How Reality Severely Limits My Vast Legal Super-Powers

The highly skilled lawyer who saves the protagonist from certain impending legal doom is one of the most iconic images in popular media.  Perry Mason of course stands out as one of the first characters that fit this bill, although others such as the cast of LA Law (a college favorite), The Practice and Law and Order stand out as well.  Real life examples include Clarence Darrow (who was portrayed wonderfully by Spencer Tracey in Inherit the Wind) and Johnny Cochran ("If the glove does not fit, you must acquit!").  These real and fictional individuals have given the public the impression that lawyers are super men who can always overcome disadvantageous odds to secure victory.

Sadly, realty often intrudes into real life expectations.  For while I would love to tell clients that I am one of these supermen of yore, I am in fact greatly hampered by three elements: the facts and circumstances of a particular case, the law as it is (not as we want it to be) and the legal code of ethics.  Let me explain each of these in more detail.

Hypothetically, suppose I'm a defense attorney, called in to defend an accused murderer.   On the other side of the court sits the prosecution who has four witnesses, all of whom are nuns with 20/20 vision and perfect recall memory, none of whom were more than 10 feet from the incident when it occurred.  Three video tapes of the crime also exist (all of which can be substantiated at trial), all with a good angle to witness the event.  While the TV or movie lawyer would be able to overcome these facts, the real attorney would merely be trying to keep his client out of the execution chamber (assuming the state had the death penalty).  Although these facts are deliberately extreme, they illustrate a key point: we are always limited by the facts and circumstances of the case we are given.  On a far more mundane (and far more realistic) note, consider a potential client who wants to form a captive insurance company, but who is also in the middle of a lawsuit.  Under the Uniform Fraudulent Transfer Act, I can't do anything because this transaction could easily be construed as an attempt to "hinder, delay or defraud" a potential creditor.  As these illustrations highlight, the facts and circumstances of a particular fact pattern can severely limit my legal options.

The law as it exists (not how we theoretically want it to be) is another element that can provide a fair amount of constraint for legal representation.  Suppose a client wants to transfer money to an offshore jurisdiction that has very tight secrecy laws with the intent of not paying US income taxes.  The clients states this is his goal.  At this point, I have to advise him that 1.) going offshore to hide money is illegal, 2.) he will have to file an informational return to comply with US law, regardless of what he wants to do, and 3.) as the US has a world wide taxation regime, he'll have to pay taxes on his offshore funds.  The preceding three statements highlight the law as it is, so, as an attorney, I would have to tell the client that his motivation runs afoul of the law.  It also means I probably won't be representing this client.

As a first corollary to the preceding point, it's also important to note that I can't fix your behavior after it occurs so that it complies with the law.  Like most people, potential clients regularly "shoot first and ask questions later."  And while I don't expect to be consulted on mundane issues, being aware of a bigger decision before it's made to discuss its legal ramifications helps to prevent bigger problems from developing.  Regrettably, attorneys are usually the last people consulted on decisions.

Finally, there is the legal code of ethics, with the biggest prohibition I face as an attorney:

(a) A lawyer shall not knowingly:

(1) make a false statement of fact or law to a tribunal or fail to correct a false statement of material fact or law previously made to the tribunal by the lawyer;

.....

(3) offer evidence that the lawyer knows to be false. If a lawyer, the lawyer’s client, or a witness called by the lawyer, has offered material evidence and the lawyer comes to know of its falsity, the lawyer shall take reasonable remedial measures, including, if necessary, disclosure to the tribunal. A lawyer may refuse to offer evidence, other than the testimony of a defendant in a criminal matter, that the lawyer reasonably believes is false.

I realize it may sound like a joke that an attorney can't lie, nor can he coach others to lie.  But there it is, plain as day in the model code of conduct.  And it's something that I and other lawyers whom I know take very seriously.  There is also new formal guidance for attorneys regarding representation and its relationship to money laundering -- rules which are very similar to the "know your client" rules.

So, what exactly can I do?  Within the confines of the above stated concepts, a great deal.  First, I can develop and implement a strategy that is compliant with the law as it exists.  Unlike the impression given by such services as Legal Zoom, the law is not merely a series of interlocking forms; each element of a form has legal ramifications and is derived from a substantive area of law that must be understood.  Second, I can keep this plan compliant with the law at it develops.  Remember, the law is always changing, sometimes in substantive ways.   Third, I can keep you out of trouble so long as you consult me on big decisions.     

So, the above three points are really my vast legal super powers as they exist in the real world.  

