Davee v. United States, 242-66

Citation444 F.2d 557
Decision Date11 June 1971
Docket NumberNo. 242-66,433-66.,242-66
PartiesKen M. DAVEE and Adeline B. Davee v. The UNITED STATES. Elizabeth Kline JORDAN and Lea Associates, Inc. v. The UNITED STATES.
CourtCourt of Federal Claims

Morris J. Coff, Chicago, Ill., attorney of record, for Ken M. Davee and Adeline B. Davee, David D. Rosenstein, Fink, Coff & Nudelman, Chicago, Ill., of counsel.

Andrew B. Young, Philadelphia, Pa., for Elizabeth Kline Jordan and Lea Associates, Inc., Robert C. Lea, Jr., Philadelphia, Pa., attorney of record, Hart, Childs, Hepburn, Ross & Putnam, Philadelphia, Pa., of counsel.

W. Stephen McConnell, Washington, D. C., with whom was Asst. Atty. Gen. Johnnie M. Walters, for the United States. Philip R. Miller, Washington, D. C., of counsel.




This case was referred to Trial Commissioner C. Murray Bernhardt with directions to make findings of fact and recommendations for conclusions of law under the order of reference and Rule 134 (h). The commissioner has done so in an opinion and report filed on July 28, 1970. Exceptions to the commissioner's opinion, findings of fact and recommended conclusions of law were filed by plaintiffs in No. 433-66 and defendant and the case has been submitted to the court on oral argument of counsel and the briefs of the parties.

Since the court agrees with the commissioner's opinion, findings of fact and recommended conclusion of law, with the deletion of matter in the opinion no longer pertinent to the case, it hereby adopts the same, as modified, as the basis for its judgment in this case as hereinafter set forth. Therefore, plaintiffs in No. 242-66 are entitled to recover and judgment is entered for them with the amount of recovery to be determined pursuant to Rule 131(c). Defendant is entitled to recover on its counterclaim in No. 433-66, however, the entry of judgment thereon is deferred pending determination of plaintiffs' case in chief in that litigation.

Commissioner Bernhardt's opinion, with the deletion of matter no longer pertinent, is as follows:

The common primary issue in these two companion petitions concerns the tax treatment to be accorded the consideration in the sale of a going business by plaintiff Davee (hereafter denoting husband and wife coplaintiffs) in the one petition to plaintiff Lea in the other petition,1 particularly wherein a portion was specifically allocated by agreement of the parties to a covenant not to compete. The stakeholding Government, which originally opposed the taxpayers' conflicting contentions on mutually inconsistent grounds, now opts for the Davee view that the sale of all but the covenant not to compete was a capital transaction and taxable as such, and opposes Lea's position that the entire sale resulted in ordinary income to Davee and amortizable deductions to Lea because (per Lea) the dominant if not sole asset bought by Lea and sold by Davee was the later's covenant. A secondary issue affecting only the Davee petition is the tax treatment for payments he made to a French concern for assembling data to launch a new market research business serving the French market.

I — Covenant Not To Compete Issue

Essentially we have two concerns (Lea and Davee) which, in 1962, were sole competitors in providing a particular market research service to large American pharmaceutical and ethical drug manufacturers in the form of periodical publications which, based upon continuous surveys compiled from nationwide panels of representative physicians reported to their respective customers the fluctuating professional response to, and the use and effectiveness of, various drugs, presumably as a basis for determining trends which would dictate future research, manufacturing and sales efforts. While each of the competing services duplicated the other's principal purpose, gathered its statistical data in comparable ways through an elaborate and expensive network of assistants in the healing profession such as doctors and interns, and computerized the myriad data thus obtained in coded form for customer consumption, each service had its own stable of customers and varied somewhat as to contents, format, and title. Thus Lea's publication was known as "National Drug and Therapeutic Index" (NDTI) and Davee's was "Physicians' Panel".

By 1962 it became apparent that the number of potential customers in the drug and pharmaceutical industry was not sufficient to support comfortably both NDTI and Physicians' Panel. Of the limited number of customers for this expensive service ($28,000 per year) Davee then had 18 and Lea, which had fewer, was gradually nibbling away at Davee's roster of customers. Physicians' Panel was only one of several profitable marketing services in generically related fields owned and conducted by Davee.

