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In high stakes litigation, the financial implications of a verdict can be as complex as the legal battle itself. The following case study delves into a representative, high value case that resulted in a substantial $20 million verdict and showcased the critical importance of strategic financial planning in maximizing the plaintiff's recovery.

The Case at a Glance

Our plaintiff, a reputable tax professional, found themselves at the center of a damaging defamation campaign. The defendant, a competitor, had knowingly and maliciously made false statements claiming that the plaintiff lacked the licenses to conduct their business legally. These allegations struck at the heart of the plaintiff's professional integrity and threatened to derail years of hard-earned success and a glowing reputation.

The ensuing legal battle resulted in a judicial award for the plaintiff. The court rendered a verdict awarding a staggering $20 million in damages plus attorney fees and costs. This victory, while vindicating, brought with it a new challenge: navigating the complex tax implications of such a substantial award.

The Tax Conundrum: Punitive Damages and Contingency Fees

Of the $20 million award, 10 million were punitive damages. While this substantial sum was a strong deterrent against future defamatory actions, it also presented a significant tax challenge. Under normal circumstances, the plaintiff and their attorneys would face hefty tax bills on this portion of the award. The crux of the issue lay in the taxation of contingency fees associated with punitive damages. Typically, these fees are taxable income to the plaintiff, even though they are paid directly to the attorney. This quirk in the tax code stems from Commissioner v. Banks, a case which was decided by the US Supreme Court addressing the issue of whether the portion of a settlement or judgment award paid to a plaintiff's attorney under a contingent fee agreement is taxable income to the plaintiff. Thus, the plaintiff will pay taxes on money they never received. This results in the need for an ingenious strategy.

As a tax professional, our plaintiff knew about the complicated tax problems that would follow his victory. In preparation, he and his legal team planned an ingenious strategy. This strategy would utilize two separate tools: the 468B qualified settlement fund and the Plaintiff Recovery Trust. By using them in conjunction, the plaintiff maximized his possible tax savings. But what is a 468B qualified settlement fund? This financial tool - named after the Internal Revenue Code section that governs it - would prove invaluable in managing the settlement proceeds.

The QSF acted as a temporary holding account for the award, providing several key advantages.

1. Time for planning - It allowed the plaintiff and their advisors breathing room to make informed decisions about the distribution of funds without immediate tax consequences.

2. Flexibility - The QSF provided options for structured settlements and other tax-efficient distribution methods.

3. Protection -During the planning phase, it shielded the funds from creditors and other potential claims and removed the defendant from creating additional problems.

Using the QSF, the plaintiff's team laid the groundwork for a comprehensive financial strategy to maximize the net recovery from the verdict. However, it was doubly effective with its paired tool. Enter the Plaintiff Recovery Trust, a tax-saving innovation.

In addition to the QSF, the plaintiff's financial advisors proposed utilizing the Plaintiff Recovery Trust (PRT) to address this looming tax burden. This specialized trust is designed to eliminate the taxation on the contingency fee portion of the punitive damages.

How the QSF and PRT Work Together

Step one, the plaintiff assigned their entire claim for damages to the PRT before the court's order or settlement.

Step two, the defendant paid funds into a QSF on behalf of the PRT.

Step three, the QSF then paid the contingency fees directly to the attorneys on behalf of the PRT.

By designing the transaction this way, the plaintiff avoided recognizing the contingency fee as taxable income. This strategic move resulted in substantial tax savings for the plaintiff, ensuring their after-tax settlement proceeds were increased by $1,480,000.

Financial Implications: A Closer Look at the Numbers

Let's break down the financial impact of using the QSF and PRT by looking at our plaintiff's potential tax liability without his strategy.

Without Strategic Planning

Total award: $20 million

Punitive Damages Portion $10 million

Contingency Fee on Punitive Damages Portion (assuming a 40% contingency arrangement) $4 million

Taxable Income to Plaintiff $20 million

Potential Tax Liability (assuming 37% federal rate) $7,400,000

Now let's look at the same numbers, this time while utilizing our plaintiff's ingenious strategy with QSF and PRT.

