In re Central of Georgia Ry. Co.

• Decision Date: 04 November 1942
• Docket Number: No. 4829.,4829.
• Citation: 47 F. Supp. 786
• Parties: In re CENTRAL OF GEORGIA RY. CO.
• Court: U.S. District Court — Southern District of Georgia

47 F. Supp. 786

In re CENTRAL OF GEORGIA RY. CO.

No. 4829.

District Court, S. D. of Georgia, Savannah Division.

November 4, 1942.

Lawton & Cunningham, of Savannah, Ga., for Merrel P. Callaway, Trustee.

Hull, Barrett, Willingham & Towill, of Augusta, Ga., for Augusta & Savannah R.R.

LOVETT, District Judge.

The main question now for decision is whether a long term lease of a railroad must expressly, directly and in words provide for the payment of federal taxes on income from rentals to justify the imposition of such a burden on the lessee.

The issue arises in this way: The debtor, a Georgia corporation, is being reorganized under section 77 of the Bankruptcy Act, 11 U.S.C.A. § 205. The Augusta and Savannah Railroad, owned by a Georgia corporation, on October 24, 1895, was leased to the debtor for a term of 101 years with a perpetual right of renewal. Recently the trustee of the debtor, under an appropriate order of the court, adopted the lease for the period of the bankruptcy proceedings; and at the same time has asked the court to determine the question of where the liability for federal income taxes assessable to the lessor rests under the language of the lease.¹

The lease contains these covenants and recitals:²

1. The lessee shall pay as an annual rental "the sum of $51,145, being equal to 5 per centum upon the amount of the capital stock of the said lessor", and

2. Shall pay the salaries of the president and secretary of the lessor corporation up to a stated sum, shall provide free transportation over lessee's whole system for these officers, and shall pay certain other corporate expenses stated in the lease, and

3. Shall pay "all Federal, State, County or Municipal taxes and assessments, ordinary or extraordinary, then resting or thereafter to be lawfully imposed upon the Lessor or its property under its charter and the Constitution and laws of the State of Georgia or of the United States".

4. "It is the intention of this contract that the lessor shall have and receive during the period of this lease, and any and all renewals thereof, the amount of said rental free from and without any deduction whatever, but nothing herein contained shall be so construed as to make the lessee . . . in any way liable or responsible for any indebtedness or liability which may be created by or arise from the acts of omission or commission of any director or other officer or employee of the lessor, unless done at the express instance or request or assent of the lessee; but neither party to this contract shall in any manner become liable for the acts of the other party, except insofar as they herein expressly authorize it".

The lease to be interpreted was a modification of an older one made in perpetuity on May 1, 1862 by the lessor to the Central Railroad and Banking Company of Georgia, of which the debtor is the successor. Under that lease the annual rental was equivalent to 7% of the amount of the capital stock of the lessor. It contained a covenant that the lessee agreed "to pay all taxes that may legally be imposed by the Confederate States of America on said Railroad leased as aforesaid, the tax imposed by the State of Georgia to be paid by the said The Augusta and Savannah Railroad" (lessor).

The "tax imposed by the State of Georgia" was fixed by the charter of the lessor granted by the legislature of Georgia in 1838, and was in the nature of an income tax. The tax was "one-half of one per centum on its annual income", and was in lieu of ad valorem taxes.³ The net amount, therefore, received under that lease and available for dividends to stockholders was slightly less than 7% annually upon the amount of the lessor's capital stock.⁴

The original lessee, Central Railroad and Banking Company, went into equity receivership in this court in 1892, and was reorganized in 1895. The reorganization plan provided for the formation of the Central of Georgia Railway Company, which should take over substantially all of the properties of the old railroad company, including the leaseholds.

On June 19, 1895, on motion of lessor's counsel, a distinguished and capable member of the Georgia bar, the president was authorized by the directors to execute a new lease to the reorganized company when incorporated, with certain provisions to be included therein, among others, "* * * at the annual rental of five per cent on the capital stock of this company, payable semiannually * * * the lease lessee to provide for and assume the payment of all taxes or assessments now due or which hereafter may become payable by this company to the State of Georgia, and sic county or municipality, or the Federal government as a direct or an income tax" (emphasis mine). The president of the lessor company, who presided at the directors' meeting, was also an outstanding member of the Georgia bar.