In 1962 Lea made overtures to purchase Davee's Physicians' Panel. The record of these negotiations over a period of several months, as reported in annexed findings 15 through 22, contains offers by Lea, counteroffers by Davee, and a series of amendments, deletions, additions, etc., culminating in two companion documents — a sale agreement of May 31, 1962 and a letter agreement of June 1, 1962. Throughout negotiations the parties had consulted with their respective tax counsel as to the tax ramifications of the transaction, and it cannot be said that either was unaware of what he was doing. Nor is there a hint of fraud, duress or mistake, or even misunderstanding, in the final arrangements they perfected or in the negotiations preceding them. These were sophisticated and informed businessmen who fully understood the legal effect of their undertaking, particularly as to resulting taxes, and without doubt the agreement was reached on the basis of prospective profits and earnings after taxes.

The sale agreement described Davee's Physicians' Panel (section 1), referred to Lea's wish to expand the NDTI service by "purchasing" Physicians' Panel (section 2), mentioned Davee's agreement to "sell" and Lea's agreement to "buy" Physicians' Panel (section 3), permitted Davee to continue to operate his other marketing research services but prohibited him for five years from soliciting or obtaining any data from physicians in the United States with specific exceptions not here germane (section 4), stipulated a purchase price of $320,000 payable in cash and installments over five years (section 5), prohibited Davee from collecting any further data for Physicians' Panel and required him to furnish Lea his past reports, casebooks, and other material concerning operation of Physicians' Panel within prescribed times so that Lea could "utilize these data and materials in the operation of its NDTI service and the business sold hereunder" (section 6), provided a $37,500 bonus to Davee for consummating the deal by July 6 or $18,750 by October 5, 1962 (section 7), provided forfeiture to Davee of both the Physicians' Panel and NDTI on Lea's default of the purchase notes (section 8) and, reciprocally, a cancellation of the notes and a return to Lea of all amounts paid Davee thereunder upon default by Davee of his obligations under the contract (section 9), assumption by Lea of Davee's obligations (nil) to his Physicians' Panel subscribers (section 11), and a commission to Davee if Physicians' Panel subscribers switched to NDTI prior to the consummation date (section 12). Repeated references in the sale agreement to the fact of purchase and sale leave no room for doubt that, at least in form, the parties contemplated the sale of a going business. It is worthy of note that the sale agreement did not allocate any portion of the purchase price to a covenant not to compete, nor contain any allocation to the covenant of Davee in section 4 not to solicit or obtain reports or data from physicians in the United States, nor did it mention goodwill by name.

The letter agreement of June 1, 1962, which was executed contemporaneously with the sale agreement, provided for the payment of compensation of $6,000 per year for five years for the consulting services of Davee and his wife. It also contained a payment in the event of death provision, and the following covenant not to compete which is at the heart of this litigation:

It is also understood that during the five years following the consummation date, neither of you i.e., neither Davee nor his wife will engage directly or indirectly as owner, manager, operator or associate or in any other capacity in the operation or control of any panel based on data obtained from physicians within the United States of America, nor will anyone employed by you engage in the operation or control of such a panel in the course of such employment. * * *

There is no particular significance to be derived from the fact of two separate but contemporaneous instruments, a sale agreement and a letter agreement. Whatever result they achieved by the separation could have been equally accomplished by a merger of the two documents into one. Merged or not, the separate allocation in the letter agreement to a covenant not to compete could be deemed to subsume the non-competition language in section 4 of the sale agreement. Further, the record reflects that, despite the literal wording, the $30,000 consideration for the letter agreement was almost exclusively for the covenant not to compete expressed therein. The consulting services proffered by Davee and his wife, and the payment-in-the-event-of-death provision, were only of fringe significance and value, and why they were included in the letter agreement along with the covenant is not quite clear.

The covenant not to compete underwent several metamorphoses in the course of negotiations before assuming its final form. In the initial draft of an agreement prepared by Lea a five-years' covenant not to compete was included, to which Lea proposed allocating three-sevenths of...

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