 

Using the Material Participation Rules to Establish Corporate Substance

As I have previously noted, the concept of corporate "substance" is a poorly developed area of law.  In this post, I wanted to expand the concept for the practitioner with the intent of borrowing from other legal areas in the hopes of providing further guidance.  I want to note upfront that the analysis I am about to offer has to my knowledge not been proposed or offered in any case law or law review article (if a reader knows of this, please post it in the comments); it's merely presented as a way to broaden the concept and provide high level guidance.

Establishing corporate substance is incredibly difficult for the small to medium size business owner for two reasons: (1) they typically work long hours building their business but (2) they have insufficient staff to document their actions in order to establish the requisite paper trail proving corporate substance.  Compare this to a larger company which either has in-house legal or an ongoing relationship with an outside firm that continually monitors and documents the company's legal developments in real time.  The former situation could leave a company vulnerable to a veil piercing claim in the event of lawsuit with the lack of a contemporaneously created record adding fuel to the fire.  But an alternative approach does exist which borrows from tax law, using the concept of material participation.

The material participation rules were added to the tax code in reaction to the tax shelter industry of the 1970s and 1980s, where promoters put together limited partnerships that primarily invested in assets with high interest deductions or depreciation expenses.  A deeper examination of these deals usually revealed a remarkable lack of business substance, and included things such as phantom loans, circular cash flows and massively overstated basis.  These deals were sold to high net worth individuals who were looking for ways to obtain losses to offset income; they wouldn't "materially participate" in these deals, instead acting as the classic "silent partner" exemplified by their legal status as a limited partner. 

As a result, Congress passed section 469 of the tax code, which divided income into passive and active income.  "Usually, passive activity losses can be offset only against passive activity income." William Hoffman, Corporations, Partnerships, Estates and Trusts, page 10-35 (c) 2008, West.  Hence, limited partners would now need to have passive gains against which to offset their passive losses, essentially shutting down this type of tax shelter.

But just as important as passive activity is active activity, which is established by a person "materially participating" in the enterprise.  Under section 469, "[a] taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is—
 

(A) regular,
(B) continuous, and
(C) substantial. 

The regulations provide some guidance on the actual definition of these terms.  Here are three basic facts patterns from the accompanying Treasury Regulations that would apply to most individuals:

(1) The individual participates in the activity for more than 500 hours during such year;

(2) The individual's participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

(3) The individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

Arguing material participation is prima facia evidence of corporate substance has one powerful benefit: counsel is not advancing a new, untested concept, but instead relying on a well-established and now well-developed area of law to prove his point.  

The three fact patterns would apply to a broad swath of entrepreneurial activities.  Assuming a 40 hour work week (which grossly understates the hours worked by most business owners), fact pattern 1 would account for 3 1/2 months of work.  Fact pattern two would be appropriate for any individual who is self-employed and has filed entity status (and when combined with fact pattern 1 would be extremely powerful) while fact pattern 3 would apply to most lightly staffed companies.  

More importantly, all three fact patterns should establish a sufficient amount of corporate substance as they indicate a fair amount of activity -- at least enough to give a potential veil piercing claim pause.

Veil Piercing and Corporate Substance

The idea of corporate substance is essential to corporate law.  Professors inform students in corporation class they must endeavor to give their corporate clients "substance" lest courts be given the opening to pierce the corporate veil.   Unfortunately there is a dearth of scholarship defining and developing this concept, despite its obvious importance.  While this post will hardly provide the depth needed for a true analysis, it will provide some insight on the exact nature of this idea.

Depending on your view, a corporation is either a privilege granted by the state (an older, more traditional view) or a nexus of contracts (from a law and economics analysis).  But regardless, it's an artificial construct with no physical existence.  At the same time, a corporation is allowed to perform many of the acts of an individual such as sign contracts, sue and be sued, hold property, transact business and the like. Del. Code Ann. tit. 8 Section 122.  This leads to the question of how exactly do we prove the corporation not only exists, but is in fact a unique entity with a separate existence? Or, to put it more existentially, how to we demonstrate it is "alive" or has "substance?" 

This is usually demonstrated by establishing a paper trail -- meeting minutes, a sales records, contracts and the like.  This leads to point number 1: the paper trail must exist and it must be documented.  Ideally, each fiscal year of a corporation's life can be placed into a folder (most likely electronic in nature) that includes contracts, payments, meeting minutes etc... outlining what exactly has occurred.  The folder should be readily available and easy to access. 

