Morrison v. Morrison
| Decision Date | 15 November 1972 |
| Docket Number | Docket No. 6895-70. |
| Citation | 59 T.C. 248 |
| Parties | JACK F. MORRISON AND MARGARET V. MORRISON, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Benjamin G. Cox and Victor E. Aldridge, Jr., for the petitioners.
Robert P. Ruwe, for the respondent.
A. and B, owners of a majority of the stock in a corporation, negotiated a plan for the merger of their corporation with a larger one. The plan tentatively agreed upon called for a pro rata exchange of the stock of the merged corporation for 666 shares of the surviving corporation and to give a covenant not to compete. At the suggestion of A and B, the plan was recast to provide for a pro rata distribution of 516 shares and to give A and B each an option to buy 75 shares of the surviving corporation at $1 per share. Held, A received the stock option covering the additional 75 shares as consideration for his promised services and the covenant not to compete; he is taxable on its fair market value under sec. 61(a)(1), I.R.C. 1954; Held, further, the fair market value of the option received by A is determined.
Respondent determined a deficiency in petitioners' income tax for 1966 in the amount of $36,555.77. The issue presented for decision are as follows:
(1) Whether a right to acquire 75 shares of stock in a corporation surviving a merger, in addition to a pro rata distribution of other shares, was received by petitioner Jack F. Morrison as consideration for future services and a covenant not to compete; and, if so,
(2) What was the fair market value of the option received by petitioner Jack F. Morrison?
At the time they filed their petition, Jack F. Morrison (hereinafter referred to as petitioner) and Margaret V. Morrison, husband and wife, were legal residents of Terre Haute, Ind. They filed their joint Federal income tax return for 1966 with the district director of internal revenue, Indianapolis, Ind.
Prior to 1966, petitioner was secretary-treasurer and a director and James C. O'Neal (hereinafter O'Neal) was president and a director of Sig: Laboratories, Inc. (hereinafter Sig), a corporation which they had organized with its principal place of business at Marshall, Ill. Sig, which had only one class of stock, was engaged in the business of purchasing, packaging, and selling prescription medicines to doctors and hospitals. Petitioner and O'Neal owned a majority of Sig's stock.
Intra Products, Inc. (hereinafter Intra), was an Ohio corporation with its principal place of business at Dayton, Ohio. It had only one class of stock and was engaged in the manufacture of hypodermic solutions and other pharmaceutical products for hospitals, doctors, and distributors. Kenneth P. Lusher (hereinafter Lusher) was the president and majority shareholder (75 percent to 80 percent) of Intra.
During the fall of 1965, petitioner and O'Neal were having difficulties getting along with each other, and they decided to dispose of their stock in Sig. In October of 1965, they ran a blind advertisement in the Drug Trade News, indicating their stock was for sale, and Lusher answered the advertisement. From October to December 1965, petitioner and O'Neal negotiated with Lusher on a sale proposal calling for a cash payment. Lusher considered the cash price set by petitioner and O'Neal too high, and they were unable to work out a stock exchange. The negotiations broke down.
In late December of 1965, petitioner and O'Neal resumed their negotiations with Lusher. Petitioner and O'Neal proposed that Sig be merged with Intra, and that the shareholders of Sig receive 660 shares (1/3 of the capital stock) of Intra, the surviving corporation. They also agreed to enter into employment contracts with Intra, including terms prohibiting them from competing with Intra. One objective was to arrange for Intra to sell its stock on the public market as soon as possible.
Lusher accepted the proposal and had a draft of a proposed merger agreement prepared by Intra's counsel and sent to petitioner and O'Neal. The proposed agreement called for the merger to be completed not later than June 1, 1966. Petitioner was to be hired as divisional sales manager in Illinois, and O'Neal as vice president and sales manager. All outstanding stock options were to be exercised or canceled prior to the completion of the merger. The proposed agreement recited that one of the principal motives of petitioner and O'Neal in entering the agreement was their desire that Intra sell its stock on the public market as soon as economically feasible.
Lusher considered it of importance that petitioner and O'Neal agree to be employed by the surviving corporation. O'Neal previously had left the employment of Marion Laboratories and allegedly and violated his agreement with that organization by competing for its business. Lusher had been informed that legal action had been brought against O'Neal for these contract violations, and he believed that petitioner and O'Neal could have damaged the business had they been allowed to compete with the surviving corporation following the merger. Lusher did not request any other officers or employees of Sig to enter an employment contract with the surviving corporation or to agree not to compete with it.
