Opinion
Civil Action No. 1435.
October 23, 1945.
Baker, Botts, Andrews Wharton, of Houston, Tex. (Robert K. Jewett and Thos. E. Mosheim, both of Houston, Tex., of counsel), for plaintiff.
Brian S. Odem, U.S. Atty., and J.K. Smith, Asst. U.S. Atty., both of Houston, Tex., for defendant.
Action by Warwick Hotel, Inc., against the United States of America to recover alleged overpayment of income taxes.
Judgment for plaintiff.
Affirmed by the United States Circuit Court of Appeals in 158 F.2d 961.
Stipulation of relevant facts referred to in opinion is as follows:
I. The Warwick, Inc., was a corporation organized in 1925 under the laws of the State of Texas to construct, own, maintain and operate the property and premises consisting of the Warwick Hotel and the hotel equipment located therein (consisting of elevators, heating system and other fixtures attached to the realty) hereinafter referred to as Warwick Hotel Properties. On or about August 31, 1925, The Warwick Inc., executed a certain Deed of Trust and Chattel Mortgage dated August 15, 1925, to Melvin L. Straus, Trustee, hereinafter referred to as First Mortgage Deed of Trust, recorded on September 10, 1925, in Volume 281, page 194, of the Mortgage Records of Harris County, Texas, to secure the payment of the principal and interest, in accordance with the covenants of said First Mortgage Deed of Trust, of $1,300,000 of 6¼% First Mortgage Sinking Fund Gold Bonds. In August, 1928, The Warwick, Inc., executed what will hereinafter be referred to as a Second Mortgage Deed of Trust to Frederick S. Livingston, Trustee, amended by instrument dated September 2, 1930, the original and amended instruments being recorded, respectively, in the Mortgage Records of Harris County, Texas, under file No. 359765 and Vol. 523, page 526, to secure the payment of an indebtedness of $100,000. The Second Mortgage Deed of Trust was expressly stated to be subject to the First Mortgage Deed of Trust in accordance with the provisions of such First Mortgage Deed of Trust.
II. In 1931, The Warwick, Inc., was delinquent in the payment of City, County and State ad valorem taxes, and had failed to make monthly deposits due in respect of payment of principal due under said First Mortgage Deed of Trust. Said tax delinquencies and failure to make deposit of principal payments due constituted default of the covenants under said First Mortgage Deed of Trust. At a meeting in July, 1931, between Don Hall, President of The Warwick, Inc., and M.A. Rosenthal, representative of the Trustee under said First Mortgage Deed of Trust, it was agreed that The Warwick, Inc., would apply all income in excess of cash operating expenses and interest due under said First Mortgage Deed of Trust to the satisfaction of the existing tax delinquencies. On October 24, 1931, a Notice of Default was forwarded to The Warwick, Inc., by Melvin L. Straus, said notice being permitted under the provisions of Articles VII, VIII and IX of the First Mortgage Deed of Trust, copy of said notice being attached to and incorporated herein as Exhibit A. After forwarding such notice, The Warwick, Inc., pursuant to the July, 1931, Agreement continued to apply all income in excess of cash operating expenses and interest due under said First Mortgage Deed of Trust to the satisfaction of the existing tax delinquencies.
III. On or about November 17, 1931, a Notice of Default under the provisions of the Second Mortgage Deed of Trust was forwarded by Frederick S. Livingston, the Trustee thereunder, copy of such notice being attached hereto and incorporated as Exhibit B.
IV. Notice of a Trustee's Sale of the Warwick Hotel Properties under said Second Mortgage Deed of Trust was posted as required by Article 3810, Texas Revised Civil Statutes, in Harris County, Texas, such sale to take place February 2, 1932. M.A. Rosenthal, representative of the Trustee under said First Mortgage Deed of Trust had no actual knowledge of this proposed Trustee's Sale of the Warwick Hotel Properties under the Second Mortgage Deed of Trust, prior to Jan. 27, 1932 when M.A. Rosenthal was notified by telegram of such sale by Don Hall.
V. On February 2, 1932, the Trustee under said Second Mortgage Deed of Trust, at a Trustee's Sale regularly held under the laws of Texas, sold the said Warwick Hotel Properties subject to the First Mortgage Deed of Trust, to C.D. Rubin. Rubin by a conveyance executed February 3, 1932, acknowledged February 6, 1932, and recorded February 10, 1932, in the Deed Records of Harris County, Texas, then transferred the said Warwick Hotel Properties, subject to the said First Mortgage Deed of Trust, to Wickwar Holding Company, a corporation of which he was President. This corporation on February 3, 1932, leased the property to Wickwar Hotel Company.
