Opinion
No. 45321.
May 1, 1944.
J. Marvin Haynes, of Washington, D.C., for plaintiff.
J.W. Hussey, of Washington, D.C., and Samuel O. Clark, Jr., Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington, D.C., on the brief), for defendant.
Before WHALEY, Chief Justice, BOOTH, Chief Justice (retired), recalled, and LITTLETON, WHITAKER, and MADDEN, Judges.
Action by the Cem Securities Corporation against the United States to recover an alleged excessive income tax payment.
Judgment for plaintiff.
This case having been heard by the Court of Claims, the court, upon the evidence and the report of a commissioner, makes the following special findings of facts:
1. Plaintiff was organized December 5, 1921, under the laws of the State of New York, and on February 21, 1928, was changed to a Delaware corporation.
For many years prior to 1921, Charles E. McManus, the principal stockholder of plaintiff, was engaged, among other things, in inventing various mechanical devices and processes, in purchasing and developing such devices and processes, and in leasing them on a royalty basis. Upon its organization in 1921 plaintiff took over those activities and it has continued in that business as well as that of a management corporation. From time to time plaintiff has also bought and sold securities. In connection with these activities plaintiff made loans on various occasions from December 5, 1921, to December 31, 1933, in the aggregate amount of more than $2,000,000. Most of these loans were made without collateral.
2. The common stock of plaintiff consisted at all times of 100,000 shares of no par value, all of which was owned by plaintiff's president, Charles E. McManus. Its preferred stock consisted of 74,100 shares of a par value of $30 per share, 40 percent of which was owned by McManus and 60 percent by his wife and sons.
3. Plaintiff controlled the Crown Cork Seal Co., Inc. (hereinafter referred to as the "Crown Company"), and its affiliates. The Crown Company had common capital stock outstanding on the dates indicated as follows:
Date Shares
December 31, 1930 .............. 302,116 December 31, 1931 .............. 384,122 December 31, 1932 .............. 384,162 December 31, 1933 .............. 384,237
On the same dates plaintiff owned the following shares of common capital stock of the Crown Company:
Date Shares
December 31, 1930 .............. 147,674 4/5 December 31, 1931 .............. 160,440 4/5 December 31, 1932 .............. 146,540 4/5 December 31, 1933 .............. 131,480 4/5
Charles E. McManus did not own personally any stock in the Crown Company.
4. In 1929 John J. Utech purchased 2,200 shares of the common stock of the Crown Company at prices ranging downward from about $60 or $70 per share. At the time the purchases were made Utech was a close personal friend of Charles E. McManus and also of Leroy W. Baldwin, president of the Empire Trust Company. In making the purchases Utech relied largely on the recommendation of McManus as to the character of the stock and its future prospects, and when the market value of the stock later declined, McManus urged Utech not to worry about his purchases of Crown stock and stated he was confident that it would later increase in price, though McManus did not at any time guarantee to save Utech harmless from loss on account of his purchases.
5. In connection with the purchase of the above stock, Utech borrowed money from the Empire Trust Company and pledged the 2,200 shares of Crown stock as security for the loan, which amounted to approximately $147,000. January 6, 1930, when the Crown stock had declined in value and the Empire Trust Company was asking for additional collateral as security for the loan, plaintiff loaned to Utech 1,000 shares of common stock of the Crown Company, which was put up as additional collateral on the loan with the Empire Trust Company. September 26 and December 15, 1930, and June 15, 1931, plaintiff made further loans of additional shares of the common stock of the Crown Company in the respective amounts of 500, 1,000, and 3,000 shares for the same purpose and these shares were deposited with the Empire Trust Company as additional collateral for the loan to Utech. On June 15, 1931, when the last loan of stock was made by plaintiff to Utech, the loan of Utech with the Empire Trust Company amounted to $147,537.56 and it was secured by 7,700 shares of common stock of the Crown Company, 2,200 shares of which were owned by Utech and 5,500 shares by plaintiff and loaned to Utech as shown above. At the time these loans were made by plaintiff, the Empire Trust Company was threatening to sell the stock then held as collateral for Utech's loan and plaintiff did not desire to have Utech's stock placed on the market because of the adverse effect it would have on the market price of Crown stock.