Total Award $20 million

Punitive Damages Handled Through PRT $10 million

Contingency Fee on Punitive Damages (portion paid directly from PRT) $4 million

Taxable Income to Plaintiff $16 million

Tax Savings $1,480,000

This simplified calculation demonstrates the significant financial benefit of employing these strategic tools. The final savings may be even more significant when considering state taxes and other factors.

The Intersection of Law and Finance

With its $20 million verdict, this defamation case serves as a reminder of the linked interrelationship between legal victories and tax outcomes. By leveraging paired tools like the 468B qualified settlement fund and the Plaintiff Recovery Trust, the legal team was able to secure victory for their client and maximize justice by improving the financial benefits. For legal professionals, this case underscores the importance of holistic client advocacy.

In an era of complex litigation and equally complex tax laws, the ability to navigate both legal and financial waters is invaluable. By staying informed about innovative financial solutions and collaborating with financial and tax experts, attorneys can provide a level of service that extends far beyond the courtroom, securing not just legal victories, but financial ones as well.

The preceding case study is an amalgamation of identities and facts adapted to simplify and protect the privacy of the parties and cases. Some facts and circumstances have been changed for educational purposes.

In 2021, fraud losses skyrocketed to $5.8 billion, a staggering 70% increase in just one year. How can financial institutions protect themselves against this growing threat? One powerful strategy to fight financial fraud and money laundering is to reduce anonymous bank accounts and closely monitor suspicious activities.

Financial organizations including banks and credit unions must adopt measures to know their customers and continuously monitor for risk factors. This process is known as KYC or Know your Customer. The implementation of KYC regulations gained momentum after the 9/11 attacks leading to stricter requirements under the PATRIOT Act. Under the PATRIOT Act’s title 3, financial institutions are required to fulfill two core components of KYC: the Customer Identification Program (CIP) and Customer Due Diligence (CDD). This means you can understand KYC as a due diligence process used by financial institutions to verify the identity of their customers and assess potential risk they impose. But why is it so crucial?

Complying with KYC regulations is essential to prevent money laundering, terrorism financing and other types of fraud. It ensures customers are who they claim to be. To meet KYC requirements, clients typically provide proof of identity and address, such as ID card identification, face verification, and biometric verification.

AML (Anti-money laundering) and KYC (Know Your Customer) are closely related but distinct concepts. AML refers to the framework of legislation and regulations to which financial institutions must adhere in order to prevent money laundering, while KYC is a key component of the overall AML framework, requiring organizations to know their customers and verify their identities.

Financial institutions are responsible for developing their own KYC processes and ensuring compliance with specific AML standards dictated by any applicable jurisdiction or country. KYC regulations have become increasingly critical for almost any institution involved in financial transactions due to the need to limit fraud as well as the requirements imposed  by banks on organizations with whom they conduct business.

Imagine a legal shield that not only consolidates multiple claims but also fiercely guards your privacy. Qualified settlement funds (QSFs), created under Section 468b of the Internal Revenue Code, are specialized tools designed for settling single-event, mass tort, and class action lawsuits. These tax-qualified entities allow related claims to be consolidated into a single, secure fund while ensuring the highest levels of privacy and security.

Privacy is not just a convenience—it's a cornerstone of a well-structured QSF. By existing as separate legal entities, QSFs protect sensitive information from prying eyes. This setup helps prevent adverse parties from inflating claims based on the knowledge of the fund's assets. Properly drafted QSFs also impose discovery limitations, reducing the scope of potential legal inquiries.

One of the most powerful features of QSFs is the ability to maintain confidentiality. The identities of claimants and details of the fund remain sealed, ensuring that transactions are not publicly accessible. Even in rare instances where fund existence is uncovered, a vigilant trustee can take decisive action to block discovery efforts, safeguarding the fund’s integrity.

An experienced QSF trustee is essential for maintaining privacy and protecting against discovery demands. Trustees can implement robust privacy policies, challenge discovery requests, and employ advanced legal strategies, such as decanting or jurisdictional tactics, to block unwarranted access. Their role is indispensable in ensuring the QSF remains a secure and confidential resource for claimants.

Qualified settlement funds are not just financial instruments; they are legal fortresses designed to protect claimants' interests. With robust privacy provisions and a dedicated trustee, QSFs minimize legal exposure and preserve confidentiality. Eastern Point Trust Company’s QSF 360 platform leads the industry in offering innovative solutions to safeguard privacy and defend against discovery demands.

