpaid principal balance of the
mortgage-loan (Howard did pay off $50,000) currently stands at about $1,000,000.
Fortunately (in a sense), Howard also owns a regular family residence in Westchester with an
appraised value of $800,000. There is no debt on the Westchester residence -- Howard owns that property
free and clear. Howard's cost for the Westchester residence, which he bought a long time ago, is $300,000.
In order to avoid the Hampton foreclosure (a terrible embarrassment, among other things), Howard
has proposed to the Bank that the Westchester residence - - which, at least, has an appraised value twice
that of the vacation home - - be substituted for the Hampton property as security for the $1,000,000
mortgage debt. If this is done, however, Howard insists (a) that the mortgage-loan be converted into a
involve no personal liability for him in the event of a future default, and (b) that the mortgage-loan itself be
changed from a 10-year to a 30-year loan so that the monthly payments will be less burdensome. The
Bank, eager to avoid the cost of a foreclosure proceeding, is apparently interested in Howard's proposition
Having recently described the above proposal to one of his golfing friends, Howard was surprised
to hear the friend mutter something about possible income tax consequences to Howard himself if the
proposal should be accepted by the Bank. Worried, Howard consults you. Advise him.
End of Examination