6. In confirmation of the understanding had when the stock was loaned by plaintiff as shown above, an agreement was entered into between Utech and plaintiff on July 22, 1931, with respect to the total loan of 5,500 shares, which read, in part, as follows:
"Now, therefore, it is understood and agreed that The Cem Securities Corporation has pledged the above shares as collateral for the account of John J. Utech, with the understanding that the loan above referred to of $147,537.56 is a separate and distinct loan on Crown Cork Seal Company, Inc., Common Stock, and
"Further, that the said John J. Utech hereby states and confirms that the above-mentioned 5,500 shares are the property of and are owned by The Cem Securities Corporation, and the said John J. Utech has no personal interest in said shares, and his heirs, executors, or administrators shall have no right or interest in the above-mentioned shares; it being agreed between the parties hereto that the shares totaling 5,500 are simply pledged with the Empire Trust Company as collateral for the accommodation of John J. Utech, and
"It is further understood that as the loan is liquidated, such shares as are released are to be forthwith returned to The Cem Securities Corporation."
When the above agreement was entered into, the Crown Company was quoted on the New York Stock Exchange at approximately $21 per share, which represented a value for the 7,700 shares of some $14,000 in excess of the Utech loan with the Empire Trust Company.
7. By April 1932 the price of the Crown Company stock had declined to between $8 and $11 per share on the basis of which the market value of the 7,700 shares of that stock which was pledged as security for the Utech loan was some $75,000 less than the amount of the loan. Because of that situation and because bank examiners were insisting that adequate security be shown for the loan, on April 11, 1932, the president of the Empire Trust Company telephoned to McManus, president of plaintiff, who was then at Nice, France, and demanded that plaintiff deposit additional collateral to secure the Utech loan. The president of the bank asserted that plaintiff had agreed to keep the loan adequately secured, but plaintiff denied the existence of any such agreement and refused to deposit any additional collateral. As a result of an exchange of cablegrams, further action in connection with the note was held in abeyance pending the return of McManus to the United States. After the return of McManus, the Empire Trust Company continued to make demands upon plaintiff for additional collateral. Plaintiff refused to make any additional deposits and continued to deny the existence of any agreement to furnish such additional collateral.
8. November 7, 1932, Utech wrote McManus as follows:
"I am very sorry, indeed, at feeling compelled to inform you of the notice I received from the bank by registered mail Saturday, calling my loan for $147,537.56 plus accrued interest, or a total of $150,679.07, secured by 7,700 Shares of Crown Cork and Seal Company stock, at 10 A.M. November 7th.
"I succeeded in reaching Mr. Nagel, who suggested that I also notify Mr. Buckner, which I did. I later 'phoned Mr. Baldwin, who told me that he was forced to sell out the loan by the Banking Department, unless it was sufficiently secured. I told him of my plight, and of your serious illness, at which he expressed sorrow, but informed me that unless the loan was sufficiently margined it would have to be closed out.
"He suggested Saturday, that I see him on Monday, which I did, and he reiterated the position that he was helpless in the matter. I wanted to call you on the 'phone today, but Mr. Nagel thought it best not to — that he would see you tomorrow, but, somehow, I feel it my imperative duty to notify you first hand, inasmuch as your securities are in jeopardy.
"I cannot tell you how depressed and sorry I feel that this condition has come about, when I realize my utter helplessness in the circumstances, more especially when you are still in the hospital, bedfast with the second major operation in a year.
"Have you any suggestion of any procedure for me to take with the bank in the premises, as it certainly seems a shame to face the prospect of losing this stock, when all conditions point to so much good immediately ahead. Is there not some way you can protect the position and save your stock?"