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Embarking on the journey of Qualified Settlement Fund Administration can be challenging, but it’s also an opportunity to improve the settlement outcomes. By grasping these ten (10) essential elements, you’ll confidently navigate administering your Qualified Settlement Fund trust, whether you’re an experienced professional or just starting.

1. Understanding the Legal Requirements: The Foundation of QSF Administration and Your Key to Success

What is a Qualified Settlement Fund (QSF)? It is a tax-advantaged statutory “purpose trust” established by the approving governmental authority, pursuant to 26 CFR § 1.468B-1 et seq., to receive and distribute settlement or judicial award proceeds. It allows defendants to claim tax deductions immediately upon funding while providing time for plaintiffs to resolve allocation and financial planning issues. § 468B trusts are commonly used in mass tort, class action, environmental cleanup settlements, and single-event cases.

At the center of a settlement fund account lies an array of legal and tax requirements to ensure the qualified settlement account’s integrity and protect the tax benefits for all parties involved.

Key Considerations:

• Proper establishment as a 468B trust under 26 CFR § 1.468B-1(c)
• Adherence to judicial awards and settlement agreements
• Maintaining independence from all parties to the litigation

Pro Tip: The documents should clearly state which party is classified as the "administrator" within the meaning of Treasury Regulation Section 1.468B­2(k)(3) Partner.

Pro Tip: With a trusted and licensed Qualified Settlement Fund Administrator, like Eastern Point Trust Company, they can ensure compliance with all related administration and tax requirements, provide expert guidance, and offer a range of cost-effective services to simplify and streamline the management of your QSF.

2. Compliance Issues: Staying on the Right Side of the Law

Compliance in Qualified Settlement Fund administration isn’t just about following rules—it’s about leveraging experience to fulfill the fund’s purpose and settlement terms, ensuring a secure and confident journey for all involved.

Critical Compliance Areas:

• Statutory compliance
• KYC/AML compliance
• Protection of privacy and confidentiality
• Regular reporting to relevant tax authorities
• Transparent record-keeping
• Speedy funds disbursement

Action Step: Schedule a Compliance Check-Up with a “QSF administration” expert to ensure your fund meets all regulatory requirements.

3. Disbursement Processes: Ensuring Fair and Timely Payouts

The heart of a Qualified Settlement Fund’s purpose lies in (i) the tax benefit it provides to all parties and (ii) its ability to disburse funds to claimants promptly and efficiently. A well-managed and proven disbursement process can distinguish between a smooth settlement and a logistical nightmare.

Best Practices:

• Utilize highly experienced and licensed fiduciaries
• Implement transparent and fair allocation methodologies
• Establish timely payment processes
• Maintain transparent and real-time reporting
• Communicate effectively with all parties throughout the process

Remember: A trustworthy Qualified Settlement Fund administrator can streamline your disbursement process, ensuring accuracy and timeliness.

4. Tax Implications: Navigating the Fiscal Maze

Understanding the qualified settlement fund tax treatment is crucial for special masters, attorneys, and claimants. Proper tax management can significantly impact the fund’s overall value and the benefits received by claimants.

Key Tax Considerations:

• Tax qualification, status, and filing requirements
• Potential tax liabilities for distributions
• Correct tax reporting

Did You Know? Expert settlement administrators can help optimize your fund’s tax strategy, potentially increasing the long-term value of distribution.

5. Licensed, Honest, and Unconflicted Administration

Effective settlement administration involves eliminating the conflicts of interest that arise from product placement by the QSF administrator.

Critical Elements:

• Utilize only a licensed fiduciary
• Avoid providers that also sell financial products

6. Compliance with Judicial Awards and Settlement Agreements

Strict adherence to Judicial awards and settlement agreements is non-negotiable:

• Maintain a compliance checklist based on all relevant orders and agreements
• Regularly review and update compliance measures
• When applicable, be prepared to provide detailed compliance reports to the court or parties

Practical Tip: Implement a system of internal audits to ensure ongoing compliance throughout the life of the trust.

