Alsobrook v. United States

• Decision Date: 07 April 1977
• Docket Number: No. LR-74-C-171.,LR-74-C-171.
• Citation: 431 F. Supp. 1122
• Parties: W. R. ALSOBROOK and Wells F. Alsobrook, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Eastern District of Arkansas

431 F. Supp. 1122

W. R. ALSOBROOK and Wells F. Alsobrook, Plaintiffs, v. UNITED STATES of America, Defendant.

No. LR-74-C-171.

United States District Court, E. D. Arkansas, W. D.

April 7, 1977.

Robt. D. Cabe, Wright, Lindsey & Jennings, Little Rock, Ark., for plaintiffs.

W. H. Dillahunty, U. S. Atty., E. D. Ark., Little Rock, Ark., for the United States.

MEMORANDUM AND ORDER

VAN SICKLE, District Judge.

This action is brought by taxpayers W. R. Alsobrook and Wells F. Alsobrook seeking refunds of income taxes previously assessed and paid. Jurisdiction is founded on 28 U.S.C. § 1346(a)(1) which provides for the bringing of a civil action to recover any internal revenue tax alleged to have been erroneously or illegally assessed or collected. The case has been submitted to the Court upon a stipulation of facts, depositions, exhibits and the respective briefs of counsel.

The present controversy concerns the tax consequences of payments made by the Plaintiff.¹

W. R. Alsobrook made payments to the Benton State Bank in partial satisfaction of the Bank's capital impairment discovered in late 1967. The Plaintiff contends he is entitled to deductions against ordinary income for ordinary and necessary business expenses pursuant to 26 U.S.C. § 162; or for business losses pursuant to 26 U.S.C. § 165; or for business bad debts pursuant to 26 U.S.C. § 166. The United States resists these claims, contending that the Plaintiff's payments should be treated as capital contributions.

The Plaintiff was the prime organizer of the Benton State Bank in Benton, Arkansas, which was chartered in 1934. He has served as its President throughout its existence. At all pertinent times Mr. Alsobrook was Chairman of the Board of Directors; additionally, he and his wife owned 50.01 percent of the outstanding capital stock. For the years 1965 through 1967, Mr. Alsobrook's annual salary and yearly dividends from the Bank were as follows:

                        SALARY      DIVIDENDS
                1965   $10,450.00   $18,230.24
                1966   $11,050.00   $20,161.66
                1967   $11,050.00   $20,152.66
                

Mr. Alsobrook personally established and implemented such policies and operating procedures as existed in the Bank. While the Bank had a Board of Directors, none of the members other than Mr. Alsobrook took an active part in the management of the Bank's affairs prior to November, 1967. Board membership was an honor bestowed by Mr. Alsobrook, and Board meetings amounted to little more than perfunctory gatherings in which management actions and decisions by Mr. Alsobrook were ratified. Until December 1, 1967, the Board had no loan committee, and Mr. Alsobrook personally supervised the loan officers and generally oversaw the loans made by the Bank with subsequent ratification by the Board.

In late October, 1967, an examination of the Bank was conducted, first by the Arkansas Bank Department and later by the Federal Deposit Insurance Corporation (FDIC). Investigation revealed that the Bank was holding a substantial quantity of questionable obligations amounting to a capital impairment of approximately $1,200,000.00.

The vast majority of the questionable loans involved Charles P. Ouletta, a substantial and active customer of the Bank for a number of years prior to November 16, 1967, who was in the construction business. Mr. Ouletta had regularly obtained and repaid loans and obtained financing for persons who had contracted with him for construction. Sometime in 1965, Mr. Ouletta began obtaining fraudulent loans from the Bank. The bulk of these loans were "secured" through the transfer of title to real property to a fictitious person or persons. Mr. Ouletta would then submit to the Bank a note and mortgage bearing the signatures of these fictitious persons. Because of his long established practice of arranging bona fide real estate loans, the Bank would accept the note and mortgage and transfer the funds to an account of Mr. Ouletta's for construction purposes. The loans were made without a bank officer or employee ever seeing the purported purchasers, and without appraisals of the land securing the loans.

While Mr. Alsobrook was generally responsible for the Bank's loan policies, he did not participate in the making of the fraudulent Ouletta loans. With but few isolated exceptions, all such loans were handled by William A. Springer, Executive Vice President of the Bank, who resigned December 31, 1967. Extensive investigation never revealed any evidence that anyone connected with the Bank knowingly accepted any of the forged Ouletta paper.²

The results of these investigations were not disclosed to officers and directors of the Bank until a special meeting of the Board called for 6:00 p.m., Thursday, November 16, 1967, at the direction of Harvel C. Adams, Commissioner of the Arkansas Bank Department. The Bank's officers and directors were given no advance notice as to the reason for the meeting. Ten of the twelve directors were present at the meeting together with the Commissioner, his examiners, staff members and legal counsel, and the FDIC examiners.

