Highland Farms Corporation v. Commissioner of Internal Revenue, Docket No. 95690.
| Decision Date | 27 November 1940 |
| Docket Number | Docket No. 95690. |
| Citation | 42 BTA 1314 |
| Parties | HIGHLAND FARMS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
John W. Martin, Esq., and G. Kibby Munson, Esq., for the petitioner.
James H. Yeatman, Esq., for the respondent.
The Commissioner determined deficiencies of $19,841.17 in income tax and $7,214.97 in excess profits tax of petitioner for 1935. Petitioner contests the inclusion in income of (1) gain from the cancellation of bonds of petitioner, and (2) awards for actual and punitive damages, and (3) the failure to allow a deduction for attorneys' fees.
FINDINGS OF FACT.
The Harry K. Johnson trust was formed in 1927, with Harry K. Johnson as trustee. Johnson and his wife together had invested from $30,000 to $40,000 in the trust and owned a one-half interest in it. Johnson's brother-in-law, Victor C. Smith, who had invested about $60,000 in the trust, owned the other half. The trust purchased in Johnson's name 7,800 acres of land in Harris County, Texas, situated along an interurban electric railroad, the Houston North Shore Railroad, which was constructed by Johnson and operated between Houston and Baytown, Texas. The trust laid out the townsite of Highlands and developed the property, which was situated principally in Highlands, constructing 25 miles of shell roads and more than 150 cottages. The trust had water mains and electric lighting and gas facilities installed. It planted 1,050 acres of strawberries at a cost of $110,000. In the latter part of 1928 and in 1929 Highlands had a population of about 1,500. It was incorporated in 1929. The trust sold real estate in Highlands to purchasers most of whom were employed by the Humble Oil & Refining Co. at its plant in Baytown.
In the latter part of 1928 and early 1929 the trust was in need of capital for development purposes and to pay off obligations. It owed W. D. Haden & Co. a balance of $27,186 for shells. Negotiations with Fidelity Trust Co. were undertaken by the trust through a Houston law firm. J. S. Cullinan, the majority stockholder and controlling executive of Fidelity inspected the properties of the trust, as did another man employed by Fidelity for that purpose.
On February 11, 1929, petitioner, which had been incorporated for the purpose of securing the loan from Fidelity, entered into a contract with Fidelity providing for the issuance by petitioner of $200,000 principal amount of 10-year first mortgage 7 percent sinking fund gold bonds, dated January 1, 1929. The bonds were to be secured by personal notes, vendor's lien notes and contracts of sale of town lots in Highlands and Highland Farm lands having an aggregate face value of $275,000, and by 1,300 acres of farm lands, 750 acres of timber lands and various other properties formerly owned by the Harry K. Johnson trust. Under the contract Fidelity was to pay petitioner 97 percent of the par value of the bonds and was to receive 1,000 shares of petitioner's no par value capital stock. Fidelity was to receive $21,000 from the strawberry crop on the 1,050 acres planted by the Harry K. Johnson trust.
Petitioner issued an aggregate of 10,000 shares of stock to Johnson and his wife and Smith. Smith turned over 500 shares to Fidelity and Johnson and his wife together turned over an equal amount. The properties pledged to secure the loan were appraised at approximately $623,000 by Fidelity. This was their fair market value on February 11, 1929. Included in the $275,000 face amount of notes pledged under the contract by petitioner was a potential or unrealized profit of $153,516.10. Petitioner used the $194,000 received from Fidelity to pay off its obligations.
On April 11, 1929, in a "personal" letter to Johnson, the president of Fidelity submitted a bill in the amount of $5.000, which purported to be for legal services rendered to the Harry K. Johnson trust and to petitioner. Johnson refused to pay the bill on the ground that no legal services had been contracted for and none had been rendered. The president of Fidelity then began informing purchasers of petitioner's land orally and in writing that petitioner was failing to turn over to Fidelity its collections on sales and that the purchasers would not receive deeds and would lose their money. Petitioner's collections, which had amounted to from $4,000 to $5,000 a month, dwindled rapidly. Purchasers of petitioner's property began to leave and the population of Highlands decreased from 40 to 50 percent. The loss of population in the outlying districts was greater. Johnson agreed to resign as president of petitioner and at his suggestion a representative of W. D. Haden & Co. took his place.
On Friday, April 13, 1929, a disastrous rainstorm washed away petitioner's strawberry beds, causing a loss of $138,000.
