Frazee McCall Joint Venture v. Commissioner, Docket No. 11297-88.

CourtUnited States Tax Court
Citation60 T.C.M. 1466
Docket NumberDocket No. 11297-88.
PartiesFrazee McCall Joint Venture, JNO. McCall Coal Co., Inc., Tax Matters Partner v. Commissioner.
Decision Date19 December 1990
60 T.C.M. 1466
T.C. Memo. 1990-639
Frazee McCall Joint Venture, JNO. McCall Coal Co., Inc., Tax Matters Partner
Docket No. 11297-88.
United States Tax Court.
Filed December 19, 1990.

John S. McDaniel, Jr., and Robert K. Briskin, One North Charles St., Baltimore, Md., for the petitioner. Elizabeth S. Henn, for the respondent.

Memorandum Findings of Fact and Opinion

COLVIN, Judge:

This is a proceeding pursuant to section 6226 for a readjustment of partnership items of Frazee-McCall Joint Venture (petitioner), for the taxable years ending December 31, 1983, 1984, and 1985.

Petitioner was formed and controlled by a 50-percent partner, the Jno. McCall Coal Co.,

60 T.C.M. 1467

and two related 25-percent partners, Edward and Donald Frazee.

The only issue for decision in this opinion is whether petitioner may deduct legal fees incurred to defend against damage claims arising from its mining operations. We hold that petitioner's legal fees are deductible in part and capitalizable in part.

Another issue for decision, relating to respondent's reallocation under section 482, will be decided by separate opinion.

Findings of Fact

Some of the facts have been stipulated and are so found.

1. Background

Frazee McCall Joint Venture is a general partnership organized in 1981 under the laws of West Virginia by the Jno. McCall Coal Company, Inc., a Maryland corporation (McCall), and two individuals, Edward G. Frazee and Donald F. Frazee (the Frazees). Petitioner's offices are located in Kingwood, West Virginia. Petitioner also maintains a laboratory and office facility at the Kleen Coal Company Preparation Plant located near Kingwood, West Virginia.

The Frazees are brothers, doing business together as coal producers. McCall is a coal distributor and wholesaler. When petitioner was organized, McCall and the Frazees entered into a written Agreement of Joint Venture dated March 13, 1981 (the Partnership Agreement).

Respondent issued a Notice of Final partnership Administrative Adjustment (FPAA) on February 22, 1988, determining adjustments to petitioner's returns for taxable years 1983, 1984, and 1985.

Respondent disallowed deductions for petitioner's legal and accounting fees in the amounts of $122,111 and $34,201 for years 1983 and 1984, respectively.

2. Preston County Coal & Coke Company Litigation — Introduction

Petitioner incurred legal expenses as a defendant in lawsuits brought by Preston County Coal and Coke Company (PCCC). PCCC sued petitioner for royalties for coal petitioner allegedly removed from certain lands owned by PCCC. Petitioner asserted various affirmative defenses and counterclaims, and claimed it was entitled to remove the coal under an oral lease with PCCC.

3. Federal Court Litigation Between PCCC and Petitioner

On August 30, 1982, PCCC brought suit in the United States District Court for the District of Maryland against John M. McCall and Donald F. Frazee, both as individuals and as Frazee McCall Coal Co. In its suit PCCC sought: (1) royalties of $39,979 for coal allegedly mined pursuant to a coal mining lease; (2) a judgment of $1,500,949 for other coal allegedly mined from lands not covered by the lease, and (3) treble damages of $4,622,784 for the alleged unpaid amounts.

Mr. McCall moved to dismiss the action against him. PCCC filed an amended complaint on November 2, 1982, substituting McCall Coal Co., a corporation at times doing business as Frazee McCall Coal Co., for Mr. McCall.

The defendants moved to dismiss the complaint for lack of jurisdiction. The motion was granted on March 2, 1983.

4. State Court Litigation Between PCCC and Petitioner

On December 8, 1982, PCCC filed a suit in the Circuit Court of Preston County, West Virginia against McCall Coal Co., and Donald F. Frazee, both separately and doing business at times as Frazee McCall Coal Co. The State court claims were the same as the amended Federal complaint. On May 13, 1983, PCCC filed an amended complaint in State court against McCall Coal Co., the Frazees, Weter Company, Inc., and Inter-State Lumber Company, Inc. (an intervening assignee between Weter Company and Frazee McCall).

a. The Complaint

The amended complaint contained four counts:

(1) PCCC alleged that petitioner failed to pay royalties on 186 tons of coal removed from the leasehold in violation of a March 1, 1979, lease (hereafter the original lease), and thus owed $232.50 to PCCC.

(2) PCCC claimed that petitioners removed coal from the leasehold after March 15, 1982, without paying the required royalties. PCCC demanded judgment against petitioner for royalties thereon.

(3) PCCC alleged that petitioner trespassed on and removed coal from an adjacent parcel of land owned by PCCC, known as the Jonathan Moore tract. PCCC demanded judgment against petitioner in the amount of $1,430,395.

(4) PCCC claimed that petitioner's trespass entitled PCCC to treble damages of $4,291,882.50.

The defendants in the original state court complaint filed an answer, affirmative defenses, and counterclaims.

b. The Answer

The answer denied most of the substantive allegations of the complaint. However, it admitted that PCCC was the original lessor under the

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original lease, that coal had been removed from the Jonathan Moore tract, and that mining operations were continuing. The answer also alleged that the original lease had been orally modified to include a portion of the Jonathan Moore tract.

c. Affirmative Defenses

The defendants alleged ten affirmative defenses: (1) failure to state a cause of action, (2) accord and satisfaction, (3) equitable estoppel, (4) promissory estoppel, (5) waiver, (6) ratification, (7) laches and limitations, (8) unclean hands, (9) that the defendants had properly accounted for all coal mined and removed from the leasehold, and (10) that the original lease had been verbally modified to add certain of PCCC's mineral rights in the Jonathan Moore tract to the lease property; that this modification was reflected in a Permit Modification Map dated November 17, 1979, and approved May 15, 1980; that acting pursuant to the modification agreement the defendants had redesigned the drainage system, obtained necessary permits, performed the necessary site preparation, undertaken the mining, and paid PCCC royalties; that PCCC had actual knowledge of and consented to the mining; that PCCC representatives had visited the mining area, observed the mining taking place, and expressed no objection thereto; and that the defendants had properly accounted to PCCC under the original lease for all coal mined and removed from the Jonathan Moore tract, and had tendered royalties to PCCC which were accepted.

d. Counterclaims

Petitioner and Inter-State asserted six counterclaims. The counterclaims alleged that after the original...

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