At the outset of the meeting, Commissioner Adams confronted the directors with the charge that the Bank had a capital impairment of $1,199,435.90, of which $1,032,546.07 was attributed to direct or indirect transactions involving Charles Ouletta. He further stated "in pretty harsh terms" (Adams Depo at 7, line 16) that steps had to be taken that night to satisfy the capital impairment, or he would not allow the Bank to open for business the next morning. The Commissioner's demands were non-negotiable and Mr. Alsobrook understood them as such.

The directors, including Fred E. Briner, the Bank's attorney, worked all through the night seeking a solution to the problem other than their paying large sums of money. Finally, voluntary contributions were made by several directors based on their ability to pay. The final commitments of the contributing directors as well as their respective share holdings were as follows:

                     NAME               AMOUNT       NO. OF SHARES
                W. R. Alsobrook     $1,045,000.00    11,195-11/12
                David Demuth           100,000.00        21
                A. B. Holiman, Jr.      20,000.00       232-2/3
                D. J. Stirman           10,000.00       800
                W. A. Springer          10,000.00        20
                Fred E. Briner          10,000.00       105
                Russell Coleman          5,000.00        20
                                    _____________
                                    $1,200,000.00
                

The Commissioner required that each contributing director sign a written agreement as evidence of his commitment since cash could not be physically obtained and placed in the Bank before the opening for business on the following morning. These agreements were prepared by Harry E. Meek, counsel for the Arkansas Bank Department. The agreement executed by Mr. Alsobrook provided in part:

". . . that as President and a Director of said bank he is obligated, jointly and severally with the other Directors, to discharge and satisfy the capital impairment above mentioned."

There are other indications that Mr. Alsobrook, Mr. Edward L. Wright, Commissioner Adams and Mr. Meek thought that Mr. Alsobrook might bear personal liability for the capital impairment.³ However, on the night of November 16, 1967, this was not discussed. That night an unexpected emergency was being dealt with. At the time the main concern of everyone involved was to keep the Bank open by replacing the questionable loans with good money. Once the Bank was saved other concerns emerged and other details were worked out in the ensuing days and weeks.

Mr. Edward L. Wright, an attorney, was hired to assist Mr. Fred E. Briner to straighten out problems created by the capital impairment. The Bank's policies were revised so that a similar situation would not arise in the future, and plans were made for the handling of the classified loans. All of the classified loans which had contributed to the capital impairment were written down to the value of $1.00 on the Bank's books and the underlying notes, mortgages and chattel paper were transferred by the Bank to a trustee for the contributing directors. Salvage efforts proceeded, and net proceeds were disbursed to the directors.⁴ In essence, these loans were purchased by the directors; however, title to the loans remained in the Bank and no formal or written trust agreement between the Bank and the Directors was ever executed.

For the calendar year 1969, the Plaintiff claimed a deduction against ordinary income in the amount of $341,593.00. In choosing 1969 as the year in which he was entitled to a deduction Mr. Alsobrook relied heavily on the fact that this was when Charles Ouletta was convicted. See, n.2, supra. While Mr. Ouletta was named a defendant in the foreclosure actions by the Bank "no additional collection efforts were made against him" (Plaintiff's brief at p. 7).

The deduction was disallowed and a notice of deficiency was issued by the Internal Revenue Service. On or about February 19, 1974, the Plaintiff satisfied the deficiency with interest in the total sum of $142,981.57. The Plaintiff then filed a timely claim for a refund which was subsequently disallowed by the Internal Revenue Service. The Plaintiff then instituted the present action seeking a refund of the amount of taxes and interest assessed against him.

Tax deductions do not turn on general equitable considerations, but are a matter of legislative grace. Deputy v. DuPont, 308 U.S. 488, 60 S.Ct. 363, 84 L.Ed. 416 (1940). The burden is on the taxpayer asserting a claim for a deduction to prove that his claim fits clearly within the scope of a specific deduction section. See, New Colonial Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 78 L.Ed. 1348 (1934); Lemoge v. United States, 378 F.Supp. 228, 233-34 (N.D.Cal.1974). In doing so, he must show that he has satisfied every requirement of the appropriate statute and its accompanying regulations.

The Plaintiff has failed in his burden of proof as to each of his...