7. Handling of Disputed or Unclaimed Funds

Proper management of disputed or unclaimed funds is crucial:

• Develop clear procedures for handling disputes aligned with the settlement agreement and judicial awards
• Establish protocols for locating and communicating with non-responsive claimants
• Plan for the disposition of unclaimed funds, which may include cy pres distributions or reversion to the defendant

‍Legal Update: Recent case law has emphasized the importance of proactive measures in locating claimants before considering alternative distributions.

8. Coordination with Related Parties

Effective QSF administration often requires seamless coordination with various parties:

• Maintain clear lines of communication with plaintiffs’ counsel, defense counsel, and when applicable, the court
• Coordinate with lien resolution administrators, if applicable
• Manage relationships with financial institutions, auditors, and other service providers

Best Practice: Regular stakeholder meetings can help ensure alignment and address potential issues proactively.

9. Documentation and Record-Keeping

Meticulous documentation is essential:

• Maintain comprehensive records of all fund activities, including financial transactions, claimant communications, and administrative decisions
• Implement a secure, easily accessible document management system
• Ensure all records comply with relevant retention policies and privacy laws

Regulatory Note: Under IRC Section 468B, QSFs must maintain sufficient records to support items reported on tax returns.

10. Winding Down and Termination

Proper closure is as critical as its establishment:

• Develop a termination plan that addresses final distributions, tax filings, and asset disposition
• Ensure all claims have been resolved and all liabilities satisfied
• Obtain necessary approvals for termination when required

Legal Consideration: The termination process must comply with Treas. Reg. § 1.468B-2(k) outlines specific requirements for termination.

Summary

In conclusion, administering a Qualified Settlement Fund requires a comprehensive understanding of several critical elements, along with ongoing attention to legal updates and best practices. By mastering these aspects, legal professionals and administrators can ensure the smooth functioning of QSFs, ultimately serving the best interests of all parties involved.

While mastering these ten aspects of QSF administration may seem overwhelming, you don't have to navigate this process alone. Professional trustees and financial institutions specializing in QSF account management can provide the expertise and support you need to navigate these complex waters successfully.

Contact a QSF 360 specialist today to learn how their experience can significantly impact administering your Qualified Settlement Fund.

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Overview

§ 468B Qualified Settlement Funds (QSFs) are tax-qualified legal entities that are useful to settle single-event, mass torts, and class action lawsuits and allow the consolidation of multiple “related” claims into a single fund for which the establishment and operation are governed by 26 C.F.R. § 1.468B-1, et seq.

Ensuring the privacy and security of a Qualified Settlement Fund and its information is crucial. In the case of pre-funded settlement funds, safeguarding sensitive information to prevent unauthorized or adverse party access protects the defendant’s privacy and the integrity of the funds. The privacy provisions of a QSF and its existence as a separate legal entity can hinder adverse parties from inflating their claims based on knowledge of the settlement fund’s available assets.

Further, a properly designed and drafted confidential settlement fund can provide valuable “discovery limitations.” Maximizing these advantages requires an experienced and steadfast trustee who will vigorously assert the associated privacy and limitation powers to suppress undesirable litigation discovery.

Privacy in QSFs

In today's cancel culture, unethical competitors, and law-fare world, defendants (accused) have justifiable apprehension regarding the question of privacy or discoverability of the details by adverse parties. In particular, when a defendant(s) utilizes a QSF to address multiple current or future claims, there can be concerns (albeit largely unfounded) regarding whether others may acquire information related to the defendant’s identity or regarding the existence of the fund and its level of funding by searching a public source or by discovery through discovery.

Unlike other entities, bank accounts, or trusts whose information is readily available through searchable databases or ordinary discovery, Eastern Point’s QSF Confidential platform, has no such public sources or databases. Accordingly, no government database searches are even possible. As such, adverse parties have no likely chance of discovering a Qualified Settlement Fund’s existence or the identity of a defendant associated with it.

Pro Tip: Even if the existence of the settlement fund becomes known, a properly drafted confidential QSF gives the trustee many practical and effective tools to quash discovery inquiries.

Pro Tip: Having a trustee who is a vigorous advocate in defending the privacy of the parties and the trust is a critical element.

