Fred H. Lenway & Co. v. Comm'r of Internal Revenue, Docket No. 6370-74.
| Citation | 69 T.C. 620 |
| Decision Date | 30 January 1978 |
| Docket Number | Docket No. 6370-74. |
| Parties | FRED H. LENWAY & COMPANY, INC., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Petitioner was a party to a transaction involving the revamping of the capital structure of X corporation, in which petitioner held a 55-percent stock interest. As part of that transaction, petitioner contributed some of its shares to the capital of X. It also warranted the net worth of X as of a given date to a third party, which made a substantial investment in X. Petitioner's obligation under the warranty could be satisfied by transferring additional amounts of its shares to X. Petitioner gave up all of its remaining shares of X in satisfaction of the warranty. Held, petitioner's loss in respect of its shares is a capital loss under secs. 1221 and 1222, I.R.C. 1954, and not an ordinary loss under sec. 165, I.R.C. 1954. Max Weingarten, for the petitioner.
James H. Ross, Jr., for the respondent.
Respondent determined a deficiency in petitioner's Federal income tax for its fiscal year ended January 31, 1968, in the amount of $115,705. This deficiency occurred as a result of the disallowance of an ordinary loss deduction claimed by petitioner for its fiscal year ended January 31, 1971, and carried back to its fiscal year ended January 31, 1968.
The issue to be determined is the deductible character of certain losses sustained by petitioner during its fiscal year 1971.
Some facts have been stipulated and are so found.
Petitioner Fred H. Lenway & Co., Inc., is a California corporation with its principal place of business in San Francisco, Calif., at the time the petition herein was filed. At all times material herein, petitioner was engaged in a metal trading business covering both import and export. Southern California Chemical Co. (hereinafter referred to as SCC) is a California corporation engaged in the production of metallic chemicals. Since 1964, petitioner and SCC owned and operated as a joint venture a chemical and metallurgical plant in Ironton, Ohio (hereinafter referred to as the joint venture), specializing in reclaiming metals, especially molybdenum and tungsten, from residues and petroleum by-products.
The joint venture also owned a large amount of bulk bismuth catalyst and a bismuth smelter. The smelter was located at SCC's place of business and was acquired for the purpose of extracting bismuth.
Since November 1966, the joint venture had a contract with General Electric Co. to convert tungsten residues into synthetic scheelite for delivery to the General Electric plant in Cleveland, Ohio. This business grew in volume and in 1968 the joint venture obtained a contract from General Electric to extract tungsten from approximately 10,000 tons of low-grade residues.
Due to the limited production capacity of the Ironton, Ohio, facility, the joint venture could only process approximately 1,000 tons of residues a year for General Electric. The joint venture therefore began to look for additional facilities to acquire for expansion purposes.
On September 1, 1968, petitioner acquired property on which was situated the only tin smelter in the United States. The property (hereinafter the Texas property) was located in Texas and included approximately 120 acres of land.
On February 17, 1969, petitioner and SCC organized the Gulf Chemical & Metallurgical Corp. (Gulf) under the laws of the State of Texas. The articles of incorporation provided for authorized capital of 1 million shares of $10 par value stock.
On March 21, 1969, pursuant to section 351,1 petitioner and SCC transferred inventory consisting of bismuth-bearing catalysts and bismuth metal to Gulf in exchange for common stock as follows:
After Gulf's incorporation, the joint venture transferred its bismuth smelting operation to Gulf and caused Gulf to take over the General Electric contract. All remaining operations of the joint venture continued to be carried out at its plant in Ironton, Ohio.
Gulf conducted its operations on the Texas property, which it leased from petitioner at a rental of $10,000 per month. The lease granted Gulf an option to purchase such property for $1 million cash. Both petitioner and SCC anticipated that Gulf's operations would produce substantial profits during its first year of production.2
Some time prior to September 10, 1969, Associated Metals & Minerals Corp. (Associated) began investigating the possible acquisition of petitioner. Associated is one of the largest privately owned companies engaged in the business of international trading in ore and metals. It also operates miscellaneous manufacturing facilities in the United States and overseas. In the process of its investigation of petitioner, Associated became interested in participating in Gulf. As a result, a series of meetings among representatives of petitioner, Gulf, SCC, and Associated were held. The main purpose of the meetings, the first of which was held on September 10, 1969, was to discuss the terms for the acquisition by Associated of a one-third interest in Gulf.
