Deshotels v. United States

• Decision Date: 04 February 1972
• Docket Number: No. 31093.,31093.
• Citation: 450 F.2d 961
• Parties: O. H. DESHOTELS, Jr., and Fay C. Deshotels, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

450 F.2d 961 (1971)

O. H. DESHOTELS, Jr., and Fay C. Deshotels, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 31093.

United States Court of Appeals, Fifth Circuit.

November 3, 1971.

As Amended February 4, 1972.

Gerald Gallinghouse, U. S. Atty., Robert H. Shemwell, Asst. U. S. Atty., Shreveport, La., Charles G. Barnett, Atty., Tax Div., Dept. of Justice, Fort Worth, Tex., Johnnie M. Walters, Scott P. Crampton, Asst. Attys. Gen., Meyer Rothwacks, Grant W. Wiprud, William K. Hogan, Attys., Tax Div., Dept. of Justice, Washington, D.C., Donald L. Walter, U. S. Atty., of counsel, for defendant-appellant.

Bob F. Wright, Domengeaux, Wright & Bienvenue, Gerald I. Hebert, Lafayette, La., O. H. Deshotels III, Kaplan, La., for plaintiffs-appellees.

Before TUTTLE, WISDOM, and INGRAHAM, Circuit Judges.

WISDOM, Circuit Judge:

The question this appeal presents is whether an attorney may deduct depletion allowance from funds realized in 1962 through litigation of oil and gas rights under a 1956 contract describing his interest as "a contingent fee coupled with an interest".

O. H. Deshotels, the taxpayer, an attorney in Kaplan, Louisiana, represented Casey Pierce, the owner of mineral rights subject to a lease held by Atlantic Refining Company. Atlantic had drilled a producing well on land not owned by Pierce but within the same unit under a state unitization order. In October 1956 when Atlantic failed to pay royalties to Pierce, Deshotels sent Atlantic a written demand for cancellation of the lease. October 29, 1956, Deshotels and Pierce executed a contract reading in pertinent part, as follows:

That the said Landowner does hereby employ the said Attorney for the purpose of suing or obtaining a compromise with respect to the voiding of certain leases executed by David White on October 10, 1950, affecting 15 acres, more or less; and that certain lease dated October 10, 1950, executed by Casey Pierce, affecting 9.25 acres, more or less, all situated in Section 37, township 14 south, range 3 east, Vermilion Parish, Louisiana.

It is agreed and understood that no compromise will be made without the consent of both parties hereto and that no expense will be borne by the said Landowner for any portion of the law suit or compromise.

For and in consideration of the above services the said Attorney is to be paid one-third (1/3rd) interest in any settlement or judgment obtained in the matter.

This is designated as a contingent fee coupled with an interest.

Upon Atlantic's refusal to cancel the leases, Deshotels sued on behalf of Pierce to have the leases cancelled. Atlantic prevailed in the trial court, but in 1962 the Louisiana Court of Appeals for the Fourth Circuit reversed the trial court's judgment, declared the leases null and void, and directed Atlantic to account to Pierce for all production from his property. Later in 1962 by an agreed accounting, Atlantic paid $169,377.25, representing the value of the minerals allowable to Pierce's interest minus a proportionate share of development and production expenses. Of this amount, Deshotels received $56,125.75; in addition he received an attorney's fee of $5000 from Atlantic. Pierce then gave to Deshotels a formal deed to one third of his seven-eighths interest in the mineral property.

In his 1962 tax return Deshotels listed the $5000 fee as ordinary income, but reported the $56,125.75 as depletable income from oil and gas production. He included no amount for the fair market value of the mineral interest deeded to him in 1962. He adopted this approach on the theory that the 1956 contract gave him a present interest in the minerals in place and that the 1962 deed was merely confirmatory.

The Commissioner disallowed Deshotels' deductions for depletion allowance, determining that the cash received in 1962 was simply a legal fee. In addition, the Commissioner determined that Deshotels should have included in his 1962 return the fair market value of the mineral interest deeded to him in that year.