Pro Tip: A trustee who maintains a robust and comprehensive privacy policy that applies to any third parties making a claim upon the trust assets or serving a demand for discovery is indispensable in protecting the QSF’s privacy. Non-trustee administrators may have no enforceable privacy policy protections for the QSFs they administer as non-trustees.

Anonymity of Parties

With QSF Confidential - privacy is maintained by ensuring the fund’s existence and claimants’ identities remain sealed and confidential. This confidentiality is crucial in sensitive legal matters, protecting the individuals involved from unwanted exposure. To safeguard the anonymity of the parties and the financial condition of the § 468B trust, the trustee plays a vital defensive role in protecting information from prying adverse parties. The trustee may employ various tactics by challenging all requests, imposing legal barriers, decanting, applying jurisdiction selection requirements, and utilizing the courts to avoid subpoenas or quash demands for information.

Decanting and Situs Shifting

As mentioned, in a properly drafted confidential settlement, the trustee will have the necessary power to employ decanting, situs-shifting, and other trustee-power tactics to protect the parties’ privacy and defeat discovery fishing expeditions.

Non-Public Records

QSF Confidential transactions and internal records are private and not part of public records. Additionally, the associated tax reporting does not disclose the identity of the defendant (accused) moreover, the IRS is prohibited from disclosing tax returns based on a civil subpoena. This integrated approach prevents access to private information related to the parties or the trust’s assets and activities. Here again, we see that privacy provisions in an adequately designed trust, such as with QSF Confidential, can protect the privacy of all associated documents and information.

Pro Tip: Courts are highly reluctant to allow third parties (with no standing) to breach all parties' privacy solely for a fishing expedition.

Conclusion

468B settlement funds offer strong privacy protections and can shield against discovery and other inquiry demands. The QSF Confidential platform (powered by the QSF 360) provides the first-of-its-kind confidential, innovative, and robust privacy and protections from the discovery of identities, accusations, and terms.

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Qualified Settlement Funds (QSFs) have increasingly become pivotal in resolving lawsuits, particularly for personal injury, wrongful death, and property damage claims. QSFs provide a tax-efficient vehicle for the settlement of claims, facilitating smoother and more efficient resolutions. However, the taxation rules surrounding 26 USC § 468B settlement funds are complex, and understanding them is vital for practical usage. This guide sheds light on the pertinent aspects of taxation and the associated reporting and underscores the importance of seeking professional advice for complex issues. Failure to adhere to these reporting requirements can lead to penalties and legal consequences. This reassurance of support from experts in the field can be a valuable resource in your professional role.

Introduction to QSFs

26 C.F.R § 1.468B-1 Qualified Settlement Funds have emerged as an essential instrument for resolving various types of claims in legal settlements. Established under § 1.468B-1 et seq. of the Internal Revenue Code, settlement funds manage the proceeds from a legal settlement (or judicial award) and offer substantial benefits to both plaintiffs and defendants. These benefits include tax deferral opportunities and the ability to structure payments over time, empowering the parties with more control over their financial arrangements and providing a sense of reassurance.

Treated as a Corporation

Except as provided for in § 1.468B-5(b), a QSF is considered a corporation for tax treatment purposes. Understanding this tax treatment is crucial as it will equip you with the knowledge to navigate the associated taxation.

Modified Gross Income

A QSF is taxed on its “modified gross income.” The term modified gross income generally comprises only the investment income generated. Moreover, settlement payment amounts transferred to a QSF to resolve or satisfy a liability for which the fund is established are excluded from the trust's modified gross income.

A deduction against modified gross income is allowed for QSF administration and other incidental costs and expenses incurred in administering the QSF. Deductible expenses may include administrative costs, such as accounting, legal, and other ministerial expenses, as well as state and local taxes. Also, the costs associated with the determination and notification of claimants and claims administration are deductible.

Note: Administrative costs and other miscellaneous expenses do not include legal fees incurred by or on behalf of claimants and are thus not deductible.

The Emergence of Form 1120-SF

IRS Form 1120-SF is a crucial component in the taxation process of a § 468B trust. It reports the transfers, income generated, deductions claimed, and distributions made. More importantly, it calculates and reports the associated income tax liability. Understanding and confidently navigating the process of filing Form 1120-SF is essential in the QSF taxation process.

