Neville Coke & Chemical Co. v. Commissioner of Int. Rev.

• Decision Date: 22 March 1945
• Docket Number: No. 8692.,8692.
• Parties: NEVILLE COKE & CHEMICAL CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

148 F.2d 599 (1945)

NEVILLE COKE & CHEMICAL CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 8692.

Circuit Court of Appeals, Third Circuit.

Argued January 18, 1945.

Decided March 22, 1945.

Thomas Watson, of Pittsburgh, Pa., for petitioner.

Muriel S. Paul, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and J. Louis Monarch, Sp. Assts. to the Atty. Gen., on the brief), for respondent.

Before BIGGS, GOODRICH, and McALLISTER, Circuit Judges.

GOODRICH, Circuit Judge.

The question for us in this case is the correctness of the Tax Court's conclusion concerning the Neville Coke & Chemical Company's tax liability for 1936. Two corporations known as the Hillman Coal & Coke Company and W. J. Rainey, Inc., had made advances of money and sold coal on credit to a corporation known as the Davison Coke & Iron Company.¹ In 1932 the debtor corporation was in some financial difficulty and a reorganization was determined upon. The Hillman and Rainey companies subsequently caused the formation of the taxpayer corporation as a step to facilitate reorganization of the Davison company. To the new corporation Hillman and Rainey transferred their claims against or interest in, the debtor. These consisted of "preferred accounts", first mortgage bonds, accounts receivable, notes of the debtor due in three, four and five years without interest,² and stock, of various classifications, in the debtor company.

The 1932 efforts not having proved sufficient to get the debtor out of its troubles, in 1935 it filed a 77B petition; a plan of reorganization was promptly approved and final decree entered on January 31, 1936. Under the plan the debtor issued new common stock and debenture bonds. Its old bonds were exchanged for debentures and the holders of certain notes, the nature of which is discussed below, got new debentures in the same face amount ($1,129,000) plus 22,580 shares of common stock in the reorganized company.

Two questions of dispute in this Court between Commissioner and taxpayer relate to (1) whether the exchange of the notes for debentures and shares was a tax free transaction; (2) whether the new debentures were properly valued at par. The Tax Court sustained the Commissioner in his determination that the taxpayer had realized a taxable gain in exchanging its notes for the new debentures and shares. It also sustained the Commissioner's determination that the debentures, on date of acquisition, had a value of par, at the same time reducing the Commissioner's valuation on the shares from $5.94 to $5.00 each.

The first question is obviously the critical one; if the taxpayer is right on that, its troubles, so far as this litigation is concerned, are over. The relevant sections of the Revenue Act of 1936, are noted in the margin.³ The storm center of the controversy here relates to § 112(b) (3). There is no gain or loss recognized if "stock or securities in a corporation * * * are * * * exchanged solely for stock or securities in such corporation * * *." Were the notes of Davison, which the taxpayer had in its possession, and which it exchanged for debentures and shares of stock issued by the reorganized debtor, "securities" within the wording of the statute? No question has been raised as to the sufficiency of the evidence of obligations issued by the reorganized debtor to qualify under the description of "stock or securities", and the problem is limited to the consideration of what the taxpayer turned in, that is, the notes above mentioned.

What then are "securities" within the meaning of the section? The taxpayer makes a tentative argument that the word ought to be taken in its common, accepted interpretation and that interpretation includes evidence of indebtedness, but he goes on to admit that the Supreme Court has read into the term a meaning differing radically from common interpretation.

It is to be noted that the phrase "stock or securities" appears twice in § 112 (b) (3). Once it refers to what a party turns into a corporation being reorganized. The second appearance of the phrase relates to what a recipient takes from the reorganized company as a result of the transaction. We have no reason for thinking that the phrase has a different meaning in either of the two instances and the argument by the taxpayer that it does differ fails to convince us. Cf. Lloyd-Smith v. Commissioner of Internal Revenue, 2 Cir., 1941, 116 F.2d 642, certiorari denied 1941, 313 U.S. 588, 61 S.Ct. 1111, 85 L.Ed. 1543.

Most of the decisions seem to have concerned themselves with what was issued to the recipient by the reorganized corporation. In Pinellas Ice & Cold Storage Co. v. Commissioner of Internal Revenue, 1933, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428, the taxpayer was given short term secured notes, maturing in 45, 75 or 105 days, respectively. The Court said that to give an exemption "the seller must acquire an interest in the affairs of the purchasing company more definite than that incident to ownership of its short-term purchase-money notes." Id., 287 U.S. at page 470, 53 S.Ct. at page 260, 77 L.Ed. 428. Was the term "security" then to depend upon the length of time between inception and maturity of the obligation? The courts talked and decided as though length of time were the test. See the discussion and authorities cited in L. & E. Stirn, Inc. v. Commissioner of Internal Revenue, 2 Cir., 1939, 107 F.2d 390. Six year bonds were held to be securities by this Court in Commissioner of Internal Revenue v. Freund, 3 Cir., 1938, 98 F.2d 201. On the other hand, when the reorganized corporation issued evidence of indebtedness, ten year notes were held to be "securities" sufficient for a tax free transaction in Burnham v. Commissioner, 7 Cir., 1936, 86 F.2d 776, certiorari denied, 1937, 300 U.S. 683, 57 S.Ct. 753, 81 L.Ed. 886.

This tendency to measure legal sufficiency on a time basis was noted by the Supreme Court in LeTulle v. Scofield, Collector of Internal Revenue, 1940, 308 U.S. 415, 60 S.Ct. 313, 316, 84 L.Ed. 355. The Court there declared that "the term of the obligations is not material." It drew the distinction between a case where, after the reorganization, the transferee retained a proprietary interest in the enterprise or simply became a creditor.

Did the notes which taxpayer held against Davison Company give it a "proprietary" interest in the enterprise or was it only a creditor? Since LeTulle v. Scofield was decided the Second Circuit has held that short term notes (six months or on demand) which, however, were secured, "were but short term obligations having the character of temporary evidence of debt," as distinguished from "the well known permanent, or semi-permanent, status of long term obligations, which are to be treated as securities within the meaning of that term in § 112(b) (3) * * *." Commissioner of Internal Revenue v. Sisto Financial Corporation, 2 Cir., 139 F.2d 253, 255. The set of facts in that case differs from those here in the length of time in which the obligation had to run before maturity. But, it is to be remembered in this connection, the time element is not the determining factor.

The Commissioner's argument is to the effect that the notes in question do not represent a stake in the business of the corporation. Their total amount was $1,129,000. $500,000 was due in three years, $250,000 in four years and $250,000 in five years. These had been received by the Hillman Company in 1932 in exchange for $500,000 demand notes and $500,000 past due promissory notes which Hillman Company had discounted for the debtor corporation. The remaining $129,000 represented three year notes received by Hillman Company and the Rainey Company in 1932 as current creditors of the debtor. It is pointed out that J. H. Hillman, Jr., of the Hillman Company, testified that the $1,000,000 loaned in 1930 was conditioned upon the debtor giving his Company its business in low volatile coal, thus indicating no intention of investing in debtor's business. The taxpayer, in its reply brief, meets this point with great vigor and considerable force. It calls to our attention the reorganization agreement of 1932 which was not a court proceeding, but an agreement between the Davison Company and its principal creditors. This document is in evidence and it is stipulated that the recital of fact...