Griffin v. Smith

• Decision Date: 16 February 1939
• Docket Number: No. 6587,6588.,6587
• Citation: 101 F.2d 348
• Parties: GRIFFIN v. SMITH, Collector of Internal Revenue. SAME v. UNITED STATES.
• Court: U.S. Court of Appeals — Seventh Circuit

101 F.2d 348 (1938)

GRIFFIN v. SMITH, Collector of Internal Revenue. SAME v. UNITED STATES.

Nos. 6587, 6588.

Circuit Court of Appeals, Seventh Circuit.

December 20, 1938.

Rehearing Denied February 16, 1939.

James W. Morris, Asst. Atty. Gen., Sewall Key and Courtnay C. Hamilton, Sp. Assts. to Atty. Gen., and Val Nolan, U. S. Atty., and B. Howard Caughran, Asst. to U. S. Atty., both of Indianapolis, Ind., for appellants.

S. Leo Ruslander, of Pittsburgh, Pa., Dailey, O'Neal, Dailey & Efroymson, of Indianapolis, Ind., and James E. Watson, of Washington, D. C., for appellee.

Before EVANS and SPARKS, Circuit Judges, and LINDLEY, District Judge.

LINDLEY, District Judge.

Defendant appeals from a judgment awarding plaintiff refund of taxes paid for the years 1930, 1931 and 1932.

In his return for 1930, plaintiff included a bonus paid to him by the corporation of which he was an officer and director, of $44,975, in addition to his salary; in 1931, one of $70,812.50, and, in 1932, another, of $69,975, the total of the three amounting to $185,762.50. Upon these items the taxpayer paid a tax without protest or reservation.

The by-laws of the corporation provided that the directors might fix the rate of compensation of all officers, agents and employees. At the end of each of the three years, the board adopted a resolution authorizing the payment of bonuses to the taxpayer and certain other officers, and in each year the stockholders, at a regular meeting, adopted a resolution approving all acts of the directors for the preceding year. The bonuses were not disclosed as such on the books of the company but were included in the salaries paid and shown on the books.

In 1933 certain stockholders, claiming to have become advised then, for the first time, of the payments made, presented the contention that the allowances were unauthorized and greatly in excess of reasonable compensation for services for the respective executives to whom they were paid, demanded that they be restored to the corporation and threatened to sue therefor. After continued negotiation, the parties entered into an agreement whereby the taxpayer repaid $128,002.50. Thereafter he filed application for refund of the taxes assessed upon the amounts which he refunded. The commissioner rejected the claim and the suit followed.

The court heard evidence as to the propriety of the action of the directors in voting and paying the bonuses. It concluded from the facts stated that the payment of bonuses pursuant to the directors' resolution was "void, of no effect, invalid, and in violation of the directors' duties to the corporation and its stockholders under the statutes and common law of the state of Indiana," and entered judgment accordingly. It made no finding of fact as to fraud on the part of the directors but did find that as a consequence of the demands of the stockholders, an agreement to make refund as stated resulted, and that, as a consequence of the settlement, plaintiff was required to make the refund.

Under Section 21 of the Revenue Act of 1928, 26 U.S.C.A. § 21, net income is defined as including all income computed under Section 22, 26 U.S.C.A. § 22, less the deductions allowed by Section 23, 26 U.S. C.A. § 23. Under Section 22, income includes compensation for personal service of whatever kind and in whatever form paid and all gains, profits and income derived from any source whatever. The sole question here is whether the bonus money received was income within the words of the statute and the answer to this question in turn lies in the answer to the controversy presented by the parties as to the legal significance of the facts mentioned. Plaintiff relies upon the conclusion of the court that the whole transaction was void and of no legal effect, and that, as a result, the money in equity was that of the corporation, title thereto never passing to the taxpayer but remaining at all times in the corporation and its stockholders. Defendant's position is that the action was not void in the strict sense of the word but merely voidable; that the court should have found that the bonus money constituted taxable income in the years mentioned, and that plaintiff, having received the money under claim of right, was bound to include it as income.

The expression "void contract," is often used to denote that the parties to the transaction have gone through the form of making a contract, but that none has been made in law by reason of lack of some essential element of a contract. Ewell v. Daggs, 108 U.S. 143, 2 S.Ct. 408, 27 L.Ed. 682. Such a contract creates no legal rights of any kind and either party thereto may ignore it at his pleasure, in as far as it is executory; and, being void, an absolute nullity, it is incapable of ratification. Page on Contracts, Section 54; Blinn v. Schwarz, 177 N.Y. 252, 69 N.E. 542, 101 Am.St.Rep. 806. A voidable contract on the other hand, is one wherein one party has the privilege of electing it to be either valid or void, at his pleasure. Barlow v. Robinson, 174 Ill. 317, 51 N.E. 1045; Johnson v. Insurance Co., 93 Wis. 223, 67 N.W. 416. The party in whom the law lodges such option is thus clothed with a right in the nature of an equitable election. A void contract, one made in the face of absolute inhibition by statute, is ineffective for all purposes, and the court may find itself unable to grant relief to either party, whereas a voidable contract may be rescinded at the option of the party who has the right to complain. The use of the terms "void" and "voidable" as indicative of the transaction is unsatisfactory and often misleading. As a consequence, the two words are frequently misused, being employed indiscriminately. The word "void" is the victim of the more frequent misapplication; frequently we have a declaration that a contract is void when the facts show that it is merely voidable, that is, that one party may avoid it or validate it at his option. Ewell v. Daggs, 108 U.S. 143, 2 S.Ct. 408, 27 L.Ed. 682. Moreover, even where the two terms are not confused, neither is strictly accurate as to the ultimate effect of the transaction. 12 Am.Jur. 507.

Where contracts of directors in violation of their duties to the stockholders involve unreasonableness of an exercise of power, it is...