Filing Due Date

The QSF administrator plays a key role in filing the tax return. They are responsible for preparing and filing the income tax return Form 1120-SF by the 15th day of the 4th month following the end of the fund's tax year. The administrator's responsibilities include ensuring all necessary forms and schedules are included, making timely tax deposits, and arranging for the fund's tax professional, financial institution, payroll service, or other trusted third party to make the deposits. It's important to note that there are exceptions for funds with a fiscal tax year ending on June 30 and those with a short tax year ending in June, in which case the filing deadline is earlier.

Private Delivery Services (PDSs) can meet the “timely mailing as timely filing/paying” rule for tax returns and payments. However, it’s essential to note that PDSs cannot deliver items to P.O. boxes, necessitating the use of the U.S. Postal Service for such deliveries.

Signature Requirements

The return must be signed and dated by the fund’s trustee or administrator. If an employee completes Form 1120-SF, the paid preparer’s space should remain empty. Anyone who prepares the form but doesn’t charge for the filing should not complete that section.

Note: A paid preparer may sign original or amended returns using a rubber stamp, mechanical device, or computer software.

The preparer must complete the required preparer information, sign the return in the designated space, and provide a copy of the return to the trustee or administrator.

Paid Preparer Authorization

If a fund trustee wishes to permit the IRS to discuss its tax return with the paid preparer, it can check the “Yes” box in the signature area of the return. This authorization applies only to the individual whose signature appears in the “Paid Preparer Use Only” section of the tax return and does not apply to the firm.

The authorization allows the IRS to contact the paid preparer to answer any questions that may arise during the processing of the return, provide any missing information from the return, get information about the processing status of the return, and respond to IRS notices about errors, offsets, and return preparation.

This authorization, however, does not allow the paid preparer to receive any refund check, bind the trust to anything, or otherwise represent the fund before the IRS. The authorization automatically ends on the due date (excluding extensions) for filing the QSF’s tax return.

Assembling the Return

To ensure correct processing, include all schedules alphabetically and other forms in numerical order after Form 1120-SF. If the return requires more space for forms or schedules, separate sheets are allowable if the pages are the same size and format as the printed forms.

Where and How to File

The Form 1120-SF return should be filed at the applicable IRS address, which (as of this writing) is as follows:

Department of the Treasury
InternalRevenue Service Center
Ogden, UT 84201-0012

Tax Payment Obligations

The taxes are due and payable in full by the 15th day of the 4th month after the end of the tax year.

QSFs must use electronic funds transfers to make all federal tax deposits. These transfers are payable using the Electronic Federal Tax Payment System (EFTPS). However, the settlement fund can also arrange for a tax professional, financial institution, payroll service, or other trusted third party to make the deposits.

Estimated Tax Payments

Generally, a QSF must make installments of estimated tax if it expects its total tax for the year (less applicable credits) to be $500 or more. The installments are due by the 15th day of the tax year’s 4th, 6th, 9th, and 12th months.

Note: If the fund overpaid estimated tax, it may file Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax.

Interest and Penalties

Interest accrues on taxes paid late, even if there is an extension of time to file. Penalties can also be imposed for negligence, substantial understatement of tax, reportable transaction understatements, and fraud.

Accounting Method

A Qualified Settlement Fund must use the accrual method of accounting. The accrual method records income and expenses when earned or incurred, regardless of when payment is received or made.

Recordkeeping

Keeping accurate and detailed tax and accounting records is essential. These records support income, deductions, or credits on the return.

Definitions

In the context of § 1.468B-1, specific terms are of particular importance:

• Administrator: The person who manages the QSF, which can include a trustee if the settlement fund is a trust.
• Transferor: A person who transfers money or property to a QSF to resolve or satisfy claims against that person.
• Related person: Any person who is related to the transferor as defined in section 267(b) or section 707(b)(1) of the IRS code.

Conclusion

Understanding the taxation of Qualified Settlement Funds established under 26 C.F.R § 1.468B-1 et seq., s can be complex.

However, platforms such as QSF 360, provided by Eastern Point Trust Company, offer the only online and turnkey service that includes all of the critical aspects of tax reporting, such as Form 1120-SF, filing requirements, and tax payments. As always, seeking professional advice when dealing with complex matters is advisable.

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