Henley v. United States

• Decision Date: 14 June 1968
• Docket Number: No. 193-65.,193-65.
• Citation: 396 F.2d 956,184 Ct. Cl. 315
• Parties: Malcolm J. HENLEY and Mary K. Henley v. The UNITED STATES.
• Court: U.S. Claims Court

184 Ct. Cl. 315, 396 F.2d 956 (1968)

Malcolm J. HENLEY and Mary K. Henley v. The UNITED STATES.

No. 193-65.

United States Court of Claims.

June 14, 1968.

COPYRIGHT MATERIAL OMITTED

Allen E. Pye, Tyler, Tex., attorney of record for plaintiffs. J. Robert Dobbs, Jr., Tyler, Tex., of counsel.

Knox Bemis, Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant. Philip R. Miller, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON, and NICHOLS, Judges.

OPINION

SKELTON, Judge.

This is an income tax case involving a mineral interest in land in Texas.^* The plaintiffs, who are a husband and wife residing in Tyler, Smith County, Texas, seek to recover the sum of $25,024.98 (plus interest) as a partial refund of the income tax which they paid for the calendar year 1961. (The plaintiff Mary K. Henley is a party to the action only because she signed a joint income tax return with her husband for 1961.)

It is our opinion that the plaintiffs are not entitled to recover.

In 1961, the plaintiff Malcolm J. Henley was executive vice president of the Tyler Pipe & Foundry Company, of Tyler, Texas. However, he had for some time been interested in the oil business and had occasionally invested substantial sums of money in oil and gas deals, such as the purchase of royalty interests, participation in drilling operations, etc.

In their joint income tax return for 1961, the plaintiffs claimed a deduction in the amount of $30,210 for "dry hole expense" (i. e., the plaintiffs claimed that this amount had been expended by them during 1961 in unsuccessfully drilling for oil and gas). On auditing the plaintiffs' income tax return for 1961, the Internal Revenue Service disallowed the $30,210 deduction for "dry hole expense," and, on the basis of such disallowance, assessed against the plaintiffs an additional tax liability of $21,824.55, plus interest in the amount of $3,200.43. The plaintiffs paid the additional assessment and interest, totaling $25,024.98, and subsequently filed a timely claim for a refund of such amount. The Internal Revenue Service rejected the claim, whereupon the present suit was instituted by the plaintiffs.

In the present action, the plaintiffs do not contend that they incurred a "dry hole expense" of $30,210 during 1961. Instead, the plaintiffs allege in the petition that the amount of $30,210 which was claimed by them as a deduction and was disallowed by the Internal Revenue Service "represented the taxpayers' cost of their mineral interest in a tract of 1,070 acres * * *, which mineral interest became completely worthless during the calendar year 1961."

The 1,070-acre tract of land referred to in the petition is situated in the northern part of Smith County, Texas, and consists of the whole of the M. McDermott Survey (Abstract No. 726) and the whole of the S.A. & M.G.R.R.Co. Survey (Abstract No. 970). This tract is bordered on the north by the Sabine River; it is mostly low-lying, river-bottom land; and it is subject to occasional flooding by water from the Sabine River. At the time with which we are concerned in the present litigation, the land was unimproved and was completely covered with timber.

The 1,070-acre tract of land is contiguous to, and lies generally to the north of, another tract of land in Smith County, Texas, which contains approximately 505 acres and which was purchased in 1959 by the plaintiff Malcolm J. Henley. (For the sake of convenience, the 505-acre tract of land will usually be referred to hereafter in the opinion as "tract 1," and the 1,070-acre tract of land will usually be referred to as "tract 2.")

Tract 1 and tract 2 lie generally in the East Texas oil and gas producing region, where production of oil and gas is obtained from different geological formations, particularly the Woodbine, the Paluxy, and the Rodessa, and in many different — and sometimes scattered — locations.

Sometime after the plaintiff Malcolm J. Henley (who, for the sake of convenience, will usually be referred to hereafter in the opinion as "Mr. Henley") acquired tract 1 in 1959, Jeff M. Bracken, who then owned tract 2, got in touch with Mr. Henley and inquired whether he would be interested in selling tract 1 to Mr. Bracken, or, in the alternative, whether Mr. Henley would be interested in buying tract 2 from Mr. Bracken. No contract resulted from this discussion.

Subsequent to the discussion referred to in the preceding paragraph, Frank G. Hill and wife acquired the ownership of tract 2. Mr. Hill thereafter approached Mr. Henley with a buy-or-sell proposition, under which Mr. Henley would either buy tract 2 from Mr. Hill and wife, or would sell tract 1 to the Hills. The discussion between Messrs. Hill and Henley took place on several occasions and extended over a period of time. Mr. Henley did not wish to sell tract 1; and, prior to July 1961, he was not particularly interested in acquiring tract 2.

