A.E. Staley Mfg. Co. & Subsidiaries v. Comm'r of Internal Revenue, No. 20225–92.

• Court: United States Tax Court
• Writing for the Court: HALPERN
• Citation: 105 T.C. No. 14,105 T.C. 166
• Parties: A.E. STALEY MANUFACTURING COMPANY AND SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Decision Date: 11 September 1995
• Docket Number: No. 20225–92.

105 T.C. 166
105 T.C. No. 14

A.E. STALEY MANUFACTURING COMPANY AND SUBSIDIARIES, Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 20225–92.

United States Tax Court.

Sept. 11, 1995.

[105 T.C. 166]

This case concerns the proper tax treatment of investment bankers' fees and printing costs incurred by petitioner in response to a series of unsolicited (but eventually successful) offers to acquire petitioner's stock. Petitioner's board of directors rejected the first two offers made by the acquirer. Ultimately, however, the board unanimously (1) approved a plan of merger with the acquirer and (2) recommended the acquirer's third offer to shareholders. Petitioner claims that, since the takeover was hostile, this case is distinguishable from National Starch & Chem. Corp. v. Commissioner, 93 T.C. 67 (1989) (target corporation's expenses incident to a “friendly” takeover are capital expenditures and, therefore, are not deductible under section 162(a)), affd. 918 F.2d 426 (3d Cir.1990), affd. sub. nom. INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), and Victory Mkts. & Subs., Inc. v. Commissioner, 99 T.C. 648 (1992) (similar). We disagree.

Held: The expenditures in question are capital expenditures;

[105 T.C. 167]

no deduction is allowable under either sec. 162(a) or sec. 165, I.R.C.

Dan Burt, Forbes Maner, Henry B. Miller, and David G. Tripp, for petitioner.

Darrell C. Weaver and Michael W. Bitner, for respondent.

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Page
                Findings of Fact 3
                Opinion 21
                I. Introduction 21
                II. Transaction 22
                III. Consequences of the Acquisition for SCI and Its Shareholders 24
                IV. National Starch and Its Progeny 27
                 A. Sections 162 and 165 27
                 B. National Starch 27
                 C. INDOPCO, Inc. 28
                 D. Victory Markets 29
                 E. Federated Department Stores 30
                V. Discussion 31
                 A. Arguments of the Parties 31
                 B. Duties of the Board 31
                 1. Arguments of the Parties 31
                 2. The Law of Delaware 32
                 3. Different Constituencies 35
                 C. Competing Theories 36
                 D. Expenditures for the Benefit of Another 37
                 E. Capital Expenditures 40
                 1. Introduction 40
                 2. Nature of the Inquiry 40
                 3. Origin of the Claim 43
                 F. Origin of the Fees 44
                 G. Federated Department Stores 48
                 H. Section 162 49
                 I. Section 165 49
                VI. Conclusion 51
                

HALPERN, Judge:

Respondent determined a deficiency of $3,544,166 in petitioner's Federal income tax for the October 1, 1987, to May 31, 1988, tax year. After concessions, the sole issue for decision concerns the proper tax treatment of investment bankers' fees and printing costs incurred by petitioner in response to a series of unsolicited (but eventually successful) offers to acquire petitioner's stock.

[105 T.C. 168]

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference.

At the time the petition was filed, petitioner's principal office was located in Decatur, Illinois.

Petitioner, A.E. Staley Manufacturing Co. and Subsidiaries, was an affiliated group of corporations, formerly named Staley Continental, Inc. and Subsidiaries (SCI). The predecessor of both petitioner and SCI was A.E. Staley Manufacturing Co. (AES), which was incorporated in Delaware in 1906.

From its organization until November 1984, the primary business of AES consisted of storing and marketing corn and soybeans and of milling, processing, and refining corn and soybeans. Through a process called “corn wet milling”, AES produced sweeteners, starches, oils, and other ingredients for the food and beverage industry. The principal product of AES was high fructose corn syrup, which is a sweet syrup made from corn that can be used as a substitute for cane or beet sugar in food production and industrial applications. By the mid–1980's, high fructose corn syrup became the leading sweetener in the U.S. food and beverage market, especially in the soft drink industry. However, corn wet milling was a cyclical business, because it was dependent on the supply, price, and perishable nature of a single commodity, corn.

As of 1975, Donald E. Nordlund (Nordlund) was the chief executive officer and chairman of the board of AES. In 1984, the board of directors and management of AES made a long-term strategic decision to diversify into the food service business, which they believed had significant growth potential. AES sought growth opportunities in the food service business, because AES management believed that the high fructose corn syrup market was a mature market that had little growth opportunity and thought that earnings from the food service business would provide a hedge against the cyclical corn-based business. As part of this growth strategy, in 1984,

[105 T.C. 169]

AES acquired CFS Continental, Inc. (CFS), a leading supplier to the food service industry.