But there is an important corollary to rule number 1: the existence must demonstrate uniqueness, which is defined as, "existing as the only one or as the sole example; single; solitary in type or characteristics."  While this is easily accomplished with a larger publicly traded or private company it can run into trouble with smaller, closely held family businesses.  As an example, take the generic company Acme Corp.; Mr. Smith is the president, and Mrs. Smith is the treasurer.  The company has made two questionable purchases: high-end cars for its executives as a perk and property in a known vacation spot like Colorado in the name of "entertaining potential clients."  Has the company purchased these for legitimate corporate reasons or has the Smith family used the company to make personal purchases disguised as company purchases?

Enter the concept of "alter ego" from veil piercing doctrine.  According to Ballentine's Law Dictionary, an alter ego is literally "the other self."  Instead of the company being a separate and distinct legal entity, it's actually an extension of an individual or another company who are using the limited liability shield not to protect their investment (a primary reason for the shield) but instead for other, non-state sanctioned purposes such as fraud.  When the inter-mingling of personal and business substance is so inter-twined -- or when a company is not "unique" but a mere extension of an individual --  a court can "pierce the corporate veil" stripping the company of its limited liability shield thereby making the individual shareholders personally responsible for the corporation's debt. 

Depending on the jurisdiction, there are either two or three elements to veil piercing.  The three prong test is usually worded thusly: (1) a single individual or small group of individuals is in complete control of the company, (2) they use the corporation to commit some type of tort or breach of contract and (3) the tort or breach is the proximate cause of the plaintiff's harm.  The two prong test is phrased thusly: there is such unity of the interests between the individual and the corporation that the separateness of the corporation is erased and holding the "alter ego" as the only liable party would lead to an injustice.  There is a fair amount of overlap between the two tests.  In addition, veil piercing is not the cause of action but the equitable remedy; the plaintiff must allege an additional cause of action such as fraud or breach of contract.

The courts will look at many factors to consider piercing the veil, such as, "(1) majority ownership and pervasive control of the affairs of the corporation; (2) thin capitalization; (3) nonobservance of corporate formalities or absence of corporate records; (4) no payment of dividends; (5) nonfunctioning of officers and directors; (6) insolvency of the corporation at the time of the litigated transaction; (7) siphoning of corporate funds or intermingling of corporate and personal funds by the dominant shareholder(s); (8) use of the corporation for transactions of the dominant shareholder(s); and (9) use of the corporation in promoting fraud."  Pointer (U.S.A.), Inc. v. H & D Foods Corp., 60 F. Supp. 2d 282, 287 (S.D.N.Y. 1999).  There is no magical combination of factors for the court to use in arriving at its decision.  Instead, they weigh various elements in relation to the facts.

And this returns us to the concept of "substance."  A company that exhibits some of the factors listed in the previous paragraph and also engages in questionable behavior does not demonstrate that it has sufficient substance to be recognized at law.  In the alternative, it is not a unique entity with its own demonstrable personality, but instead an abuse of the limited liability granted by law.  As there is insufficient substance, a court can hold individual shareholders personally liable for corporate debts and obligations.  

 

An Inquiry Into the Legitimacy of Offshore Planning: Establishing Business Purpose

I have previously referred to US anti-avoidance law as a "conceptual briar patch."  In learning about this law, the practitioner is first faced with a fundamental question of just how many US doctrines exist.   He could easily come to the conclusion there were five, which are

1. Substance over form
2. Sham Transaction
3. Business Purpose
4. Economic Substance 
5. Step Transaction Doctrine

At the same time, he could reasonably conclude the sham transaction and economic substance doctrine are the same concept (both have an objective and subjective component) with sham transaction terminology used from the late 1950s to the late 1970s/early 1980s and the economic substance doctrine used thereafter. Or he could conclude the sham transaction is used in simpler transactions (such as interest deduction manipulations) whereas economic substance is used in more complex transactions (such as the tax evasion plans promulgated during the 1990s).  And is the business purpose doctrine a separate doctrine or one of the factors of the shame transaction/economic substance doctrine?  A reading of the case law supports both views.  And just to make matters that much more confusing, aren't they all really just branches of the substance over form doctrine?  

