Estate of Smith v. Commissioner

• Decision Date: 21 November 2001
• Docket Number: Docket No. 19200-94.
• Citation: 82 T.C.M. 909
• Parties: Estate of Algerine Allen Smith, Deceased, James Allen Smith, Executor v. Commissioner.<SMALL><SUP>*</SUP></SMALL>
• Court: U.S. Tax Court

82 T.C.M. 909

T.C. Memo. 2001-303 Estate of Algerine Allen Smith, Deceased, James Allen Smith, Executor v. Commissioner.^*

Docket No. 19200-94.

United States Tax Court.

Filed November 21, 2001.

Harold A. Chamberlain and Michael C. Riddle, Larchmont, New York, for the petitioner. R. Scott Shieldes, for the respondent.

SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge:

This case is before the Court on remand from the Court of Appeals for the Fifth Circuit for further consideration consistent with its opinion in Estate of Smith v. Commissioner [2000-1 USTC ¶ 50,147], 198 F.3d 515 (5th Cir. 1999), reversing our decision in [Dec. 52,069] 108 T.C. 412 (1997), regarding the deductible amount of a claim against the estate for purposes of section 2053(a)(3),¹ vacating our judgment, and remanding for a determination of the value of the claim against the estate as of decedent's date of death.

FINDINGS OF FACT

We stated the detailed and intricate facts of this case in our original opinion. Estate of Smith v. Commissioner [Dec. 52,069], 108 T.C. 412 (1997). We summarize the relevant facts from that opinion and set forth additional findings of fact for purposes of deciding the issue on remand.

General Facts

On April 23, 1970, Algerine Allen Smith (decedent), as lessor, entered into an oil, gas and mineral lease with Humble Oil & Refining Co. (Humble). Pursuant to this lease agreement, decedent retained a royalty interest in oil and gas production obtained from an 80-acre tract of land in Wood County, Texas. On April 23, 1970, Jessamine and Frankie Allen, decedent's aunts, also entered into oil and gas leases with Humble, pursuant to which they retained royalty interests from the oil and gas production obtained from certain tracts of land in Wood County. Humble was subsequently acquired by Exxon Corporation (Exxon).

Jessamine and Frankie Allen died in 1979 and 1989, respectively, and decedent served as the independent executrix of both estates. Upon Jessamine's death, decedent inherited a portion of Jessamine's interest in the leased property. Upon Frankie's death, decedent inherited all of Frankie's interest in the leased property, as well as the remaining portion of Jessamine's interest, which Frankie had previously inherited.

Decedent's, Frankie's, and Jessamine's interests in the Wood County property were part of a unit formation known as the Hawkins Field Unit (HFU). The Texas Railroad Commission, which regulates oil and gas operations in Texas, approved the HFU for unitization on November 26, 1974. In a unit agreement, effective January 2, 1975, interest owners in the area utilized oil and gas rights pertaining to the unitized formation. The unit agreement embraces interests of approximately 2,200 royalty interest owners² and 300 working interest owners. Exxon is the sole unit operator of the HFU and possesses the exclusive right to conduct HFU operations pursuant to a unit operating agreement between Exxon and the other working interest owners.³

During the early operation of the HFU, the Federal Government, acting initially through the Federal Energy Administration and later through the Department of Energy (DOE), regulated the price of domestic crude oil through the application of two-tier price regulations under 10 C.F.R. secs. 212.73 and 212.74 (1975). Producers were required to sell "old" crude oil at the lower tier price and were allowed to sell "new" crude oil at a higher price.

In June 1978, the DOE filed suit against Exxon as operator of the HFU. The DOE contended that Exxon had misclassified crude oil produced from the HFU, which resulted in overcharges in violation of the DOE's petroleum price regulations. Exxon vigorously defended against the DOE's allegations. Nevertheless, on October 9, 1980, Exxon announced to the HFU interest owners that it would begin to withhold amounts owed to the interest owners under Exxon's posted prices for the oil produced. In justification for tendering less than the amount due under Exxon's classification of the oil, Exxon stated that it desired to create a fund for payment of any liability it might eventually have to the DOE. The amounts withheld represented the difference between the higher price charged by Exxon and the lower price the DOE contended was the maximum lawful selling price. Exxon withheld these amounts from October 1, 1980, to January 28, 1981, the date on which oil prices in the United States were decontrolled.