At the date of the above letter the Utech note with accrued interest amounted to $150,679.07, and at that time the Crown Company common stock was quoted on the New York Stock Exchange at approximately $21 per share, which made a total market value for the 7,700 shares of Crown stock pledged as collateral of approximately $161,700. At the same time Utech had another note with the same bank for $25,000 which was in no way connected with the other loan, and this note was secured by 1,000 shares of common stock of International Petroleum Company, 33 shares of common stock of General Baking Corporation, 70 shares of common stock of U.S. Steel Corporation, and 500 shares of common stock of Chrysler Corporation, which had a total fair market value in November 1932 of $23,520.75. All of this stock (with the exception of that of General Baking Corporation, which had a total value at the time of approximately $420 and which was owned by Utech) was owned by Utech's wife, who had endorsed the certificates in blank and delivered them to him to be used as collateral, but Utech did not advise plaintiff or plaintiff's officers of his wife's interest in this stock.
9. Up to November 19, 1932, the Empire Trust Company was continuing its demands on plaintiff as well as on Utech for a settlement of the Utech note on which the Crown Company stock was pledged as collateral. On November 19, 1932, in order to secure the release and return to it of the 5,500 shares of Crown stock which plaintiff had loaned to Utech and to prevent the placing of Utech's 2,200 shares of Crown stock on the market, Utech gave plaintiff an unsecured demand note bearing interest at 5 percent for $115,500, the fair market value of plaintiff's 5,500 shares of Crown Company stock. Thereupon plaintiff gave Utech a check in the amount of $115,500, which was endorsed by Utech to the Empire Trust Company. At that time the Utech note amounted to $150,679.07, and by applying the check of $115,500 referred to above and a cash payment of $10,089.86 made by Utech, the note and accrued interest were reduced to $25,089.21. That balance, together with the amount of $25,000 owed by Utech on the other note referred to above, was consolidated into one note of $50,089.21 with the Empire Trust Company. Utech left with the bank as security for that note the 2,200 shares of Crown Company stock and the other stock referred to above which had been pledged as collateral for the note of $25,000. At the same time plaintiff's 5,500 shares of Crown Company stock were returned to it by the bank. On November 19, 1932, the fair market value of the securities which were left pledged as collateral for the note of $50,089.21 was $69,720.75. No collateral was given by Utech to plaintiff for the note of $115,500. Plaintiff, however, believed that the market for the securities which were pledged by Utech as collateral for the note of $50,089.21 would improve, and that with such improvement an excess amount would be realized which would be used by Utech to satisfy the demand note of $115,500. There was, however, no agreement between Utech and plaintiff, or notation on the note of $50,089.21, or agreement in connection with the pledging of the collateral, which required that any excess amount realized on the sale of the collateral be applied on the note for $115,500.
10. After the consolidated note had been given by Utech with the collateral set out above, the president of the bank told Utech that he believed the bank examiners would be satisfied with the note and that he would make no further demands on the note unless they forced him to take such action, or the collateral became inadequate. However, in the spring of 1933, the president of the bank informed Utech the bank was forced to make collection of the note in order to improve the liquidity of its condition, and during or shortly prior to June 1933, the bank liquidated Utech's note by selling the 2,200 shares of common stock of the Crown Company and the 33 shares of General Baking stock. The remaining collateral was delivered by the bank to Utech, who in turn delivered it to his wife, to whom it belonged. An amount was realized by the bank by the sale of collateral more than sufficient to satisfy the note of $50,089.21, and that excess was turned over to Utech, who, instead of applying it on the note of $115,500, used it in the stock market in an effort to make a recovery, but without success.