AES reorganized in 1985 to emphasize the changes in the company and its new business strategy and, also, to consolidate the management of its corn wet milling business and food service businesses; SCI was formed and became the parent company of AES and CFS. SCI moved its corporate headquarters from Decatur to Rolling Meadows, Illinois, a suburb of Chicago. The objective of SCI was to modernize the corn wet milling plants to make them more efficient so as to reduce costs and to use the revenues from corn wet milling to pursue growth in the food service business. As part of this objective, SCI acquired Smelkinson Bros. Corp., a Baltimore–Washington food service distributor; Garden Products, Inc., a Portland produce distributor; Bit O'Gold, a Chicago food service distributor; the HAVI Corp. and Fresh Start Bakeries, suppliers to the McDonald's restaurant chain; Collins Foodservice, Inc.; Churchill, Inc., a Florida coffee roasting operation; Interstate Shortening; and Full Sail Products, Inc., a Los Angeles produce distributor. In 1986, SCI disposed of its soybean processing plants, because they no longer fit within the strategic plan of the company.

Tate & Lyle

Tate & Lyle PLC (Tate & Lyle), a publicly held United Kingdom corporation, was the largest refiner and distributor of sugar in the world. The chairman of the board of directors and chief executive officer of Tate & Lyle was Neil M. Shaw (Shaw). As of April 1988, Tate & Lyle was not involved in corn refining or the production of corn sweeteners, except for its interest in the Cereal Science and Technology Group (CST Group).

The CST Group consisted of Amylum N.V., a Belgian corporation, and Tunnel Refineries, Ltd., a United Kingdom corporation, and was involved in research and refining of starches, sweeteners, and related corn, wheat, and other small grain products. Tate & Lyle, SCI, and Compagnie Industrielle et Financiere des Produits Amylaces, S.A. (Compagnie Industrielle), a Belgian corporation, each owned 33.33 percent of the CST Group. Nordlund and Shaw were on

[105 T.C. 170]

the board of directors of Amylum N.V. and of Tunnel Refineries, Ltd.

Takeover Concerns of SCI

Sometime around 1986, SCI became concerned that it could become a potential target of a hostile takeover. Its concern stemmed in part from the mergers and acquisitions “climate” at that time and in part from actions allegedly taken by Drexel Burnham Lambert, Inc. (Drexel). On February 19, 1987, SCI filed a complaint in the U.S. District Court for the Northern District of Illinois against Drexel, charging Drexel with extortion and securities fraud, in violation of the Federal Racketeer Influenced and Corrupt Organizations Act and with violations of the Securities Act of 1933. In its complaint, SCI alleged that, in the fall of 1986, it planned to make a public offering of new common stock to raise capital and that Drexel deliberately accumulated SCI stock and threatened to sabotage the stock offering unless SCI abandoned its offer and agreed to a leveraged buy-out of SCI that would be managed by Drexel.

SCI hired the law firm of Skadden, Arps, Slate, Meagher & Flom (Skadden Arps), which recommended that SCI adopt “antitakeover” devices. SCI adopted some antitakeover measures such as stockholder rights plans (“poison pills”) and management retention agreements.

SCI also hired two investment banking firms, the First Boston Corp. (First Boston) on January 6, 1987, and Merrill Lynch Capital Markets (Merrill Lynch) on February 13, 1987. The retainer agreement with Merrill Lynch provided that Merrill Lynch was retained as a “financial advisor” to SCI “in connection with certain merger or acquisition situations.” Among other services, the Merrill Lynch retainer agreement provided that Merrill Lynch would provide (1) assistance in the evaluation of advance defensive preparations of SCI and (2) advice and assistance in the event that an unsolicited offer was threatened or initiated. The First Boston retainer agreement provided that First Boston would, among other things, assist SCI in defining merger and acquisition priorities. Merrill Lynch and First Boston were each paid a retainer fee of $75,000. Additionally, both agreements provided that Merrill Lynch and First Boston would

[105 T.C. 171]

be retained to represent SCI if an offer were made for the acquisition of the stock or assets of SCI.

In March 1987, Merrill Lynch made presentations to the management and board of directors of SCI. Although no company was attempting to acquire SCI at that time, Merrill Lynch recommended a number of actions that SCI should take to prepare itself against potential unsolicited takeover attempts. SCI implemented many of these actions, including setting up a “defensive team” of lawyers, investment bankers, and SCI executives who would be ready to respond quickly to any hostile bid; implementing a “stock watch program” to track the stock of SCI; strengthening the...