Petitioner, at the time of its formation, assumed the $27,186 debt owing from the Harry K. Johnson trust to W. D. Haden & Co. for shells. Johnson put up 5,250 shares of petitioner's stock to secure the $27,186 debt. In 1931 W. D. Haden & Co. advanced about $29,000 to petitioner in cash, which petitioner paid to Fidelity in an effort to keep Fidelity from foreclosing. In January 1932 W. D. Haden & Co. took certain second mortgages from petitioner in payment of the $29,000. In that year W. D. Haden & Co. also wrote off the $27,186 as a bad debt and charged off as worthless the stock pledged with it by Johnson, but it kept the stock. In 1934 the Harry K. Johnson trust went through bankruptcy and in 1935 W. D. Haden & Co. sold back the 5,250 shares of stock to Johnson at $6 a share, receiving in payment his notes. None of the interest or principal has been paid on the notes.
On January 1, 1932, Fidelity notified petitioner that it was going to begin foreclosure proceedings and on March 1, 1932, it filed suit against petitioner in the District Court of Harris County. Petitioner filed an answer and cross-action denying that it had defaulted and alleging, in the alternative, that if it had defaulted then the breach was caused by the acts of the plaintiff, that heavy damages and losses had resulted to petitioner, that the obligations and mortgage sued on were usurious, and that the president of Fidelity had commenced and pursued a course of slander against Johnson.
In suing Fidelity for $400,000 actual damages and $100,000 punitive damages, petitioner alleged as a basis for its claim for $400,000 actual damages that there was a plan "to injure" petitioner, that the false statements "were made for the purpose of wrecking the enterprise, and depriving the Highland Corporation of these properties, and for the purpose of preventing it from carrying on its enterprise, and paying the money borrowed, so that the property might be foreclosed and bought by the Fidelity Co. or its associates and those conspiring with it; or otherwise seized." As a basis for its claim for $100,000 punitive damages petitioner alleged that there was a "plan and conspiracy" carried out "in an attempt to wreck the Highland Corporation and prevent it from carrying out its enterprise, and to seize the proceeds of the enterprise legitimately belonging to it, and which it would have obtained if it had not been for the wrongful acts complained of", and that "all of this was done wilfully, maliciously and greedily and with animosity and with the deliberate and malicious effort to destroy the business of the Highland Corporation and prevent it from completing the enterprise with success."
The case was tried before a jury. The trial began July 3, 1933. On August 5, 1933, the jury found that the transaction of petitioner with Fidelity was a loan of $194,000, that the 1,000 shares of petitioner had a reasonable fair cash value of $40,000 on February 11, 1929, that Fidelity had slandered petitioner's title to its lands and had prevented realization by petitioner on its assets and interfered with the orderly conduct of its business, that $90,000 was reasonable compensation to petitioner for damages, and that petitioner was entitled to $10,000 as exemplary damages.
On November 23, 1933, the court decreed that the obligation evidenced by the bonds sued on was usurious, that all payments made and received thereon, whether as interest or principal, be credited on the principal, and that such obligation, originally $200,000, was subject to credits, as follows:
Money paid to Fidelity and used by it to retire and purchase bonds
for the sinking fund __________________________________________ $51,900.00
Money collected by Fidelity on notes and contracts pledged under
the mortgage __________________________________________________ 3,907.56
Interest paid on bonds more than two years prior to the bringing
of the suit ___________________________________________________ 20,410.83
Double $12,903.40 interest paid within two years before suit was
brought _______________________________________________________ 25,806.80
Value of 1,000 shares Highland Farms stock _____________________ 40,000.00
Three percent of the face value of the loan retained by Fidelity 6,000.00
__________
Total credit _____________________________________________ 148,025.19
After deducting the total credit to petitioner of $148,025.19 from the $200,000 loan, the court decreed (there being an error of $70 in subtraction in the decree) that there was a credit of $51,904.81 in favor of Fidelity. The court also decreed that Fidelity recover of petitioner expenses of $1,044.24 and $5,000 for services as trustee; that petitioner recover from Fidelity the $90,000 awarded by the jury as actual damages and $10,000 as exemplary damages; that from the aggregate of these sums should be deducted the $57,949.05 credits due Fidelity, and that petitioner should recover of Fidelity the residue, $42,050.95, together with interest at 6 percent from the date of judgment....
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