11. Shortly after the liquidation of the Utech note, plaintiff in June 1933, investigated the status of Utech's loan at the bank and learned for the first time that it had been paid and the securities released. In June 1933, the high and low prices for the stock which had been pledged as collateral were as follows:
--------------------------------------------------------- Stocks | High | Low ------------------------------|-------------|------------ Crown Cork Seal Co., | | Inc., Common .............. | 63¼ | 45¼ Chrysler Corp. Common | 36 3/8 | 22¼ International Pet. Common ... | 18 3/8 | 13 7/8 U.S. Steel Common ........... | 60 | 51 General Baking Corp. | | Common .................... | 19½ | 15¾ ---------------------------------------------------------
On the basis of the above "high" prices, the total amount realizable in June 1933, from the collateral securing Utech's note of $50,089.21 was $180,556.
12. Prior to June 1933, plaintiff had made demands on Utech for the payment of interest, but without success. After it was found by plaintiff that the note of $50,089.21 had been settled and the collateral released, plaintiff made further demands on Utech for the payment of his note of $115,500, which were likewise unsuccessful, and after further investigation came to the conclusion in 1933 that Utech was not financially responsible and that the note could not be collected. Plaintiff did not institute suit at this time, since it was advised that a judgment would be worthless. Further requests for payment were made by telephone at various times over the period from 1934 to 1938, with the same results, and finally, in 1938, when the six-year statute of limitation on collection of a note of that kind was about to run, plaintiff instituted suit for its collection. The suit was dismissed in November 1938 upon execution of a new unsecured demand note for $115,500. That note is still outstanding, and no amount, either of principal or interest, has ever been paid on the original note or the new note.
13. In 1933 plaintiff charged off the note of $115,500 on its books of account as a bad debt and took a deduction therefor in its income-tax return for 1933. Except for the stock pledged as collateral for the loan of $50,089.21, Utech's financial position was substantially the same throughout 1933 as in the years immediately prior thereto, when he had no real or personal property which was available for the payment of his indebtedness to plaintiff and the same situation has existed since 1933. During those years, Utech was employed as a manufacturer's representative on a commission basis when the largest amount earned in any one year did not exceed $5,000.
On the basis of market prices prevailing at some period during each of the years mentioned below, a total fair market value for the securities which were pledged as collateral for the loan of $50,089.21 existed as follows:
1933 ......................... $200,396.37 1934 ......................... 147,978.13 1935 ......................... 198,197.63 1936 .......................... 316,801.25 1937 ........................... 338,548.50
14. June 12, 1929, plaintiff acquired 1,000 shares of common stock of the Crown Company at a cost of $42,369.13. In 1932, plaintiff gave an oral option to Max Amberg, a partner of Hyman Company, members of the New York Stock Exchange, to purchase 1,000 shares of common stock of the Crown Company at $10 per share. At the time the option was given, the Crown Company stock was selling on the market at $10 per share. March 20, 1933, plaintiff sold 1,000 shares of common stock of the Crown Company to Max Amberg for $10,000, in accordance with the aforesaid option. On the date of the sale of the Crown Company stock to Amberg, the stock was quoted on the New York Stock Exchange at $22.75 per share.
At the time of giving the option, plaintiff owned a total of approximately 154,000 shares of the common stock of the Crown Company and traded from time to time in that stock. Exclusive of the 1,000 shares sold to Amberg, plaintiff sold 13,450 shares of the Crown Company stock during 1933 and reported a profit from such sales in its 1933 income-tax return in excess of $200,000. The option was given to Amberg on account of services which he had rendered and would continue to render to plaintiff in publicizing the common stock of the Crown Company and disseminating literature on the activities of the company. There was no arrangement with Amberg or anyone else whereby plaintiff was to be paid in cash or in any way other than by the services mentioned in the preceding sentence, directly or indirectly anything in excess of the $10,000 which Amberg paid for the 1,000 shares of common stock of the Crown Company and plaintiff did not receive from any source anything in addition to the $10,000, and the services mentioned above.
