MEL DAR CORPORATION v. CIR

• Decision Date: 06 December 1962
• Docket Number: No. 17421-17423.,17421-17423.
• Citation: 309 F.2d 525
• Parties: MEL DAR CORPORATION, a corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Coy BURNETT and Mildred K. Burnett, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

309 F.2d 525 (1962)

MEL DAR CORPORATION, a corporation, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Coy BURNETT and Mildred K. Burnett, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 17421-17423.

United States Court of Appeals Ninth Circuit.

October 27, 1962.

Rehearing Denied December 6, 1962.

Enright, Elliott & Betz, Joseph T. Enright, Norman Elliott, and Bill B. Betz, Los Angeles, Cal., for appellant.

Crane C. Hauser, Chief Counsel, Internal Revenue Service; Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Robert N. Anderson, Arthur I. Gould, and John B. Jones, Attys., Tax Division, Dept. of Justice, Washington, D. C., for appellee.

Before BARNES, HAMLEY and HAMLIN, Circuit Judges.

HAMLIN, Circuit Judge.

Petitioners, Coy Burnett and Mildred K. Burnett, are husband and wife who duly filed joint income tax returns for the calendar years 1951 and 1952. In 1957 the Commissioner of Internal Revenue assessed deficiencies in taxes against them for 1951 in the amount of $48,160.92 and for 1952 in the amount of $78,905.72. Petitioner Mel Dar Corporation is a Nevada corporation with its principal place of business in Los Angeles, California, which is wholly owned by the Burnett family. Using the accrual method of accounting, Mel Dar duly filed its tax returns for the fiscal years 1952 and 1953 covering the period beginning with May 1, 1951 and ending April 30, 1953. The Commissioner in 1955 assessed against Mel Dar deficiencies in income and excess profits taxes in the amount of $62,772.68 for fiscal 1952 and $7,733.28 for fiscal 1953. The Burnetts and Mel Dar filed petitions in the Tax Court for redetermination of deficiencies. The petitions were consolidated for trial in the Tax Court due to common issues of fact and law. The Tax Court had jurisdiction by virtue of section 272(a) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 272(a). After decisions favorable to the Commissioner petitioners timely filed petitions with this court for review of the Tax Court decisions. The above entitled cases were consolidated for review. We have jurisdiction under the provisions of section 7482 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 7482.

In the Tax Court the parties entered into an extensive stipulation of facts. At trial the petitioners produced five witnesses and introduced certain documentary and photographic exhibits. The Commissioner offered no evidence. The Tax Court adopted the parties' stipulation of facts and then paraphrased many of them in its Memorandum Findings of Fact and Opinion. Thus, on review the facts are substantially undisputed.

At all times pertinent to this case Coy and Mildred Burnett have been owners of Shamrock Island which is about 130 acres of land located off the coast of Corpus Christi, Texas. The high potential of Shamrock Island for oil and gas production was demonstrated prior to 1950 when the Atlantic Refining Company under leases from the State of Texas began producing oil and gas from adjoining property.

In February, 1950, the Burnetts entered into negotiations with Mar-Tex Realization Corporation, hereafter Mar-Tex, for an oil and gas lease to Shamrock Island. Thereafter, the Burnetts terminated the negotiations. On April 8, 1950, Mar-Tex instituted a suit against the Burnetts in the District Court of Nueces County, Texas, contending that it had a valid lease or contract to make a lease and praying that the Burnetts be compelled to deliver an oil and gas lease to Shamrock Island.¹ Under the terms of the lease claimed by Mar-Tex, it was entitled to possession of the property and 60% of the oil and gas produced therefrom. The Burnetts contested the Mar-Tex suit.

On May 19, 1950, petitioner Mel Dar Corporation, was incorporated in Nevada as the successor to Mel Dar Company, a family company owned by the Burnetts and their married daughters. Mel Dar Corporation was thus a closely held family corporation.

On June 5, 1950, the Burnetts entered into a lease with Mel Dar Corporation for the development of Shamrock Island for oil and gas purposes. The Burnetts as lessors in the Mel Dar lease were to receive from the lessees 25% of the gross receipts from the sales of oil and gas produced upon Shamrock Island. Financing arrangements were made with the Security National Bank of Los Angeles with whom the Burnetts had dealt over a period of many years in connection with other enterprises. The bank was kept informed of all phases of the Shamrock oil operations. As lessee, Mel Dar commenced operations for the production of oil and gas, the bank having agreed to lend Mel Dar $150,000 as of August 14, 1950.

