Frazee McCall Joint Venture v. Commissioner
| Decision Date | 19 December 1990 |
| Docket Number | Docket No. 11297-88. |
| Citation | 60 T.C.M. 1466 |
| Parties | Frazee McCall Joint Venture, JNO. McCall Coal Co., Inc., Tax Matters Partner v. Commissioner. |
| Court | U.S. Tax Court |
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
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. 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.
Some of the facts have been stipulated and are so found.
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.
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.
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.
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).
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.
The answer denied most of the substantive allegations of the complaint. However, it admitted that PCCC was the original lessor under the 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.
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.
Petitioner and Inter-State asserted six counterclaims. The counterclaims alleged that after the original lease was signed, the parties agreed for PCCC to lease to Inter-State (later to petitioner) the right to mine certain tracts of land (the second lease). The defendants charged that they incurred expenses of approximately $271,000 in preparation for mining, which resulted in material and valuable improvements to PCCC's property.
Three counterclaims sought enforcement of the alleged lease. Other counterclaims sought compensatory and punitive damages. The specific counterclaims were:
(1) Defendants alleged that PCCC breached the agreement by disclaiming its existence, and refusing to execute the second lease. Defendants claimed that they had sustained substantial damages, and sought specific performance by PCCC (i.e., execution of the second lease) and compensatory damages.
(2) Defendants alleged that PCCC's conduct constituted an implied consent to the agreement regarding the second lease, and sought specific performance of the agreement by PCCC.
(3) Defendants alleged that PCCC should be promissorily estopped from denying the existence of the second lease, and requested the same relief as was requested in counts 1 and 2.
(4) Defendants alleged that PCCC was unjustly enriched by the expenditures made by defendants in preparation for mining, and sought compensatory damages.
(5) Defendants alleged that PCCC's representations that it would execute the second lease were fraudulent, and requested compensatory and punitive or exemplary damages.
(6) Defendants alleged civil conspiracy based on representations made by PCCC, and sought compensatory and punitive or exemplary damages.
On June 8, 1983, the defendants filed an amended counterclaim, adding Greer Steel Company, Richard G. Raese, and John R. Raese as defendants to counts 5 and 6, and asserted an additional claim against these defendants for compensatory and punitive damages for tortious interference with contractual relations between PCCC and petitioner.
On June 21, 1983, PCCC filed a motion to strike defendants' answer, a motion to dismiss counterclaim, and an answer to counterclaim.
On July 6, 1983, the counterdefendants Greer Steel Company, Richard G. Raese, and John R. Raese filed a motion to dismiss the counterclaim against them.
On August 25, 1983, the various motions to strike the answer to the complaint and to dismiss the counterclaims were denied. On September 6, 1983, PCCC and the other counterdefendants filed amended answers, in the nature of more definitive statements, to the amended counterclaim.
On June 1, 1984, the parties to the State court suit executed a settlement agreement and mutual release. Under the settlement agreement, each party released with prejudice its claims for damages. PCCC and petitioner entered into an agreement and lease, pursuant to which (1) PCCC leased to petitioner the lands covered by the original and second leases; (2) PCCC acknowledged that petitioner had a lease covering coal owned by PCCC under surface mining permits that petitioner had secured; and (3) PCCC granted to petitioner a right of first refusal to purchase or lease certain tracts of coal and coal mining rights.
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