The preceding discussion highlights the overall complexity of this area of US tax law.  I will admit to treating the business purpose doctrine as one of the factors of the economic substance doctrine for a number of years, largely based on the BNA Tax Portfolio asserting this argument. However, I have come to the conclusion that business purpose is a separate doctrine for two reasons.   The first is the Frank Lyon Supreme Court Decision Frank Lyon Co. v. United States, 435 U.S. 561 (1978).  Any doctrine outlined in a Supreme Court case should rise of the level of black letter law, largely based of the precedential weight afforded the deciding body.  But just as importantly, this case provides a positive set of factors with which the practitioner must comply.  This is in sharp contrast to the vast majority of anti-avoidance cases which contain only negative suggestions: most cases essentially state don't do this, but offer no affirmative guidance. 

The facts in the case are straightforward.  Worthen bank in Arkansas wanted to build a new headquarters.  However, "[a]s a bank chartered under Arkansas law, Worthen legally could not pay more interest on any debentures it might issue than that then specified by Arkansas law. But the proposed obligations would not be marketable at that rate."  To avoid this problem, the bank structured a sale-leaseback transaction, selling the building and underlying property to the Frank Lyon company (Frank Lyon sat on the bank's board), who in turn leased the building back to the bank.  New York Life also provided financing.  The service determined that for tax purposes Lyon did not own the building, so the deductions claimed as a result of property ownership were not allowed.  While the lower court sided with Lyon, the appellate court ruled for the service.

Sale-leaseback transactions are hardly a revolutionary concept.  In fact, I believe one could argue they are part and parcel of corporate transactional practice -- a reality recognized by the court:

The present case, in contrast, involves three parties, Worthen, Lyon, and the finance agency. The usual simple two-party arrangement was legally unavailable to Worthen. Independent investors were interested in participating in the alternative available to Worthen, and Lyon itself (also independent from Worthen) won the privilege. Despite Frank Lyon's presence on Worthen's board of directors, the transaction, as it ultimately developed, was not a familial one arranged by Worthen, but one compelled by the realities of the restrictions imposed upon the bank. Had Lyon not appeared, another interested investor would have been selected.  The ultimate solution would have been essentially the same. Thus, the presence of the third party, in our view, significantly distinguishes this case from Lazarus and removes the latter as controlling authority (Lyon at 576-576).

By noting the taxpayer had a legitimate business reason to structure the transaction in this manner, the court outlined several factors that must be present in all business transactions to demonstrate business purpose:

1. there is a genuine multiple-party transaction 
2. with economic substance that is 
3. compelled or encouraged by business or regulatory realities, 
4. that is imbued with tax-independent considerations, and 
5. that is not shaped solely by tax-avoidance features to which meaningless labels are attached.  (Lyon at 583-584)

Now that we've outlined business purpose factors, the question logically turns to proving a transaction complies with them.  As I've previously noted, one commentator has correctly observed that business transactions fall into three categories: increasing revenue, lowering expenses, raising financing or some combination of the three (Peter C. Canellos, Business Purpose, Economic Substance and Corporate Tax Shelters, 54 SMU L. Rev. 47, 52-53, (2001)).  I would add that lowering a risk profile is also a valid business purpose.  This is one of the fundamental reasons corporations divide themselves into divisions and a primary motivator for incorporation in the first place.  Successfully showing that a transaction falls into one or more of these categories would demonstrate substance.  The process of making this determination requires the lawyer to look at the transaction at the company level, making an exhaustive inquiry one that is similar to those engaged in by courts implementing an economic substance doctrine investigation.  Only after the practitioner develops the facts of the case should he begin developing a transactional strategy that incorporates various elements of law such as business entities, tax, securities and insurance.

An Inquiry Into The Legitimacy Of Offshore Tax Planning; Substance Over Form and World Wide Taxation

When planning and constructing a transaction, merely complying with the technical provisions of the code is insufficient.  For example, the tax code allows a specific deduction for interest (26. U.S.C. 163).   But the debt used in a transaction claiming the deduction must comply with certain factors in order for the transactional instrument to be recognized at law.  All tax code sections contain this added layer of depth with which each element of the transaction must comply.  This is the lesson learned from the myriad tax shelters promoted by large accounting firms in the 1990s that followed the letter of the law to a "T" but had no corporate substance (see this Senate report (from the 108th Congress) on the US tax shelter industry).  

All of the transactions listed in this report (BOSS, son of BOSS, OPIS, BLIPs and many others) began with an extremely technical analysis of a particular code provision -- or even a much smaller sub-section of the code.  A structure was then built around this particular analysis and sold to clients.  The inherent problem with this methodology is it completely ignores the particular client's situation and moreover assumes a uniformity of structure and need between potential clients that does not exist.  The proper way to construct a transaction is the exact opposite: begin with an analysis of a client's overall situation and stated goals then develop a solution which complements that situation.  While it sounds cliche' (and perhaps a bit like a legal inside joke) the individual facts and circumstances of each circumstance really are unique and should be considered in their respective entirely to craft a unique solution to each situation.

