Thornberry Const. Co., Inc. v. US

• Decision Date: 17 May 1978
• Docket Number: No. 271-75.,271-75.
• Parties: THORNBERRY CONSTRUCTION COMPANY, INC. v. The UNITED STATES.
• Court: U.S. Claims Court

576 F.2d 346

THORNBERRY CONSTRUCTION COMPANY, INC. v. The UNITED STATES.

No. 271-75.

United States Court of Claims.

May 17, 1978.

Charles F. Wood, Louisville, Ky., attorney of record, for plaintiff. Wood, Goldberg, Pedley & Stansbury, Louisville, Ky., of counsel.

James L. Malone, III, Washington, D.C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D.C., for defendant. Theodore D. Peyser and Robert S. Watkins, Washington, D.C., of counsel.

Before NICHOLS, KASHIWA and MILLER^*, Judges.

OPINION

PER CURIAM.

This case comes before the court on defendant's exceptions to the recommended decision of Trial Judge Harry E. Wood, filed April 7, 1977, pursuant to Rule 134(h), having been submitted on the briefs and oral argument of counsel. Upon consideration thereof, since the court agrees with the trial judge's recommended decision, as hereinafter set forth, it hereby affirms and adopts the decision as the basis for its judgment in this case^**. Accordingly, it is concluded that plaintiff is entitled to recover and judgment is entered for plaintiff with the amount thereof to be determined in further proceedings pursuant to Rule 131(c).

OPINION OF TRIAL JUDGE

WOOD, Trial Judge:

In this action, plaintiff, a corporation engaged during its fiscal year ended March 31, 1974, in the business of strip mining coal in western Kentucky, sues to recover $90,705 in federal income taxes, plus deficiency interest of $5,666 thereon, paid in consequence of the Internal Revenue Service's denial of a deduction for depletion claimed by plaintiff on its federal income tax return for the said fiscal year.

The issue is whether plaintiff possessed "an economic interest" in certain coal in place under a February 14, 1973 agreement styled "Coal Mining Lease and Sublease" between American Metal Climax, Inc. (AMAX) and James R. Thornberry, and a March 1, 1973 assignment from James R. Thornberry to plaintiff. If, as plaintiff contends, it had such an interest, it was entitled to a proper deduction for depletion, while if defendant's contrary argument is valid, the petition should be dismissed. For reasons hereinafter set forth, it is concluded that plaintiff is entitled to recover.

I

From 1963 to 1972, James M. Thornberry (plaintiff's sole stockholder during the tax year in suit), worked as general manager of Thornberry Construction Company, an unincorporated business owned by his father, James R. Thornberry. During that period, Thornberry Construction Company engaged in, among other things, the construction of haul roads from mines, mine sites, roads and dams, and, during the period 1970-72, in mining operations in southern Indiana. Thornberry Construction Company's clients included AMAX, and AMAX's upper management level personnel thus came to know both James R. Thornberry and James M. Thornberry. In early 1973, James M. Thornberry purchased all of the stock of Thornberry Construction Company, Inc., from his father, and became (and was throughout the fiscal year ended March 31, 1974) plaintiff's president and operating manager.

Sometime prior to 1973, James R. Thornberry had informed AMAX that if it ever had a block of coal extraneous to its mining operations, he would be interested in leasing the block of coal and operating a mine. On February 14, 1973, AMAX and Mr. Thornberry entered into the "Coal Mining Lease and Sublease" (sometimes hereinafter "the lease") at the center of this litigation, and shortly thereafter Mr. Thornberry made an assignment of the lease to plaintiff. At least in defendant's view, however, the lease and the assignment must be viewed in the light of precedent facts and circumstances, described hereinafter.

Coal in western Kentucky lies under the surface in beds or seams that are described by numbers. Each seam has distinct British Thermal Unit (BTU) and other quality characteristics. No. 12 coal, a low quality, thick seam coal, overlies no. 11 coal, a medium quality, thick seam coal. While these two seams are usually separated by several feet of limestone, they are always mined together. No. 12 coal normally has a BTU rating of 10,800 to 11,000, while no. 11 coal normally has a BTU rating of about 11,000. No. 9 coal, a substantially better coal with lower ash content, has an average BTU rating of 11,300 to 11,400.