In the early part of July 1961, Mr. Henley received confidential information to the effect that the Humble Oil & Refining Company was planning to drill an exploratory well (or to have such a well drilled) in a parcel of land within the James M. Rush Survey (Abstract No. 147), Smith County, Texas, which lies to the south of, and fairly close to, tract 2. After Mr. Henley ascertained that Humble was definitely going to drill in 1961 an exploratory well that was considered to be a "hot prospect" — but before Humble's plan to drill became general knowledge in the area — Mr. Henley began a serious effort to buy from Frank G. Hill and wife the minerals in tract 2, or, if necessary, the entire estate of the Hills in tract 2.

As of July 1961, Frank G. Hill and wife owned tract 2 in fee simple, except that one-half of the mineral royalty interest (i. e., one-half of a one-eighth interest in any minerals that the tract might contain) had been conveyed to and was permanently owned by another person, and except that an additional one-quarter of the mineral royalty interest had been reserved by a former owner of tract 2 until June 30, 1984. The Hills had the "executive rights" in the minerals (i. e., the right to drill for oil and gas in tract 2, the right to lease the land for oil and gas development, and the right to receive any bonus and rental payments in connection with such a lease). The fractions of the mineral rights which the Hills did not own were non-participating interests (i. e., the owners of such interests did not have any right to drill for oil and gas in tract 2, or to exercise any control over the leasing of the land for such development, or to receive any bonus or rental payments in connection with an oil and gas lease).

In addition to the outstanding mineral interests in tract 2 held by other persons as of July 1961 and referred to in the preceding paragraph, Frank G. Hill and wife had borrowed money from J. P. Rice and on July 30, 1960 had issued an oil and gas lease on tract 2 to Mr. Rice as security for the loan. The agreement between the Hills and Mr. Rice was to the effect that, upon the repayment of the loan secured by the oil and gas lease, Mr. Rice would relinquish or assign the lease to the Hills or their nominee.

On the basis of the confidential information which Mr. Henley received in July of 1961 relative to the prospective drilling of an exploratory well by the Humble Oil & Refining Company on nearby land, Mr. Henley broached to Frank G. Hill the subject of the possible purchase by Mr. Henley of the mineral interest in tract 2 owned by Mr. Hill and wife. Mr. Hill was unwilling to dispose of the mineral interest separate and apart from the surface of the land, but he was willing to sell the entire estate of the Hills in tract 2. Mr. Henley then began serious negotiations with Mr. Hill concerning the purchase of the Hills' entire estate in tract 2. The Hills' "asking price" was $70 an acre. However, as a result of the negotiations between Messrs. Henley and Hill, it was finally agreed that the Hills would sell, and that Mr. Henley and his wife would buy, tract 2 at a price of $50 an acre. The Hills were unaware at the time that the Humble Oil & Refining Company was going to drill an exploratory well on nearby land within the reasonably near future.

After consulting with his tax accountant, his banker, and his lawyer, Mr. Henley decided that it would be advisable: (1) to make an allocation of the lumpsum total price for tract 2 as between the mineral value, to which Mr. Henley allocated the sum of $30,210, and the surface value, to which he allocated the sum of $22,910.39; (2) to have Frank G. Hill and wife execute two deeds, one covering the minerals in tract 2 and the other covering the surface of tract 2; and (3) to issue two separate checks to the Hills in payment for tract 2.

At the request of Mr. Henley, Frank G. Hill and wife executed two separate deeds in August 1961 for the purpose of consummating the agreement relative to the sale and purchase of tract 2. One of the deeds was dated August 18, 1961 and conveyed to Mr. Henley and wife all of the oil, gas, and other minerals in tract 2 (with the exception of the one-half and the one-fourth mineral royalty interests previously mentioned as being held by other persons). The other deed was dated August 25, 1961 and conveyed tract 2 (with the exception of the oil, gas, and other minerals) to Mr. Henley and wife. Mr. Henley paid the Hills in the form of two checks, one dated August 18, 1961 for $30,210, and the other dated August 25, 1961 for $22,910.39.

In August 1961, J. P. Rice surrendered and assigned to Mr. Henley and wife the oil and gas lease on tract 2 that had been held as security for a loan from Mr. Rice to Frank G. Hill and wife, the loan having been repaid.

After Mr. Henley and wife bought tract 2 from Frank G. Hill and wife, the Humble Oil & Refining Company drilled its exploratory well in the vicinity of tract 2, as planned. The...