Leckie v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 01 February 1938 |
| Docket Number | Docket No. 86565. |
| Citation | 37 BTA 252 |
| Parties | FREDERICK L. LECKIE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Arthur E. Petersilge, Esq., for the petitioner.
T. M. Mather, Esq., for the respondent.
The Commissioner determined a deficiency in petitioner's income tax for the year 1934 in the amount of $867.29. In an amended answer which he, as respondent, filed in the instant proceeding he not only denied that he had erred in determining the deficiency but alleged that he had erred in not increasing petitioner's net income by the addition of $3,004 as a capital net gain. He accordingly asked for an increased deficiency. Petitioner, in his reply, admitted that such capital gain was realized. Effect will be given to this admission in a recomputation under Rule 50.
The sole issue for determination is whether or not the respondent erred in disallowing the deduction from gross income of $4,610.35 as a bad debt. In the notice of deficiency it is stated that said amount was disallowed because a bondholders' committee, acting for the holders of bonds issued by the Morgan Properties Co., had "acquired the properties of the company in pursuance of a plan of reorganization, hence under section 112 (b) of the Revenue Act of 1934 no loss is recognized."
The petition alleges that the respondent erred in disallowing the amount claimed and in holding that the bonds were not ascertained to be partially worthless; that he erred in holding that the committee acquired the properties "in pursuance of a plan of reorganization in such manner as to prevent the recognition of loss under section 112 (b)"; and that he "erred in holding that a partial bad debt deduction cannot be allowed if the holders of the bonds evidencing said debt participate in a plan of reorganization by means of which they acquire the properties of the debtor which were mortgaged to secure the debt."
All of the facts were stipulated. A summary will be sufficient for present purposes.
In November 1926 petitioner paid $5,000 for $5,000 par value bonds of the Morgan Properties Co. (hereinafter called the Morgan Co.). The bonds were secured by a mortgage covering all of the properties of the Morgan Co., consisting of two parcels in Ohio and one in New York. The Morgan Co. leased all of its properties to the Morgan Lithograph Co. (hereinafter called the Lithograph Co.), the agreed rental being an amount equal to the interest on the bonds, the annual maturities of the bonds, and taxes and operating expenses of the Morgan Co. The Lithograph Co. sustained losses from its operations for each of the four years ending June 30, 1929, to June 30, 1932, inclusive, and failed to pay the rental maturing August 1, 1932. The Morgan Co. defaulted in the payment of principal and interest due on its bonds August 15, 1932.
The bondholders' protective committee (hereinafter called the committee) was formed December 1, 1932. On January 5, 1933, petitioner deposited his bonds with the committee. Ultimately 97 percent of the $1,280,000 outstanding bonds were so deposited. The Union Trust Co. of Cleveland was the designated depositary of the bonds. All depositing bondholders assented to the provisions of the bondholders' protective agreement.
On June 3, 1933, the United States District Court at Cleveland, Ohio, appointed a receiver for the Lithograph Co. upon the application of one of its creditors. The trustee for the bondholders filed a claim for the rent due the Morgan Co. and received three dividends, totaling $86,043.71, in 1934. Nondepositing bondholders received their shares of this sum in cash, while the shares of the depositing bondholders were paid to the committee.
Under date of July 1, 1933, the committee adopted a "plan of readjustment" and forwarded copies thereof to all bondholders on July 6, 1933. Bondholders assented to the plan by depositing their bonds with the committee, or by permitting them to remain with the committee if they had already been deposited. In accordance with the provisions of the plan the following steps were taken:
On January 12, 1934, the committee caused the trustee for the bondholders to commence foreclosure proceedings. On June 4, 1934, the Payne Avenue plant of the Morgan Co. located in Cleveland, Ohio, was sold at public sale pursuant to the foreclosure decree. The committee bid $75,250 and its bid was accepted.