Deshotels paid the assessed tax and sued in the district court for a refund. The district judge permitted the taxpayer and the client to testify as to their intention in signing the 1956 contract. Each testified that in the 1956 contract they had intended a transfer of title from Pierce to Deshotels of one third of Pierce's interest in the mineral property.¹ The district judge made the following finding of fact:

Their understanding and specific intention was that Pierce was then and there transferring and O. H. Deshotels, Jr. was acquiring a 1/3rd interest in 7/8ths of Pierce\'s minerals. The parties recognized that the 7/8ths interest was then covered by an outstanding lease to Atlantic Refining Company which they felt had been terminated by Atlantic\'s failure to pay royalties. They further recognized that even if the lease was not terminated by the state court suit, the 7/8ths mineral interest might eventually revert to Pierce by forfeiture, other nonperformance, or otherwise, and Deshotels\' 1/3rd interest therein would be more valuable. They agreed that their contract would not be recorded so that Deshotels would not have to be made a party to the lease cancellation suit.

On the basis of this finding,² the court concluded that Deshotels was entitled to take depletion deductions on the cash realized from the 1962 accounting and that the value of the mineral rights need not have been included in Deshotels' 1962 gross income. We reverse the judgment of the district court.

The contract between Deshotels and Pierce must first be considered in light of existing federal precedent. In Blake v. C. I. R., 1953, 20 T.C. 721, an attorney agreed to represent a client in attempting to regain title to certain land and its attendant mineral rights. At the time of the agreement they drew up a contract defining the rights and duties of the attorney and the client. The contract included the following language:

In consideration for the services heretofore performed and to be performed by Mr. Blake as my said attorney, I hereby bargain, sell, and convey unto Mr. Blake an undivided one-fourth (¼th) part of all my right, title and interest in said tract of land, and in all the settlements, benefits and proceedings arising therefrom. * * * (Emphasis added.)

Later the client executed and recorded a confirmatory deed to the attorney. The tax court found that the contractual language conveyed a present interest in the land and mineral rights to the attorney. The court therefore concluded that the attorney was entitled to deduct depletion allowance from the cash recovery he received for past production when litigation was successfully concluded.

Blake is significant because it emphasizes the clarity with which the attorney's present interest was granted to him by the client. "The language in the agreement was unequivocal," the Tax Court stated. It then continued: "The agreement must speak for itself, and it speaks as a conveyance of a present interest to petitioner."³ Thus Blake, the only federal case directly in point with the present set of facts, allowed a deduction only upon an agreement not ambiguous on its face.

The application and interpretation of the Internal Revenue Code is a matter of federal law. The form of a document and its effect under state law are therefore not controlling in these federal determinations. Burton-Sutton Oil Co. v. C. I. R., 1946, 328 U.S. 25, 66 S.Ct. 861, 90 L.Ed. 1062. We may, however, look to Louisiana law in this case to assist us in understanding the Deshotels-Pierce agreement which forms the nucleus of this dispute. Unfortunately for Deshotels, Louisiana law does not support his interpretation of the agreement with Pierce any more than the Blake case constitutes federal precedent for Deshotels' view of that agreement.

The Louisiana cases distinguish two broad categories of attorneys' "interests" in client property which is the subject matter of litigation by the attorney on the client's behalf. These rights have been considered not with respect to tax consequences but instead with respect to the effect of attorney-client contracts upon the attorney's property rights and his right to prevent his client from unilaterally ending litigation when the attorney's fee is dependent on the outcome.

An attorney-client contract unequivocally granting the attorney a present possessory interest in the client's property was considered by the Louisiana Supreme Court in McClung v. Atlas Oil Co., 1921, 148 La. 674, 87 So. 515. McClung employed Huey P. Long to clear title to mineral property. The contract included the following language:

In consideration of the professional services of the said Huey P. Long, Jr., in bringing whatever action or actions he may deem necessary, in order to secure judgment in favor of said McClung for the mineral rights as above set out, and in further consideration of the said Long paying whatever court costs decreed against said McClung in said suit or suits, the said McClung does by these presents, transfer, set over and deliver to the said Huey P. Long, Jr., one-half of his undivided one-half mineral rights of the property described above and in this instrument, excepting a 1/16 royalty on all the property described herein.

Long recorded the contract in the conveyance office. Thereafter McClung settled with those who claimed to have a lease on his property. Long sought to continue the litigation in his own name. In considering this issue the Supreme Court said

As we read the contract, it was not alone a transfer of an interest in the subject-matter of the contemplated lawsuit, but it was a present conveyance of a fixed undivided interest in such title as McClung then owned in the mineral rights of the property described.

The Court held that Long had a vested title to the portion of the property conveyed to him in the employment contract and that therefore he could litigate as to that interest in his own name....