On August 6, 1895, the stockholders of the lessor company also acted by resolution. They accepted the reorganization plan insofar as it related to their railroad and agreed to cause a lease on its railroad for 101 years to be executed, "the same as now enjoyed by the Central Railroad and Banking Company of Georgia, under the lease dated May 1st, 1862". The resolution then recited, "the proposed draft of the lease now submitted be and it is hereby accepted". A copy of the proposed lease follows in the minutes and is substantially the lease finally executed. In like manner on October 24, 1895 the directors of the lessor company adopted resolutions authorizing the execution of the new lease. These resolutions recited that the proposed draft of lease was "intended as a renewal of, and substitution for" the original lease of 1862. The new lease as executed refers only to the resolution of the directors of October 24, 1895.

It will thus be seen these changes in the old lease were made:

1. Substitution of a new lessee;

2. A term of 101 years, with the perpetual right of renewal, instead of a perpetual lease in the beginning;

3. Reduction of the stated, fixed annual rental from the equivalent of 7% to 5% of the lessor's capital stock;

4. An expanded covenant relating to taxes and assessments which should be paid by the lessee in addition to the stated rentals.

A few months before the lease of 1895 was negotiated and the formal contract executed the Supreme Court of the United States by a divided court held the federal income tax law of 1894, 28 Stat. 509, to be violative of the Constitution of the United States, as it was a direct tax, and was not apportioned among the several states as required by Sec. 2, Art. 1.⁵ While this decision provoked wide discussion at the time of the necessity and wisdom of an amendment of the Constitution, it was not until 1909, some fourteen years later, that the Sixteenth Amendment was proposed, and after four more years (1913) it was ratified.

In 1895 Georgia lawyers were not unacquainted with income taxes as a possible source of revenue, and, of course, those familiar with railroad charters like that held by the Augusta and Savannah Railroad knew of their tax exemptions from ad valorem taxes through a tax based upon a percentage of annual income. The Supreme Court of Georgia theretofore had twice considered the power of municipal governments to levy taxes on earnings or income. Both of these cases arose in Savannah where the principal offices of the lessee were located.⁶ In one of these cases the law firm of which the president of the lessor company was a member was of counsel, and in that case the Supreme Court said "It will not be disputed that income is a legitimate subject of taxation" (by the State).

In the light of these several decisions by the highest courts of the State and the United States the language in the resolution of the board of directors of the lessor company of June 19, 1895, referring to taxes and assessments which thereafter might become payable by the lessor to the "State of Georgia, and county or municipality or the federal government, as a direct or an income tax", may take on added significance and aid in the interpretation of the language to be construed. This is particularly so if the language of the resolution was communicated to the lessee. It seems unlikely information as to the language of the resolution would have been withheld. The officers of the two corporations were men of the highest character and I feel sure they dealt with each other in the negotiations of the new or modified lease with entire candor and good faith.

From the year 1913, when the federal income tax law now in effect as amended was first enacted,⁷ to June 19, 1940, when these proceedings for reorganization in bankruptcy were instituted, the lessee (debtor) and its equity receiver⁸ paid all of the federal income taxes assessed to the lessor.⁹

Since June 19, 1940 advancements have been made by the trustee in these proceedings to the lessor to pay income taxes "as provided in the lease" under orders of the court, but these orders provided that all advances should be "subject to adjustments . . . as may be determined by the court when the said Trustee or Trustees elect to adopt or reject the lease . . this order shall not prejudice the rights of any of the parties to the cause".¹⁰

Continuously since 1895 the lessor has owned stocks and bonds producing income. It has always paid its own federal income taxes on that portion of its earnings. It has never been reimbursed by the lessee for these payments, nor has it ever made any claim for such reimbursement.

The argument of the lessee's trustee proceeds upon the postulates that the tax clause in the lease is clear and unambiguous in its terms, its meaning is to be found within its four corners, and as there was no federal income tax levied — indeed, no constitutional authority for one — when the lease was made, it must be assumed in the absence of express language to the contrary the parties did not have it in contemplation and did not intend to place the burden of...