When looking at the legislative intent (or substance) of the tax code, one fact stands out very clearly, rising to the stature black letter law: the US' tax code intends to tax US citizens on their world wide income.  This is derived from two sources, the first of which is a plain reading of 26 U.S.C. 61 which states, "gross income means all income from whatever source derived, including (but not limited to) the following items."  The accompanying Treasury Regulations use the exact same phrase: "Gross income means all income from whatever source derived, unless excluded by law."  And finally, Treasury Regulation 1.1-1(b) states, "In general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States."

Regarding foreign earned business income, earnings from various foreign corporations is included in the income of certain US shareholders under the controlled foreign corporation statute (sections 951-965 of the tax code).  These rules were added to the tax code in the early 1960s as a way to prevent the then growing practice of forming a corporation offshore and then transferring family wealth to the newly formed foreign corporation.  The assumption in this section of the code is that certain offshore structures are prima facie evidence of tax evasion.  Offshore partnership income is assumed to flow through to US taxpayers via general partnership law tax principles and the code sections listed in the previous paragraph clearly and indisputably apply to personally earned income.  Certain income from offshore trusts are also included in US taxpayer's income under specific grantor trust rules.  Finally, the US tax code uses a foreign tax credit system, offsetting US taxes with foreign taxes paid.    

The legislative intent could not be clearer: the code defines income in the broadest terms possible, and then specifically excludes various categories of income, all contained in Chapter 1, Subchapter B of the tax code.  The locus of the earning activity is not relevant; it is included unless specifically excluded.  Put more directly, the substance of the tax code when read in its entirely is that all income earned by US citizens is taxable by the US.  Moving offshore for the sole purpose of avoiding US taxation runs counter to legislative intent and the substance of the tax code when read holistically.  And complying with the technical requirements of code -- especially in small section level pieces -- is insufficient legal grounds for a transaction to be recognized at law.



       

 

An Inquiry Into The Legitimacy Of Offshore Tax Planning; Part I the Parameters

Apple's tax plan -- and subsequent appearance before Congress defending their plan -- has again drawn attention to the idea of offshore planning.  The overall debate has fallen into the fairly predictable pattern of the political right saying Apple is 100% allowed to perform whatever they can to lower their taxes while the political left has decried the practice as a deliberate evasion of taxes.  What both sides have failed to do is place the idea of offshore planning in the context of US anti-avoidance law in order to determine if the structure would indeed stand-up to scrutiny in the event it was challenged in court.  While the analysis that follows will hardly be an in-depth treatment, it should serve to highlight some of the legal issues involved with complex international tax planning of this nature.

By way of introduction, there are two core concepts of US anti-avoidance law, both of which are derived from the same case, Gregory v. Helvering.  The concept which is by far most cited is that taxpayers are allowed to structure their affairs to minimize taxation.  However, just as important -- but not cited with near the frequency -- is that all transactions must have substance; merely complying with the technical requirements of the code is insufficient.  In Gregory, the taxpayer performed a corporate formation and liquidation over a three day period.  The court ruled this short duration indicated the corporation was not meant to be used for a legitimate business purpose, but was instead a technical shell game used to minimize taxes.  In ruling against the taxpayer, the court forever added an additional layer to tax planning -- the need to demonstrate transactional "substance."

Further complicating our analysis are two issues.  The first is that "legal substance" is an ephemeral and ill-defined concept.  Little to no scholarship has been performed on the idea.  The vast majority of courts dealing with this issue gloss over it, usually stating the act of formation is sufficient in and of itself to demonstrate a legitimate enterprise.  However, this is exactly what the taxpayer did in Gregory only to have the court rule against her.  Perhaps the best list of factors for practitioners to use to demonstrate substance (or at lease corporate separateness) comes from veil piercing law, where many courts have a list of factors to determine if a company is in fact an "alter ego" of the person incorporating the company.  A strong argument could also be made that the material participation standards of 26 U.S.C. 469 could provide some much needed parameters for comparison.  However, no court decision that I'm aware of has formally applied these commonly used and understood concepts to the area of corporate substance. 