15. March 15, 1934, plaintiff filed its income and excess profits tax return for 1933 showing taxable net income of $15,396.98 and a tax liability of $2,170.84, which was paid in quarterly installments during 1934. In that return plaintiff claimed as a bad-debt deduction the Utech note of $115,500 heretofore referred to, and a loss of $32,369.13 on account of the exercise by Amberg of the oral option for the purchase of the Crown Company stock; that is, the difference between the cost of the stock to plaintiff, $42,369.13, and the price for which it was sold to Amberg under the option, $10,000.
16. Upon an examination of plaintiff's return for 1933, the Commissioner of Internal Revenue disallowed the bad-debt deduction of $115,500 on account of the Utech note. The Commissioner also reduced the loss on account of the sale of the stock to Amberg by $12,750, thus allowing a loss of $19,619.13 on the ground that plaintiff's loss should be measured by the difference between plaintiff's cost of that stock, $42,369.13, and the price on the open market at the date of sale, $22,750. On the basis of that examination the Commissioner made an additional assessment against plaintiff for 1933 of $20,128.66, together with interest of $3,867.46; that is, a total of $23,996.12, and that amount was paid by plaintiff June 9, 1937.
17. June 3, 1938, plaintiff filed a claim for refund for 1933 in the amount of $21,023 on the grounds, among others, that it had suffered a loss in 1933 by reason of the sale of the stock to Amberg under the oral option entered into with him in 1932, and that the Commissioner had erroneously disallowed the bad debt deduction of $115,500 on account of the Utech note.
December 20, 1938, the Commissioner advised plaintiff that the claim for refund would be disallowed, assigning his reasons, in part, as follows:
"It is held by this office that the note of Mr. Utech, who was a personal friend of Mr. McManus, your majority stockholder, was without value when accepted by you in 1932 and the same method used by you in 1933 to ascertain that the loan was bad could have been used by you in 1932 before the loan was made.
"You state that your net income should not be increased by $12,750.00, representing additional profit from sale of common stock of Crown Cork and Seal Company to Mr. Max Amberg for the reason that he was given an oral option in 1932 to purchase 1,000 shares of this stock at $10.00 a share and that he exercised this option on March 20, 1933.
"It is held that inasmuch as the option was not put in writing, and therefore not binding, the transaction constitutes a sale at the market value of $22.75 a share."
January 25, 1939, the Commissioner formally rejected the claim for refund and notified the plaintiff of such action.
Plaintiff, in its income-tax return for the year 1933, claimed a bad-debt deduction of $115,500 because of a charge-off in that year as worthless of a note of one Utech for that amount which plaintiff held, and a business loss of $32,369.13 occasioned by the sale of 1,000 shares of stock to one Amberg for that amount less than the cost of the stock to plaintiff. The Commissioner of Internal Revenue disallowed the bad-debt deduction entirely, and partially disallowed the loss on the sale of the stock, reducing that loss to $19,619.13. Plaintiff paid the taxes as computed by the Commissioner, filed a claim for refund and, upon its disallowance, brought this suit.
The Government's defense as to the bad debt deduction is that the Utech note, charged off by plaintiff as worthless in 1933, was worthless when made in November 1932, and that the charge-off should have been taken in that year, if at all. The facts of the transaction are fully set forth in the findings, and a full recital of them will not be given here. In brief they are as follows: In 1929 Utech purchased 2,200 shares of common stock of the Crown Cork and Seal Company, which company was controlled by plaintiff. Utech was a close personal friend of Charles E. McManus, the principal stockholder of Crown, and of Leroy W. Baldwin, president of the Empire Trust Company. To make the purchase, Utech borrowed $147,000 from Empire, and pledged the Crown stock as collateral. In January 1930 the Crown stock had declined in value, Empire was calling for additional collateral, and plaintiff loaned Utech 1,000 shares of Crown which Utech pledged to Empire. Later in 1930 and in 1931 plaintiff loaned, at various times, a total of 4,500 additional shares of Crown to Utech for the same purpose. Plaintiff was the owner of about 150,000 shares of Crown stock during this time, and was interested in maintaining the market price of the stock. It made the additional loans of Crown to Utech to prevent Empire from selling Utech's 2,200 shares, as Empire was threatening to do, because of the adverse effect which such a sale might have had on the market price of the stock.