In response, certain HFU royalty interest owners filed suit against Exxon in October 1980 in the U.S. District Court for the District of Texas (Tyler Division), arguing that Exxon was required to pay them the full amount of their royalty. Jarvis Christian College v. Exxon Corp., Docket No. TY-80-432-CA (the Jarvis Christian litigation). On February 6, 1981, decedent, individually and as executrix for the estate of Jessamine Allen, along with Frankie and other members of the Allen family (the Allen parties), filed a motion to intervene as party plaintiffs in the Jarvis Christian litigation. On February 24, 1981, the District Court filed an order granting leave to intervene.

On March 25, 1983, the U.S. District Court for the District of Columbia ruled that Exxon had violated the two-tier pricing regulations. United States v. Exxon Corp., 561 F. Supp. 816 (D.D.C. 1983) (Exxon I). The District Court entered judgment in favor of the DOE and ordered Exxon to make restitution to the U.S. Treasury (Treasury) of the full amount of HFU overcharges plus interest arising from sales of HFU crude oil for the period January 1, 1975, through January 27, 1981. The total amount of the judgment exceeded $895 million. On July 1, 1985, the Temporary Emergency Court of Appeals affirmed the District Court. United States v. Exxon Corp., 773 F.2d 1240 (Temp. Emer. Ct. App. 1985).

On February 27, 1986, Exxon paid the judgment, which amounted to just under $2.1 billion with interest. The amount paid consisted of $895,501,164 in overcharges, $771,997,881 in prejudgment interest, and $428,273,813 in postjudgment interest.

On January 26, 1988, Exxon filed suit in the U.S. District Court for the Eastern District of Texas (Tyler Division) against the owners of royalty and mineral interests in the HFU. Exxon v. Arnold, Docket No. TY-88-110-CA (E.D. Tex., Jan. 26, 1988). Exxon's suit was consolidated with the Jarvis Christian litigation at Docket No. TY-80-432-CA (Consolidated Action).⁴ Exxon sought reimbursement from the interest owners of the amounts which it had paid to the Treasury as a result of the DOE litigation.

Decedent, individually and as the executrix of the estate of Jessamine Allen, and Frankie were parties to the suit. The HFU royalty interest owners vigorously contested Exxon's claims. On June 22, 1988, the District Court issued an order declaring the threshold issue in the Jarvis Christian litigation to be the existence of a Federal common law reimbursement claim and ordering the parties to file dispositive motions as to that issue. Pursuant to this order, on July 22, 1988, the HFU royalty interest owners filed a motion for judgment for lack of Federal statutory or common law claims, asserting that neither Federal statutory law nor common law authorized any of Exxon's claims against them. On July 5, 1989, James M. Knowles (Mr. Knowles) entered his appearance on behalf of the Allen parties in the Jarvis Christian litigation. In his notice of appearance, Mr. Knowles informed the District Court that negotiations between Exxon and the Allen parties were presently underway.

On August 25, 1989, the District Court issued an order directing Exxon to address certain of the royalty interest owners' arguments. In its order, the District Court found that Exxon had an implied cause of action under Federal common law for reimbursement; however, it noted that, "If called upon to rule today, the Court would be inclined to dismiss Exxon's claim against the royalty owners. However, the Court is also aware that Exxon has not fully addressed the above issues." On August 29, 1989, Mr. Knowles advised decedent that, in light of the order, settlement discussions should be discontinued until Exxon filed its reply to the order, except that any proposals by Exxon for a nominal or nuisance value should be considered. On August 30, 1989, a letter from R.H. Kuhlmann (Mr. Kuhlmann), on behalf of Exxon, was sent to Mr. Knowles. The letter stated that Exxon was rejecting a settlement offer by the Allen parties and proposed a counteroffer of $944,280 for Exxon's claim against the Allen parties. The counteroffer was not accepted.

On October 10, 1989, Exxon filed its brief addressing the royalty owners' arguments. In its brief, Exxon noted that the majority of claims had settled and indicated Exxon's willingness to settle the remaining claims.

On November 7, 1989, the District Court issued an order finding that genuine issues of material fact existed as to whether Exxon breached any duties owed to the royalty interest owners. The District Court was also persuaded that Exxon's entire cause of action for reimbursement against the royalty interest owners was not barred by the doctrine of collateral estoppel, although the factual findings regarding the reasonableness of Exxon's actions made in Exxon I would preclude relitigation of the reasonableness of the same actions in the Jarvis Christian litigation.

On November 7, 1989, the District Court also issued an order granting an oral motion for reverse bifurcation. The District Court ordered that the trial on the damages issue in the case would precede trial on the liability issue. By order dated December 5, 1989, the District Court directed the parties to file any motions for summary judgment with respect to the issue of whether Exxon had suffered any damages. Pursuant to this order, on January 16, 1990, Exxon filed a motion for partial summary judgment and a brief in support of its motion against the royalty interest...