Although the exchange of 666 shares of Intra stock for all the Sig stock was satisfactory with petitioner and O'Neal, they decided that they wanted a higher proportion of such shares than a distribution on a pro rata basis would allow them. The proposed to Lusher that 516 shares be distributed pro rata to the shareholders of Sig and that petitioner and O'Neal each be given an option for an additional 75 shares at $1 per share. Lusher agreed to this counterproposal on the conditions, however, that petitioner and O'Neal acquire the shares of all objecting shareholders, and that they save Intra harmless from any liability to any dissenting shareholder. The parties agreed to these conditions, and the merger agreement and related employment contracts were prepared.
An agreement, signed on March 22, 1966, by ‘Kenneth P. Lusher, principal officer and shareholder of Intra,‘ and Intra, first parties, and ‘Jack F. Morrison (petitioner) and James C. O'Neal, principal officers and shareholders of Sig,‘ and Sig, second parties, reflected the terms on which the parties had agreed. This signed agreement was basically similar to the draft agreement described above, with the exception of the provisions designed to give petitioner and O'Neal the option for the additional shares rather than to provide for a pro rata distribution of all the shares. For the purposes of this case, the following paragraphs are pertinent:
(1)INTRA and SIG shall merge into one Ohio corporation to be known as Intra Products, Inc., subject to the approval of the number of the shareholders of each corporation required to approve said merger by the laws of the State of Ohio and Illinois.
(2) The merger shall be completed by June 1, 1966, or as soon as the legal and accounting problems and work required, can be completed, whichever occurs first.
(3) Intra Products, Inc. has Two Thousand (2,000) shares authorized, and at the time of the merger shall have Thirteen Hundred and Thirty-four (1,334) shares outstanding to the present INTRA shareholders, and at the time of the merger, Five Hundred Sixteen (516) shares shall be issued on a pro-rata basis to the present shareholders of SIG in exchange for all of the outstanding shares of stock of SIG.
(4) Jack F. Morrison and James C. O'Neal, as part of their employment contracts, will each be granted an option by INTRA so that each of them has the right to purchase Seventy-five (75) shares of common stock of INTRA at One Dollar ($1.00) per share. Each may purchase all or any part of his Seventy-five (75) shares within three (3) years from the date of this Agreement.
(5) The number of directors of INTRA shall be increased from five (5) to seven (7) upon completion of the merger, and Morrison and O'Neal shall serve on the Board of Directors of the surviving corporation with the present board members of INTRA.
(7) O'Neal, after the merger is complete, shall be hired by Intra Products, Inc. as a Vice-President and Sales Manager, and shall be given an employment contract, a copy of which is attached hereto and incorporated by reference, as though rewritten herein, and marked Exhibit ‘B’.
(8) All outstanding stock options now in existence by either SIG or INTRA, shall be exercised or cancelled prior to completion of the merger and shall be known to parties, and no more stock options shall be granted by either INTRA or SIG after the execution of this Agreement.
(10) Jack F. Morrison and James C. O'Neal shall equally buy all the shares of stock from any and all shareholders of SIG who dissent to this merger and/or demand cash payment for their shares of stock in SIG, and shall save harmless the surviving corporation from any liability thereon and shall defend at their expense any suits filed by any dissenting SIG shareholders.
The agreement further recites that one of the principal motives and considerations inducing petitioner and O'Neal to enter the deal was the desire to have Intra ‘go public whenever it is economically feasible for INTRA and its shareholders.’ It was agreed that Intra would take the necessary steps to this end prior to January 31, 1969.
The agreement of merger was approved by Sig's directors on March 19, 1966. Petitioner and O'Neal sent letters to all of the Sig shareholders on or about March 24, 1966, advising them of the terms of the proposed merger and the approval thereof by Sig's directors and offering to purchase the Sig shares at the price of $12 per share. The letter states that the current book value of the stock was $7.70 per share.
Under date of March 25, 1966, Intra's attorney wrote petitioner's attorney a letter which, in part, stated:
I assume that a copy of the merger agreement executed...
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