In 1931 and 1932 the price of the stock continued to decline and by April 1932, all of the Crown stock, 7,700 shares, pledged with Empire on the Utech loan, was worth $75,000 less than the amount of the loan. Empire was demanding additional collateral from Utech and the plaintiff. On November 7, 1932, Utech wrote McManus that Empire had given him notice that it was going to sell the Crown stock and that Utech was helpless to prevent it. The Crown stock was at that time quoted at $21 per share, so that the 7,700 shares had a market value of $161,700. Utech's loan with accrued interest amounted to $150,679.07. Utech had another note with Empire for $25,000, secured by shares of various stocks other than Crown, which in November 1932 had a market value of about $23,000. Most of these stocks belonged to Utech's wife, but the plaintiff's officers were not aware of that fact.
On November 19, 1932, in order to get back its 5,500 shares of Crown stock, and to prevent Empire from putting Utech's 2,200 shares on the market, plaintiff loaned Utech $115,500, the market value of plaintiff's 5,500 shares, on Utech's unsecured demand note bearing interest at 5%. Utech turned the money over to Empire, together with $10,089.86 of his own money, as a payment on his $147,000 note and its accrued interest; thus reducing that note to $25,089.21. That balance was consolidated with Utech's other note for $25,000, and Utech gave a new note to Empire for $50,089.21, secured by his 2,200 shares of Crown stock and the other stock which had been pledged on his $25,000 note. At this time the market value of all this collateral was $69,720.75. Plaintiff believed that the market price of all these stocks would increase to an amount sufficient for Utech to pay both the Empire note and plaintiff's note for $115,500. At the time this rearrangement of the affairs of Utech, the plaintiff, and Empire was made, Empire's president told Utech that the collateral was now adequate, and that Empire would not make further demands on the note unless the bank examiners compelled it to do so. In the spring of 1933, however, Empire informed Utech that it was compelled to collect his note in order to improve the liquidity of its condition. During or shortly prior to June 1933, it sold Utech's 2,200 shares of Crown, and 33 shares of another stock which was among those pledged to it by Utech, realizing more than enough from these sales to pay Utech's note to it. It returned the unsold collateral to Utech, and also the excess money. Utech used the money in the stock market in an effort to make a profit, but lost the money. During June 1933, that is, within approximately one month after Empire had sold or returned the collateral on the Utech note, the various shares of that collateral were quoted on the Exchange at prices which would have produced a total price of $180,556, or more than enough to pay both the Empire note for $50,089.21 and the plaintiff's note for $115,500. These quoted prices were, in general, maintained or exceeded during the following few years, as is shown in finding 13.
When the plaintiff learned that Empire had sold some of the Utech collateral and returned the rest to Utech, together with the excess cash realized on the sale, it demanded payment of his note for $115,500 to it. Utech made no such payment. The plaintiff then concluded, after further investigation, that Utech was financially irresponsible and that the note was worthless. It charged the note off as a bad debt in 1933. It filed no suit to collect the note at that time, thinking that a judgment would be uncollectible. It made demands for payment during the years 1934 to 1938, and filed a suit just before the statute of limitations would have run. That suit was dismissed upon the execution by Utech of a new demand note for $115,500 upon which no payments have been made.
