Ridge Realization Corp. v. Comm'r of Internal Revenue, Docket No. 2907-62.

• Decision Date: 04 March 1966
• Docket Number: Docket No. 2907-62.
• Citation: 45 T.C. 508
• Parties: RIDGE REALIZATION CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

45 T.C. 508

RIDGE REALIZATION CORPORATION, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 2907-62.

Tax Court of the United States.

Filed March 4, 1966.

[45 T.C. 508]

Jerome R. Hellerstein and Victor Brudney, for the petitioner.

James Q. Smith, for the respondent.

Central States Electric Corp. and two subsidiary investment companies were reorganized in a chapter X bankruptcy reorganization. As part of the plan of reorganization, petitioner was created for the sole purpose of prosecuting, realizing upon, and distributing the proceeds of two lawsuits which had been commenced by or on behalf of Blue Ridge Corp., one of the subsidiaries, seeking recovery from certain former directors of Blue Ridge and others for losses sustained by Blue Ridge as a result of alleged wrongdoing. In 1959 petitioner received $800,000 from one defendant in partial settlement of one of these suits. Held: The losses incurred by Blue Ridge which had been deducted without tax benefit determined the basis for the claims and such basis became petitioner's basis when the lawsuits were assigned to petitioner in 1951 in a nontaxable exchange pursuant to the bankruptcy reorganization plan. Accordingly, the recovery, which did not exceed petitioner's basis, represents the recovery of capital, not taxable income.

HOYT, Judge:

The respondent determined a deficiency in petitioner's income tax for the calendar year 1959 in the amount of $387,990.58. The sole issue for decision is whether an amount of $800,000 recovered by petitioner in partial settlement of a litigation claim in 1959 must be included in taxable income.

FINDINGS OF FACT

Most of the facts have been stipulated. The stipulation of facts, supplemental stipulation of facts, and attached exhibits are incorporated herein by this reference. Some of the facts which have been agreed upon will be set forth hereinafter in detail.

Petitioner is a corporation organized on April 27, 1951, under the laws of the State of Delaware, with its principal office in New York City. Its Federal income tax return for the year 1959 was filed with the district director of internal revenue in New York City. Petitioner

[45 T.C. 509]

maintains its books and files its tax returns on the accrual system and calendar year basis.

On or about March 30, 1959, petitioner was paid $800,000 by Countess Mona Bismarck, the widow of Harrison Williams, in partial settlement of an action initiated for the benefit of petitioner and its stockholders against Harrison Williams and certain former officers and directors of Blue Ridge Corp. which action is still pending against other parties in the U.S. District Court for the Southern District of New York.

The circumstances behind the organization of petitioner were as follows: In 1942 a reorganization proceeding under chapter X of the Bankruptcy Act was begun, involving Central States Electric Corp. (referred to as Central States), Blue Ridge Corp. (referred to as Blue Ridge), and American Cities Power & Light Corp. (referred to as American Cities). Prior to reorganization all three of these corporations were publicly owned closed-end investment companies; Central States owned, either directly or indirectly, controlling interests in both American Cities and Blue Ridge. At the time the bankruptcy court approved the final plan in 1950, Central States held approximately 31 percent of Blue Ridge's outstanding stock and 82 percent of American Cities' outstanding shares; American Cities in turn owned approximately 42 percent of the outstanding shares of Blue Ridge and Blue Ridge owned 806,258 shares of Central States stock (approximately 8 percent). Central States, a closed-end investment company, had outstanding multiple series of bonds and preferred stock; American Cities and Blue Ridge, both also closed-end investment companies, had no senior securities outstanding.

In addition to its holdings of securities and some cash, Central States had interests in certain contingent assets. These consisted principally of a pending lawsuit brought by its trustees in reorganization against Harrison Williams, a former director, and others, and its interest in Blue Ridge's contingent assets. Blue Ridge's contingent assets, in turn, consisted of two separate lawsuits of which one was a stockholder's derivative suit brought by Harry Marco on behalf of Blue Ridge against Harrison Williams and certain other former directors and other persons (hereinafter referred to as the Marco action). The other lawsuit was one which had been brought directly by Blue Ridge against Central States, American Cities, Harrison Williams, and Onondaga Corp.