During the course of the negotiations and in anticipation of Associated acquiring a one-third interest in Gulf, Associated advanced to Gulf as loans during the months of September, October, and November 1969, a total of $1,200,000 which was evidenced by three promissory notes.
The negotiations culminated in a written contract as of February 1, 1970, among petitioner, SCC, Gulf, and Associated.
Because the contract contemplated the issuance of preferred and common stock to Associated by Gulf, the articles of incorporation of Gulf were amended on February 27, 1970, to increase the corporation's authorized capital of 1 million shares of $10 par value stock to 1,020,000 shares consisting of 20,000 shares of $50 par value preferred stock and 1 million shares of $10 par value common stock.
On March 2, 1970, the closing of the transaction contemplated by the contract took place in Galveston, Tex.
At the closing, pursuant to the terms of the contract, several transactions took place, including the following:
(1) Associated purchased from Gulf 20,000 shares of Gulf preferred stock for $1 million and 20,000 shares of Gulf common stock for $1 million. The $2 million purchase price was paid at the closing as follows:
+-----------------------------------------------------------------------------+
¦Cancellation of the three promissory notes evidencing Gulf's ¦$1,200,000.00¦
¦indebtedness to Associated ¦ ¦
+---------------------------------------------------------------+-------------¦
¦Interest accrued on the above notes ¦32,499.90 ¦
+---------------------------------------------------------------+-------------¦
¦Cash ¦767,500.10 ¦
+---------------------------------------------------------------+-------------¦
¦ ¦2,000,000.00 ¦
+-----------------------------------------------------------------------------+
(2) Petitioner and SCC each transferred 4,000 shares of Gulf common stock to Gulf as a capital contribution.3
(3) Petitioner and SCC transferred to Gulf as a capital contribution all operating assets relating to the joint venture, including, but not limited to, the real property owned by them in Ironton, Ohio, together with all fixed assets located in the Ironton plant.
(4) SCC paid $125,000 to Gulf as a capital contribution.
(5) Petitioner sold the Texas property to Gulf for $610,000.
(6) Gulf granted to SCC and petitioner options to purchase 3,000 and 1,000 shares of Gulf common stock, respectively, at $50 per share.
(7) The contract contained certain representations and warranties by the parties, including a representation and warranty by petitioner and SCC to Associated that the net worth of Gulf as of June 30, 1970, should not be less than $2,500,000. To secure compliance with such warranty and pursuant to the terms of the contract, petitioner delivered to Associated 18,000 shares of Gulf common stock and SCC delivered to Associated 14,000 shares of Gulf common stock.
The warranty provision in the contract, as amended, pertaining to Gulf's net worth on June 30, 1970, provided in part as follows:
3.10 The net worth of Gulf as at June 30, 1970 shall be not less than $2,500,000, as determined by a certified audit * * *. In the event of the breach of this representation and warranty:
(a) If the net worth of Gulf as at said date is $2,400,000 or more, SCC and Lenway shall each, at the respective option of each, within thirty days after the delivery of the said certified audit, either contribute to Gulf one-half of the amount of the difference between the net worth as at June 30, 1970 and $2,500,000, or, failing so to do, its right to the return of 2000 Common Shares of Gulf under 8.1 below, and the option granted to it by Gulf under 8.2 below and all its rights thereunder shall thereupon cease, terminate and come to an end.
(b) If the net worth of Gulf is less than $2,400,000, then SCC and Lenway shall each, at the respective option of each, within thirty days after the delivery of said certified audit, each (sic) either contribute to Gulf one-half of the amount of the difference between the net worth as at June 30, 1970 and $2,500,000, or, failing so to do, its right to the return of 2000 Common Shares under 8.1 below and the option granted it by Gulf under 8.2 below, and all its rights thereunder shall thereupon cease, terminate and come to an end, and, in addition, it shall at its option either (i) pay to Gulf as a capital contribution one-half of each deficiency or (ii) transfer to Gulf sufficient of its Common Shares at the book value thereof as at June 30, 1970 to equal for each one-half of the difference between the net worth of Gulf at June 30, 1970 and $2,500,000.4
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Freeland v. Comm'r of Internal Revenue
...v. Commissioner, supra,7 relied to some extent on those cases. As this Court noted in note 9 to its opinion in Fred H. Lenway & Co. v. Commissioner, 69 T.C. 620, 628 (1978), affd. F.2d (9th Cir. 1980), referring to the first three cases above: It is arguable whether these cases continue to ......