The lease was amended on August 8, 1950, at the suggestion of the bank and it had been amended once before on July 3, 1950. These amendments provided certain changes in favor of Mel Dar. They referred to the Mar-Tex litigation and provided "as additional consideration" a conditional royalty of $100,000 after payment of expenses of the venture and the creation of a reserve of current assets equal to one and one-half times current liabilities. Paragraph 10 of the August 8, 1950, "Second Amended Lease" provided for the possibility of further amendments in the event "a change of any kind is deemed advisable by the parties hereto."²

The August 14, 1950, agreement between Mel Dar and the bank in which the bank agreed to loan Mel Dar $150,000 provided, among other things, that (1) the loan would be used solely for financing Shamrock Island Oil development, (2) so long as the loan existed Mel Dar would submit its financial policy to the bank for clearance, (3) Mel Dar would not "cancel, alter or modify the leasehold estate" to Shamrock Island without the bank's consent. On the same day the Burnetts agreed to subordinate in favor of the bank all existing and future claims held by them against Mel Dar except the Burnetts' royalty under the lease as amended; however, the Burnetts agreed to lend back to Mel Dar the proceeds from their royalty from Shamrock Oil development. Part of the $150,000 loan made by the bank was used to liquidate an existing indebtedness of approximately $60,000 which Mel Dar had obtained from the bank and had used to pay Shamrock Oil expenses, and the balance of approximately $90,000 was received in cash by Mel Dar from the bank.

After some difficulty in obtaining drillers to deal with Mel Dar, Coy Burnett on September 9, 1950, entered into a contract with A. J. Bankhead Drilling Company, Inc., for the drilling of the first oil well on Shamrock Island on a cash footage basis. Mel Dar paid this expense, and the drilling of the first well began on October 5, 1950.

As the time approached when oil was expected to be produced, attempts were made to find a buyer for the oil. Atlantic Refining Company held most of the leases surrounding Shamrock Island and it was approached as a prospective buyer. Atlantic refused at first. Later, however, on October 25, 1950, Atlantic agreed to buy the oil produced on Shamrock Island in consideration of Burnetts' granting to Atlantic easements and sites on Shamrock Island for tanks and a pipeline, and upon the further condition that Atlantic could withhold and impound 60% of the proceeds in order to protect itself from any possible claim by Mar-Tex.

On October 16, 1950, before any oil had been produced and before Atlantic had agreed to purchase any oil, Mel Dar and the Burnetts made another agreement entitled "Lease Amendment" which, after reciting certain difficulties which had occurred, made certain changes in the royalty payments to be made by Mel Dar to the Burnetts. The principal change in these payments was that the Burnetts were to receive 25% of the "net profits" as defined therein instead of 25% of the gross sales as provided for in the August 8, 1950, amendment.

The first well on Shamrock Island was completed on November 7, 1950, and the oil it produced was sold shortly thereafter to Atlantic in accordance with the agreement.

In the fall of 1950 the litigation between Mar-Tex and the Burnetts was proceeding.³ On October 30, 1950, a jury trial commenced on the question whether there was a valid lease or contract entered into between Coy Burnett and Mar-Tex requiring Coy Burnett to execute and deliver an oil and gas lease. This was the first phase of the Mar-Tex suit. On November 7, 1950, the jury decided this issue in favor of Mar-Tex.

On April 30, 1951, Mel Dar intervened in the Mar-Tex suit claiming reimbursement for amounts expended by it in the development of Shamrock Island for oil and gas purposes and for any enhancement in the value of the leasehold. This was the second phase of the Mar-Tex suit and it was tried before the court without a jury. On August 1, 1951, the court entered judgment upon the verdict for Mar-Tex finding that it was entitled to the lease claimed, and judgment was entered for the Burnetts and Mel Dar holding that they were entitled to reimbursement for the $513,000 expended by Mel Dar up to that time for development. The court, however, denied recovery for any enhancement in the value of the lease. The Burnetts appealed the lease question and Mel Dar appealed the enhancement question. In June, 1952, the Texas Court of Civil Appeals reversed the trial court, holding that as a matter of law there was no lease or contract to make a lease.⁴ The court did not reach the question of the enhancement raised in Mel Dar's appeal. The Texas Supreme Court denied an Application for a Writ of Error in November, 1952, and the litigation was finally terminated when a motion for a rehearing was denied.

Pursuant to its agreement Atlantic impounded a large sum of money (60% of the proceeds from the sale of oil) from the commencement of oil production until December, 1951. On December 18, 1951, after negotiations, Atlantic released the impounded funds to Coy Burnett upon receipt of a bond on which Burnett was the principal and on which the United States Fidelity and...