We think the plaintiff was entitled to charge off the Utech note in 1933 as a bad debt, and that the Government's claim that the note was worthless in November 1932 when given, is not valid. Utech could not have paid the note in full, at the time he gave it, out of his assets at their then market value. But he did find some $10,000 at that time to pay on his note to Empire, and he left collateral with Empire on his remaining indebtedness to it which was substantially in excess of that indebtedness. He seemed to the plaintiff, therefore, to have resources which could and would be used to make payments on plaintiff's note after the collateral shares had made a further recovery, which plaintiff expected, not unreasonably, that they would do. In fact, if Empire had waited only one month longer to sell the Utech collateral, and had happened to sell it at the high prices of that month, June 1933, the proceeds of the sale and the returned collateral would have considerably more than paid Utech's notes to Empire and to the plaintiff. Since the plaintiff in 1932 expected that these increases would occur somewhat as they did occur, it could not honestly have charged off Utech's debt to it as bad, at that time. In 1933, however, Utech lost his Crown stock, so that he could no longer gain by increases in its market value. He failed to apply the excess cash turned over to him by Empire, to reduce the plaintiff's note. He failed to give the plaintiff the security of the excess collateral which Empire had turned back to him. The plaintiff then concluded that Utech's note was uncollectible, and again subsequent events have shown that that conclusion was correct. We think the plaintiff was entitled to the bad debt deduction which it attempted to take in 1933, and should win that phase of its suit.
As to the sale to Amberg, upon which the plaintiff claimed a deductible loss for 1933, which the Commissioner disallowed, the facts are these. In 1929 the plaintiff bought 1000 shares of Crown stock for $42,369.13. In 1932 the plaintiff gave an oral option to one Amberg, a partner in a New York Stock Exchange firm, to purchase 1000 shares of Crown stock at $10 a share, the price at which the stock was then quoted on the Exchange. No time limit was placed on the option. On March 20, 1933, Amberg called for the stock and it was sold to him for $10,000. On that date Crown stock was quoted on the Exchange at $22.75. When the plaintiff gave the option, it owned 154,000 shares of Crown and was trading from time to time in it. During 1933 the plaintiff sold, in addition to the 1000 shares sold to Amberg, 13,450 shares of Crown and reported a net profit of more than $200,000 from such sales in its income tax return. The reason for the plaintiff's giving Amberg the option was that he had in the past, and the plaintiff expected that he would in the future, publicize the Crown stock orally and by giving out literature concerning it to prospective customers.
The plaintiff in its income tax return for 1933 claimed as a business loss the difference between the $42,369.13 which it paid for the stock in 1929 and the $10,000 which it received from Amberg in 1933. The Commissioner of Internal Revenue determined that the allowable loss was only the difference between the cost of $42,369.13 and the price at which the stock would have sold on the Exchange on the day of the sale to Amberg, which was $22,750, or $22.75 per share. We think the Commissioner was right. When the plaintiff gave to Amberg, without any legal consideration for it, an option to purchase the stock at a fixed price, in the future, it was entering into a bargain from which it could not possibly make a profit, and from which it might, as it did, suffer considerable loss. The plaintiff, as we have seen in our discussion of the Utech note transaction, expected Crown to increase in value, so that it must have anticipated not only a possible, but a probable loss. We think that one who enters into such an arrangement does so with the intention of making a gift to the optionee of the difference between the option price and the readily ascertainable market price at the time the option is exercised. The option is, then, a combination of a promise to sell and a promise to make a gift. And the transfer, when it occurs, is a combination of sale and gift. To the extent to which the transfer to Amberg was a gift, i.e. to the extent of $12,750, it did not represent a business loss to the plaintiff, but an intentional donation by the plaintiff to Amberg. The reason for the donation was that Amberg had done favors for plaintiff in the past and the plaintiff expected that he would continue to do so in the future. This reason, not amounting to legal consideration, is not material. There is always a reason for a gift. It may be affection, relationship, hope of future favors, or something else. But it is still a gift. What we have said disposes of the plaintiff's argument that the uncompensated value of the stock at the time it was transferred to Amberg should be regarded as an advertising cost or business expense, and therefore deductible as such, if not as a loss on the sale of the stock. Here the favors, which were the reason for the gift, had been done for the plaintiff by Amberg during an unspecified number of past years, and were hoped for by the plaintiff for an unspecified time in the future. For this reason, if not for others which we do not stop to discuss, the plaintiff may not charge this portion of its loss as a 1933 business expense.