The plan of reorganization finally developed and approved was designed to combine the assets of Central States and Central States' portion of the assets of its two subsidiaries, American Cities and Blue Ridge, into one new open-end investment corporation, the stock of which would be owned by Central States initially and distributed by Central States to its creditors, bondholders, and preferred stockholders

[45 T.C. 510]

in their order of priority. However, in order for the creditors of Central States to be paid with stock of the newly formed corporation it was essential that the new corporation's stock have a readily ascertainable market value based on net asset values. This requirement of the plan would be defeated if the new corporation were to hold as assets the contingent lawsuit claims of Central States and Blue Ridge. Also, the reorganization could not be delayed, in fairness to the debenture holders and 7-percent preferred stockholders of Central States, until the lawsuits were reduced to judgment.

It was not necessary to transfer the contingent assets to the reorganized company in order to preserve them for the security holders and to consummate the reorganization under chapter X. Hence, these contingent assets had to be dealt with outside of the reorganized corporation.

The reorganization plan provided for the segregation of the contingent assets of Central States and of Blue Ridge and that the contingent assets of Blue Ridge be transferred to a trustee or corporation for the benefit of shares or certificates of interest therein which were to be distributed to the stockholders of Blue Ridge, including Central States. The plan also provided that the contingent assets of the estate consist of the following:

(a) The Trustee's lawsuit against Harrison Williams, and others.

(b) The interest of Central States in contingent assets of Blue Ridge, represented by separate lawsuits instituted by or on behalf of Blue Ridge against Harrison Williams, and others.

(c) Possible minor miscellaneous recoveries which might be received upon final dissolution of American Cities, and any other contingent assets.

It then specified that the net proceeds of the contingent assets should be distributed to Central States' respective shareholders.

The following steps were taken pursuant to the plan finally adopted in 1950 and approved by the court:

(1) American Cities redeemed the stock of all its public shareholders and then liquidated, distributing its remaining assets to Central States.

(2) Ridge Realization Corp., petitioner in the instant case, was created under the laws of Delaware, and the lawsuits begun by Blue Ridge and Marco (for the benefit of Blue Ridge), $300,000 in cash, and the 806,249 shares of Central States common stock (which might be required for tender in the pending litigation) were assigned by Blue Ridge to petitioner solely in exchange for 7,422,483 shares of petitioner's common stock (all of the issued and outstanding shares). Both petitioner and Blue Ridge treated this transaction as a nontaxable exchange of stock for assets and reported no gain or loss there-from in their income tax returns.

(3) Blue Ridge then distributed this stock in petitioner to its public shareholders and to Central States according to their respective

[45 T.C. 511]

interests in Blue Ridge, with Central States receiving approximately 66 percent thereof.

(4) A new corporation, Blue Ridge Mutual Fund, Inc., was created in the form of an open-end investment company (hereinafter sometimes referred to as the reorganized corporation), and to it Central States transferred all of its assets except its contingent lawsuit against Williams, et al., certain cash and 66 percent of the stock of Ridge Realization Corp. which it had acquired from Blue Ridge, in exchange for stock in the reorganized corporation.

(5) Divested of its contingent assets, Blue Ridge merged into the reorganized corporation (Blue Ridge Mutual Fund, Inc.), and upon completion of the merger its stock in the new company was distributed to Blue Ridge stockholders, including Central States.

(6) Central States distributed its stock in the reorganized corporation to its bondholders and preferred stockholders in order of their priorities.

At the completion of these transactions the reorganized corporation owned all of the assets of the Central States group except some cash, certain specifically reserved assets, and contingent assets in the form of pending lawsuits. Bondholders and some of the preferred stockholders of Central States were satisfied by stock in the reorganized corporation, and Central States continued to own its own lawsuit against Williams, et al., plus 4,900,788 shares of stock in petitioner (66 percent), whose only significant assets were the other two lawsuits against Williams, et al. Any amounts received by Central States either from its own lawsuit or from its share of proceeds from petitioner's lawsuits would be distributed to remaining shareholders who had not been satisfied previously from the distribution of shares in the reorganized corporation, in the order of their priority of claim specified by the plan.

Of the two actions assigned by Blue Ridge to petitioner in the reorganization proceedings, one was an action begun in 1946 by Blue Ridge itself against Harrison Williams, Central States, American...