The best explanation I have found for "substance" is from a law review article titled "Business Purpose, Economic Substance and Corporate Tax Shelters" by Peter C. Canellos (54 SMU L. Rev. 47) where he notes that the vast majority of legitimate business transactions (which would therefore survive a substance over form challenge) have at their core one of three purposes: increasing profit, lowering expenses or acquiring/raising financing.  However it should be noted that only lowering a tax expense is insufficient.  Unfortunately from a practicing perspective, whether or not a transaction falls into one of the three categories usually falls under the, "I know it when I see it" column.

The second problem complicating an analysis of the transaction is that substance over form law is itself a conceptual briar patch.  Despite it's importance to tax law, no case law book has ever been written on this topic.  Shepherdizing the Gregory case returns over 1000 cases, law review articles, CLE materials and practitioner's guides.  Courts routinely use various substance over form terms interchangeably and incorrectly, and return conflicting decisions on the same or similar facts.  While five actual anti-avoidance law concepts have been cited and developed in the case law (substance over form, the sham transaction, business purpose, the economic substance doctrine and the step transaction doctrine), legitimate scholarly debate could support the contention that there is only one, or three, four and five doctrines.     

Going forward, I'm going to look at offshore  from three perspective: substance over form, economic substance and business purpose.  Substance over form will use the concepts outlined above ("material participation" and the factors in "alter ego" analysis will be used.  There will also be an explanation of legislative intent).  I will make the assumption that the economic substance doctrine is a latter day version of the sham transaction doctrine ("sham transaction" language was used primarily in the 1950s-1970s while "economic substance" language was used from the late 1980s/early 1990s onward; both contain an objective and subjective component).  The business purpose doctrine will use the factors outlined in the Frank Lyon case.  As the step transaction doctrine is most often used in corporate reorganizations or shorter duration transactions, it will not be used. 

Captives and Insurance Policies/Contracts

In my opinion, the ability to draft your own insurance policies is one of the largest advantages of a captive insurance company.  However, it's very difficult to explain to the non-lawyer why this is such a great benefit.  To the uninitiated, this is at best an advantage that barely gets past a "ho-hum."  Words are words, phrases are phrases, and the placement thereof is not important.  But as attorneys who draft documents on a regular basis,the choice of words, the nature of a phrase and all other manners of writing English is our milieu; the placement of a word of phrase can make or break a document.  Let me provide two examples, one from the captive world and one from the non-captive world. 

The parties in "Frigaliment Importing, Co, v. B.N.S. International Sales Corp. (190 F. Supp. 116, SDNY 1960) were engaged in the poultry business.   The defendant agreed to sell "chickens" to the plaintiff.  Simple transaction, right?  The problem arose when the plaintiff and the defendant disagreed on exactly what a "chicken" was.  Because both parties defined chicken differently, the product supplied by the defendant to the plaintiff was considered sub-standard by the plaintiff, leading to very expensive litigation.  This entire situation could have been avoided if both parties had agreed to define "chicken" in the contract.  In fact, a well-written contract will have an entire section devoted to definitions to avoid this very type of misunderstanding. 

In the captive world, consider the case of Beech Aircraft (Beech Aircraft v. U.S., 1984 WL 988 at 1) who had an insurance policy which gave the insurance company complete control of insurance counsel throughout the entire litigation process.  The company did not like insurance appointed counsel during a very expensive product liability case, and went so far as to file a motion to have the court remove counsel.  The court denied the motion and Beech eventually lost the case, facing an adverse judgment of over $17 million dollars.  Beech formed a captive to gain complete control of counsel in the event of a lawsuit.

Because an insurance transaction is viewed more as a sale then a contract negotiation, the parties pay remarkably little attention to the contents of the policy, nor do they consider how beneficial it would be to re-draft the document to their liking.  For example, suppose we define the terms of a cyber liability policy very broadly, so that a breach would occur in a wider variety of circumstances.  This would allow the parent company to have far broader coverage for its cyber exposures.  Or consider the addition of a clause in the claims section of a policy that stated minor mistakes in the claims submission process would not jeopardize the claim itself.  Both of these additions are very beneficial to the insured -- and would therefore not be included in the average policy.

Let me leave you with a most egregious example.  Over the last year, I reviewed a policy for a client.  I wrote a basic legal summation of the policy and returned it to him.  During the call where we reviewed the analysis, he asked for the "quick down and dirty."  I told him that there was literally no way the insurance company would ever pay on the policy -- the language was that restrictive.  And while the company might argue that the policy was an adhesion contract and would therefore be interpreted against them by a court, the reality is the adhesion contract concept is a great law school exam answer that has little effective application in the real world.  

As the examples above illustrate, writing your own policy gives you complete control of the transaction -- a benefit no third-party insurance company would ever allow you to have.