VI. On February 15, 1932, a Deposit Agreement was executed under which a Bondholders' Committee agreed to act and accept for deposit the bonds of the First Mortgage Bondholders. Provision was made in such Deposit Agreement, in the event of acquisition of the Warwick Hotel Properties by the Bondholders' Committee, for the adoption of a Plan of Reorganization, and a request was sent to all First Mortgage Bondholders to deposit their bonds in accordance therewith. On February 15, 1932, the Trustee under said First Mortgage Deed of Trust filed his bill of complaint, seeking appointment of a receiver for and foreclosure of the said Warwick Hotel Properties, under said First Mortgage Deed of Trust in the United States District Court, Southern District of Texas, Houston Division, Action in Equity No. 508. On February 18, 1932, Wickwar Holding Company and/or Wickwar Hotel Company were temporarily restrained by court decree in said Action in Equity No. 508 from dealing with the said Warwick Hotel Properties and the income therefrom except insofar as it was necessary to carry on the ordinary operations of the hotel. On March 3, 1932, the court in said Action in Equity No. 508, dissolved the temporary restraining order and injunction.
VII. On or about March 1, 1932, the Bondholders' Committee under the said First Mortgage Deed of Trust entered into an agreement with Wickwar Holding Company, copy of which is attached hereto and incorporated herein as Exhibit C. Also on or about March 1, 1932, Melvin L. Straus, Trustee under said First Mortgage Deed of Trust entered into an agreement with Wickwar Holding Company, copy of which is attached hereto and incorporated herein as Exhibit D. Upon payment of the consideration specified in the agreement between the said Bondholders' Committee and Wickwar Holding Company, Wickwar Holding Company on or about May 19, 1932, executed a deed to Robert Straus, nominee of said Bondholders' Committee, copy of which is attached hereto and incorporated herein as Exhibit E.
VIII. In November, 1932, the Bondholders' Committee, pursuant to the provisions of the Deposit Agreement formulated a Plan of Reorganization, contingent upon the purchase at foreclosure sale of the said Warwick Hotel Properties by the Bondholders' Committee, providing for the conveyance of the property to a corporation whose stock was to be issued to three Trustees, appointed by said Bondholders' Committee, under a Trust Agreement to continue for ten years, and providing for the issuance by the said Trustees to the Depositing Bondholders of voting trust certificates for one-fifth (1/5) shares of the stock of such corporation for each One Hundred Dollars ($100) of bonds deposited, and providing for the continuance of such trust agreement for a period of ten (10) years unless sooner terminated by a majority of the Trustees or by instruments executed in writing by the holders of more than two-thirds (2/3) in amount of outstanding certificates, and providing for the management of such corporation and its properties by such Trustees during such ten (10) year period.
IX. On or about December 21, 1932, there was entered a decree in said Action in Equity No. 508 providing for the appointment of a special master to sell the said Warwick Hotel Properties in the event of failure of the defendant The Warwick, Inc., to pay such amount found in said decree to be due within three (3) days from the entry of said Order; such sale to be made in accordance with the provisions of said decree.
X. That on or about February 7, 1933, the said Warwick Hotel Properties were sold by F.W. Nisbet, Special Master, appointed by the court in said Action in Equity No. 508, to J.W. Link, Jr., the nominee of the Bondholders' Committee, and on or about June 10, 1933, the Court entered in said Action in Equity No. 508 its decree confirming such sale, specifying the delivery of a deed to the purchasers or their nominees on payment of the purchase price as therein decreed.
XI. In accordance with such decree of the Court, dated June 10, 1933, a deed recorded in Vol. 930, page 151, of the Deed Records of Harris County, Texas, a copy of which is attached hereto and incorporated herein as Exhibit F, to said Warwick Hotel Properties was executed by Frederick Nisbet, Special Master, appointed in said Action in Equity No. 508, on or about June 20, 1933, to the Warwick Hotel, Inc., a corporation organized on or about June 20, 1933, under the laws of the State of Texas. Said deed was not filed among the papers in Equity No. 508. As provided under such said Plan of Reorganization adopted by said Bondholders' Committee, the stock of said Warwick Hotel, Inc., was delivered to said Trustees acting under said Plan of Reorganization and said Trustees issued to the depositing bondholders voting trust certificates for one-fifth (1/5) share of stock of said Warwick Hotel, Inc., for each One Hundred Dollars ($100) of bonds deposited. In the decree of the court in said Action in Equity No. 508 ordering sale of the said Warwick Hotel Properties, it was specified that the principal amount of the bonds outstanding and unpaid under said First Mortgage Deed of Trust was $1,186,000. There was deposited, prior to the conveyance of said Warwick Hotel Properties to Warwick Hotel, Inc., with said Bondholders' Committee, pursuant to the above referred to Deposit Agreement formulated by said Bondholders' Committee 92.43% of the Bonds issued under said First Mortgage Deed of Trust outstanding and unpaid as above set forth. Voting Trust Certificates for all of the stock of The Warwick, Inc., therefore were issued to and held by persons who were formerly the owners of 92.43% of the bonds issued under said First Mortgage Deed of Trust outstanding and unpaid as above set forth.
