West Los Angeles Institute for Cancer Research v. Mayer

Citation366 F.2d 220
Decision Date06 October 1966
Docket NumberNo. 19551.,19551.
PartiesWEST LOS ANGELES INSTITUTE FOR CANCER RESEARCH, Appellant, v. Ward MAYER et al., Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (9th Circuit)

COPYRIGHT MATERIAL OMITTED

Koerner, Young, McColloch & Dezendorf, Frank H. Spears, Herbert H. Anderson, James H. Clarke, George L. Kirklin, Portland, Or., for appellant.

Charles M. Price, Robt. W. Wright, Jr., Spray, Price, Hough & Cushman, Chicago, Ill., Hugh L. Biggs, Cleveland C. Cory, Davies, Biggs, Strayer, Stoel & Boley, Portland, Or., for appellee.

Before POPE, MERRILL and BROWNING, Circuit Judges.

BROWNING, Circuit Judge:

In August 1951, Ward Mayer and his wife and son — who, with D. F. Kinder, were the stockholders of Timber Structures, Inc. — contracted to sell the business to the West Los Angeles Institute for Cancer Research, a tax-exempt entity. The transaction was patterned after the sale and leaseback agreements described in the opinions in Commissioner of Internal Revenue v. Brown, 380 U.S. 563, 85 S.Ct. 1162, 14 L.Ed.2d 75 (1965) and 325 F.2d 313 (9th Cir. 1963). In March 1960, the Mayers1 brought this action to recover the property. The district court granted the relief sought, and we affirm, on the ground that the sale and leaseback arrangement was frustrated by Revenue Ruling 54-420, 1954-2 Cum.Bull. 128, issued in September 1954, which rejected the tax premises upon which the transaction was based.

Under the plan, the Mayers sold the stock in Timber Structures to the Institute for $2,500,000 — $10,000 down, the balance payable under the following arrangement. It was agreed that the Institute would lease the business to a newly-formed operating company for a five-year period; that the operating company would pay 80 per cent of the operating profits to the Institute as rent; and that the Institute would return 90 per cent of the rentals to the Mayers in payment of the purchase price of the property. To make these payments possible, it was contemplated that the operating company would deduct the rental payments as a business expense and that the Institute, because of its tax-exempt status, would pay no tax on these receipts. It was contemplated that the Mayers would pay tax on the amounts which they received from the Institute at capital gain rates.

However, in Revenue Ruling 54-420 the Commissioner took the position that in transactions of this type the operating company's rental payments would be taxable to the purchasing entity as unexempt income, and payments to the selling stockholders would not be entitled to capital gains treatment. In October, 1954, when the Mayers had received approximately $350,000 of the $2,500,000 purchase price, they and the Institute were informed by the Internal Revenue Service that the ruling applied to their transaction. The district court found that this "completely frustrated the carrying out of the transaction. The tax consequences which were denied by this ruling were the keystone of the plan, without which it was wholly unfeasible and would never have been seriously considered by the selling stockholders."

Viewed as of the time of the Revenue Ruling,2 the finding seems unassailable. The Revenue Ruling did not specifically state whether the rental payments could be treated as a business deduction to the operating company, but the rationale of the ruling strongly suggested that they could not, and instead must be treated as taxable income to the operating company. This, of course, would make it impossible for the operating company to make the contemplated payments to the Institute. In any event, since the Revenue Ruling made it clear that the payments would be taxable income to the Institute, the Institute would be unable to make the contemplated pay-out to the Mayer group. It was also evident that even if the Institute were able to pay the Mayers, completion of the transaction would be calamitous to the Mayers since the ruling denied them the anticipated benefit of capital gain treatment of these receipts.