The plaintiff may recover upon the item of its claim which relates to the Utech note, with interest. Entry of judgment will await the filing of a stipulation as to the amount.
It is so ordered.
WHALEY, Chief Justice, and BOOTH, Chief Justice (retired), recalled, concur.
I think the plaintiff is entitled to deduct the difference between the purchase price of the stock of the Crown Cork Seal Company and the price for which it was sold to Max Amberg.
The majority opinion states that there was no consideration for the option given Amberg to purchase this stock at $10 a share. This does not seem to me to be true. Amberg had rendered services to the plaintiff in times past and it was desired that he should render services to it in the future in the way of publicizing the stock of the Crown Cork Seal Company, of which plaintiff was a heavy holder, and in boosting its value. This was the actual and I think a sufficient consideration for the option.
But whether or not the option was legally binding, plaintiff felt itself obliged to honor it in order to induce Amberg to continue to boost the stock; in other words, it felt compelled to sell Amberg the stock for $10 a share and it actually did so. Therefore, it is unquestionably out of pocket the difference between what it paid for the stock and what it sold it for.
If a man enters into an unenforceable agreement to sell a piece of property at an agreed price and, although the market for the property advances in the meantime, he nevertheless carries out his agreement merely as a matter of honor, he is bound to take the actual sale price as the basis in determining gain or loss.
Even though it properly can be said that plaintiff gave Amberg the difference between the market value of the stock and the price fixed in the option, I still think plaintiff is entitled to deduct the difference between the cost and the price for which it actually sold the stock, because this, concededly, was done both for his past services in boosting the stock and to induce him to continue to do so. Plaintiff held a great deal of this stock and was constantly trading in it. Keeping up the value of the stock was a part of plaintiff's business, which it thought it could promote by inducing Amberg to continue to boost it. The transaction, therefore, might be viewed in the same light as gifts to customers and the expenses of entertaining them in order to retain their goodwill and business.
The Board of Tax Appeals (now The Tax Court) has held that both gifts to customers and the expenses of entertaining them are deductible. Appeal of James F. Coleman, 3 B.T.A. 835; Adler Co. v. Commissioner, 10 B.T.A. 849; Flanagan v. Commissioner, 47 B.T.A. 782; Hartford Hat Cap Co. v. Commissioner, 7 B.T.A. 714.
The Second Circuit Court of Appeals has held that entertainment expenses are deductible. Schmidlapp v. Commissioner, 96 F.2d 680, 118 A.L.R. 297; Blackmer v. Commissioner, 70 F.2d 255, 92 A.L.R. 982; Cohan v. Commissioner, 39 F.2d 540.
A taxpayer is entitled to deduct a bonus paid employees, not because the corporation was under the obligation to pay the bonus, but because it was done in order to improve the efficiency and productivity of employees. The sale to Amberg at this low price was done for the same reason. Both the Commissioner's regulations and the decisions of the Board of Tax Appeals recognize the right of the taxpayer to deduct bonuses to employees. Appeal of Boericke Runyon, 3 B.T.A. 684; Ferry Market, Inc., v. Commissioner, 5 B.T.A. 167; Ketcham v. Commissioner, 9 B.T.A. 1208; Liberty Hosiery Mills v. Commissioner, 31 B.T.A. 64; Guitar Trust Estate v. Commissioner, 34 B.T.A. 857; Regulations 103, sec. 19.23(a)-8.
Although I think the taxpayer would have been entitled to the deduction as a business expense, it cannot recover on this ground in this case, since it did not base its claim for refund on this ground. Real Estate Land-Title Trust Co. v. United States, 309 U.S. 13, 60 S.Ct. 371, 84 L. Ed. 542. However, I am of the opinion that it can deduct it on the ground it asserted in its claim for refund, to wit, as a loss.
I concur in the majority opinion on the deductibility of the bad debt.
LITTLETON, Judge, concurs in the foregoing opinion.