XII. The original cost of the Warwick Hotel Properties, together with depreciation accrued thereon up to June 10, 1933, was as follows:
Hotel Hotel Item Total Building Equipment
Cost ....................... $1,758,622.69 $1,504,851.34 $253,771.35 Accrued depreciation ....... 209,803.17 142,124.73 67,678.44 _____________ _____________ ___________ Undepreciated cost ...................... $1,548,819.52 $1,362,726.61 $186,092.91 ============= ============= ===========
Depreciation was accrued by The Warwick, Inc., on the Warwick Hotel building based upon an original estimated life of 71.5 years from October, 1926. Depreciation was accrued by The Warwick, Inc., on the Warwick Hotel permanent equipment and fixtures therein upon an original estimated life of 25 years from October, 1926. Depreciation was allowed by the Bureau of Internal Revenue on the Warwick Hotel building and permanent equipment and fixtures therein for the year 1938 at three per cent on a value of $680,000 such rate and value having been established for the Warwick Hotel and the permanent equipment and fixtures located therein by a Revenue Agent's Report, dated April 3, 1936.
XIII. The taxable net income established for the Warwick Hotel, Inc., for the year 1938, by a Revenue Agent's Report dated August 7, 1940, accepted and agreed to by the Warwick Hotel, Inc., was $45,602.92. In computing this taxable net income depreciation on the Warwick Hotel building and permanent equipment and fixtures therein was allowed in the amount of $20,400 as set out above.
XIV. That thereafter Melvin L. Straus, Trustee under said First Mortgage Deed of Trust, filed his final report and account as Trustee covering his management of said Warwick Hotel Properties from the date of deliverance into his hands on March 1, 1932, through June 9, 1933, the date of transfer of said property by said Special Master to the Warwick Hotel, Inc. On March 12, 1934, there was entered in said Action in Equity No. 508 an order of the Court's approving said Trustee's final report and account.
XV. On or about February 27, 1942, plaintiff filed its claim for refund of the income tax for which this suit is brought. On September 12, 1942, notice of disallowance in full of said claim for refund was given by the Commissioner of Internal Revenue.
Warwick Hotel, Inc., a Texas corporation (Plaintiff), owns the Warwick Hotel Properties in Houston, in this Division and District. Originally such properties were owned by Warwick, Inc., also a Texas corporation, organized prior to August 1925. Warwick, Inc., placed on the properties a first mortgage, dated August 31, 1925, and in August 1928 (amended in 1930) a second mortgage. In 1931, Warwick, Inc., was in default under both mortgages, and there followed certain proceedings (hereinafter set forth), whereby the title to the properties passed into Plaintiff. Plaintiff claims that by such proceedings, a " reorganization" was effected, and that Plaintiff, in making its Income Tax Return for 1938, was entitled to claim depreciation from October 1926, the date the properties were placed in operation. The Commissioner ruled and the Government contends that such proceedings were not a "reorganization," and that Plaintiff was entitled to depreciation only from the time title passed into Plaintiff on June 20, 1933. Plaintiff claims that this ruling by the Commissioner and claim by the Government resulted in an overpayment of taxes by it for 1938, amounting to $5503.64, plus interest, for which it filed claim, which was rejected, and for which it now prosecutes this suit.
The facts are as follows:
(a) A lengthy Stipulation has been filed, in which substantially all the major facts necessary to decision have been set forth. It is referred to and adopted.
(b) Other facts were brought out at the hearing and in depositions which will be mentioned in the discussion.
1. It seems clear that the proceedings taken under the first mortgage, standing alone, constitute a "reorganization" under the Statute. Helvering v. Limestone, 315 U.S. 179, 62 S.Ct. 540, 86 L.Ed. 775; Palm Springs Holding Corporation v. Commissioner, 315 U.S. 185, 62 S.Ct. 544, 86 L. Ed. 785. But the Government says that the proceedings taken under the second mortgage brings the case under the rule laid down in Marlborough House v. Commissioner, 315 U.S. 189, 62 S.Ct. 537, 86 L.Ed. 784, and that that case is controlling.
It will be observed from the Stipulation and evidence that after the control of the properties and/or the revenue therefrom passed to the bondholders under the first mortgage (Summer 1931), and after the trustee under the first mortgage had given notice (October 24, 1931) of default thereunder, and while such bondholders were struggling during a season of depression with the question of preserving such properties, the trustee under the second mortgage gave notice of default (November 17, 1931), and contrary to what bondholders under the first mortgage believed would be done, began foreclosure proceedings which culminated in a public sale under the second mortgage of the properties on February 2, 1932. The trustee under the first mortgage did not learn of such foreclosure proceedings until January 27, 1932, about a week before such sale.
C.D. Rubin, the purchaser of the properties at such sale, on the day after such sale, transferred same (subject to the first mortgage) to the Wickwar Holding Company, a corporation of which Rubin was President, which corporation on that day leased such properties to the Wickwar Hotel Company. On March 19, 1932, pursuant to an agreement, dated March 1, 1932, a committee of bondholders under the first mortgage acquired for a cash consideration of $15,000 the title of the persons holding under such sale.
The facts here are, therefore, radically different from those in the Marlborough case, and I do not think that case is controlling.
Judgment for Plaintiff.