There was abundant evidence that the parties recognized that application of the ruling to their transaction rendered performance impossible. The parties agreed that no further payments under the contracts would be made, and the Institute did not renew the operating company's original five-year lease. The Institute sought to have the ruling revoked or to exempt their transaction from its application. When these efforts failed the parties undertook negotiations looking toward rescission of the transaction, and reached an informal agreement for the return of the properties to the Mayers, subject to approval of the plan by the Internal Revenue Service.3

We agree with the district court that the circumstances would seem appropriate for application of the doctrine of "commercial frustration" or "supervening impossibility of performance," which, as stated by the Oregon Supreme Court, "reads into" contracts "an implied condition that the promisor shall be absolved from performance if, through a supervening circumstance for which neither party is responsible, a thing, event or condition which was essential so that the performance would yield to the promisor the result which the parties intended him to receive, fails." Dorsey v. Oregon Motor Stages, 183 Or. 494, 194 P.2d 967, 971 (1948). See also Cabell v. Federal Land Bank, 173 Or. 11, 144 P.2d 297, 302 (1943). Compare Eggen v. Wetterborg, 193 Or. 145, 237 P.2d 970 (1951); Strong v. Moore, 105 Or. 12, 207 P. 179, 183 (1922); and Elmore v. Stephens-Russell Co., 88 Or. 509, 171 P. 763 (1918). But see Crane v. School Dist. No. 14, 95 Or. 644, 188 P. 712 (1920).4

The Institute argues that rescission of the contract on this ground would be improper for a number of reasons.

First. The Institute contends that performance of the contract is not in fact impossible, because Revenue Ruling 54-420 was rejected in a number of subsequent court decisions which allowed operating companies to treat the rental payments as a business expense,5 and which allowed purchasing entities to claim their exemption;6 because in April 1961, after this action was commenced, the Institute offered to pay the agreed-upon purchase price in full out of funds other than rental payments from the operating company; and because in April 1965, the Supreme Court in Commissioner of Internal Revenue v. Brown, supra, 380 U.S. at 570-573, 85 S.Ct. 1162, held that in a transaction of this type selling stockholders would be entitled to capital gains treatment of the payments which they received.

But the "performance" to which the Institute refers is not that contemplated by the contract. Payment in April 1961, of the balance due on the purchase price would not have accomplished the purpose for which the Mayers entered into the transaction, as the Institute knew. Commissioner of Internal Revenue v. Brown still lay in the future, and the agreed-upon purchase price taxable at capital gain rates was not the equivalent of that purchase price taxable as ordinary income. As the district court found, "The consideration bargained for by the sellers was not merely $2,500,000 but $2,500,000 recognized by the IRS as proceeds from the sale of a capital asset and entitled to capital gain treatment."7

Nor could the result for which the Mayers contracted have been achieved by payment of the unpaid balance of approximately $2,150,000 (over 85 per cent of the purchase price) in April 1965, when Commissioner of Internal Revenue v. Brown was finally decided. The evidence refuted any suggestion that the parties contemplated that performance could await the favorable outcome of an extended tax controversy. On the contrary, it is clear that the parties intended that all or a substantial portion of the Mayers' investment would be liquidated over a relatively brief period after August 1951.8

Second. The Institute argues that the doctrine of commercial frustration is inapplicable because the parties foresaw the possibility of an adverse tax ruling and included the default provisions in the contract to meet this contingency.

The Institute places particular emphasis upon evidence indicating (contrary to the district court's finding) that the parties did in fact foresee the possibility that the tax premises of the transaction might be challenged. But that alone would not bar rescission. We think it proper to assume that the Supreme Court of Oregon follows the now more widely accepted view that foreseeability of the frustrating event is not alone enough to bar rescission if it appears that the parties did not intend the promisor to assume the risk of its occurrence.

The ultimate question in every case is "whether or not proper interpretation of the contract shows that the risk of the subsequent events, whether or not foreseen, was assumed by the promisor. If it appears from the nature of the contract as well as from the surrounding circumstances that, although they were reasonably foreseeable, the promisor did not assume the risk of the subsequent events, the contract shows a gap subject to supplementation in accordance with rules of objective law. Conversely, if the contract, properly construed, shows that the promisor assumed the risk of unanticipated events, the occurrence of such events does not excuse performance." Smit, 58 Colum.L.Rev. 287, 314 (1958). See also L. N. Jackson & Co. v. Royal Norwegian Gov't, 177 F.2d 694, 699 (2d Cir. 1949); 6 Williston, Contracts § 1953, pp. 5475-5476; Restatement, Contracts §§ 288, 461.9

In the present case the district court found, on substantial evidence, that the Mayers did not intend to assume the risk of an adverse tax ruling, and, implicitly, that the express terms of the contract, including the default provisions, were not intended to provide for this contingency. As the district court said, "the selling stockholders made it clear throughout the negotiations that they were relying on the transaction...

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