On June 5, 1934, the committee organized an Ohio corporation known as Industrial Properties, Inc. On July 11, 1934, the committee assigned to this corporation the $1,235,000 principal amount of the bonds which had been deposited with it pursuant to the plan and also its bid at the foreclosure sale. Most of the sum bid at the foreclosure sale, or $69,145.29, was paid by a credit in that amount endorsed on the deposited bonds, the balance of the debt represented by the bonds remaining uncanceled. The difference between the sale price and the amount credited on the bonds (which difference was for court costs and other cash requirements of the foreclosure), was paid in cash out of the funds received by the committee in connection with the claim for rent due from the Lithograph Co. All of the capital stock of the new corporation, Industrial Properties, Inc., was received by the committee and held by it during the year 1934 for the benefit of the depositing bondholders.
On November 30, 1934, the second parcel of Ohio property of the Morgan Co., was sold at a public sale, pursuant to the foreclosure decree. Industrial Properties, Inc., was the purchaser, the price bid being $30,000, of which $27,096.32 was paid by a credit in that amount endorsed on the deposited bonds. The balance of the debt represented by the bonds remained uncanceled and the difference between the sale price and the amount credited on the bonds was paid in cash out of the proceeds of the claim for rent.
Industrial Properties, Inc., leased the first mentioned property for two years to a corporation formed to continue the business of the Lithograph Co. This corporation was given the option to purchase the property under lease for $500,000 at any time while the lease was in effect. The last mentioned property was leased to an Ohio corporation engaged in the business of producing continuous business office forms printed on paper.
The New York property could not be sold for enough to produce any substantial return to bondholders, and this situation existed prior to December 31, 1934. Following the receipt of an offer from Laundered Service, Inc., a New York corporation, in June 1935, the committee caused foreclosure proceedings to be instituted on the New York property covered by the mortgage. At the foreclosure sale in December 1935, Industrial Properties purchased this property for $46,000. It applied the deposited bonds in part payment of the purchase price, leaving the balance of the debt represented by the bonds uncanceled. It paid in cash taxes of approximately $18,060, and also court costs in connection with the foreclosure. Industrial Properties, Inc., immediately transferred this property to Laundered Service, Inc., for $45,000, of which $15,000 was paid in cash and the balance was represented by a bond secured by a purchase money mortgage.
Under date of October 1, 1936, the committee wrote a letter to the depositing bondholders, including petitioner, advising them of the action theretofore taken pursuant to the plan. The letter stated that the committee, in accordance with the plan, would distribute the capital stock of the new corporation to holders of certificates of deposit on the basis of one share for each $100 principal amount of bonds deposited with the committee and that the new corporation contemporaneously would pay a dividend of $2 per share. Petitioner surrendered the certificate of deposit which had been given to him when his bonds were turned over to the depositary and on October 19, 1936, received 50 shares of the capital stock of Industrial Properties, Inc., and $100 in cash representing dividends at the rate of $2 per share.
Nondepositing bondholders have received cash distributions totaling $154.5873 per $1,000 bond, representing their proportional interest in the amounts received through sale of the properties and on the claim for rent filed in the receivership of the Morgan Co. Of this sum they received $127.928 per $1,000 bond during 1934.
Petitioner is one of the partners in the firm of Duncan, Leckie, McCreary, Schlitz & Hinslea, attorneys, of Cleveland, Ohio, which represented the trustees for the bondholders under the trust mortgage and prosecuted the Ohio foreclosure action, including the sale of the two Ohio properties owned by the Morgan Co. The facts with respect to the condition of the Morgan Co. were known to these attorneys (including petitioner) in 1934. Petitioner determined in 1934 that the debt represented by the bonds was partially worthless, made a partial charge-off of $4,610.35 in 1934, and claimed a bad debt deduction of this amount in his income tax return for that year. This deduction was disallowed by the respondent.
At the hearing both parties made reference to the case of Irene O. Kitselman, 33 B. T. A. 494, which had been reversed by the United States Circuit Court of Appeals for the Seventh Circuit in Commissioner v. Kitselman, 89 Fed. (2d) 458, and upon brief it is discussed at length. At the time of the hearing application had been made to the Supreme Court for a writ of certiorari but the writ had been neither denied nor granted. Respondent, having prevailed in the Circuit Court and the facts in the instant proceeding being somewhat analogous to those in that case, relies upon the decision of the court. Petitioner, while admitting that an affirmance by the Supreme Court of the decision of the court in the Kitselman case would have been decisive of the present controversy, nevertheless urges that the Board give...
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