During the fall of 1969, Ayrshire Coal Company (which in October 1969 merged into and became a division of AMAX) began mining no. 12 and no. 11 coals at the Ayrgem Mine, Muhlenberg County, Kentucky. Most of the coals mined at the Ayrgem Mine were sold to the Tennessee Valley Authority for delivery to the Paradise Steam Plant, a TVA facility some 10 miles from the Ayrgem Mine. From almost the inception of mining operations at the Ayrgem Mine, AMAX experienced only marginal profitability from such operations because of a low profit realization on its TVA contract. In order to increase the profitability of its Ayrgem mining operations, AMAX sought to, and, commencing in 1970, did, sell a portion of its Ayrgem coals to Mr. Thomas W. Talbert, an independent coal broker.

Mr. Talbert had an agreement with Dairyland Power Cooperative ("Dairyland"), LaCrosse, Wisconsin, to purchase coal for it each year in and after 1969, and, in effect, resold to Dairyland the Ayrgem coals he purchased from AMAX. While the Talbert-Dairyland agreement did not contain any specific BTU guarantee or requirement, at least some of AMAX's agreements with Mr. Talbert did contain a BTU rating guarantee (10,500 in 1970, and 10,000 in 1971). In 1971, and in each of the years thereafter through 1974, Mr. Talbert purchased from AMAX 400,000 tons of Ayrgem coals.

For 1973, Mr. Talbert was attempting to furnish to Dairyland coal having an average BTU rating of 10,500. By that time, however, the no. 12 and no. 11 coals produced at the Ayrgem Mine had deteriorated in quality to the point where the Ayrgem blend, with an average BTU rating of only 9,500, was about to reach a noncompetitive position with other coals available on a BTU basis. AMAX realized that, if it were to continue to sell the Ayrgem blend to Mr. Talbert, an upgrading in quality was necessary. The only way the Ayrgem blend could be upgraded was to blend it with a better quality coal.

For several years prior to 1973, AMAX had owned a seam of no. 9 coal, amounting to more than 2,000,000 tons, adjacent to its Ayrgem Mine. For a number of reasons (including the undesirability of putting a small satellite operation around the Ayrgem Mine, the confusion and labor problems such an operation would cause, a lack of proper equipment with which to strip the no. 9 coal reserve, and a lack of management to supervise the operation), AMAX had determined that it was not economically feasible or practical for it to mine this seam of no. 9 coal itself, and that determination was, as of 1973, still a valid one from AMAX's standpoint.

In early 1973, AMAX was well aware of Mr. Talbert's problems with AMAX's Ayrgem coals. It knew, too, that unless it took steps designed to result in an upgrading of those coals, Mr. Talbert probably would not accept them in the future because of their inferior BTU quality, and that its own no. 9 coal reserve adjacent to the Ayrgem Mine was the only known available source of high quality coal that could be economically blended with the Ayrgem coals being sold to Mr. Talbert. Since mining the no. 9 coal was, for AMAX, neither economically feasible nor otherwise practical, however, leasing the no. 9 coal to a lessee who would mine it and sell it to Mr. Talbert (and pay AMAX a royalty) made excellent sense from AMAX's standpoint, since it would permit depletion of the no. 9 coal, allow AMAX to enhance its profit position at the Ayrgem Mine, and also result in AMAX's receipt of a profit from the mining of the no. 9 coal.

In late January or early February 1973, Mr. Hopper, president of AMAX Coal Company, advised James R. Thornberry, in substance, that AMAX was interested in leasing its no. 9 coal to someone who would mine it and sell to Mr. Talbert a sufficient amount thereof to blend with Ayrgem coals to upgrade the latter. Mr. Thornberry indicated he would be interested in entering into such a transaction. Mr. Hopper told Mr. Thornberry he was sure Mr. Thornberry would be able to sell coal to Mr. Talbert on the basis of a fair deal, and that if Mr. Thornberry could "work out something" with Mr. Talbert, AMAX would lease the no. 9 coal to Mr. Thornberry.

At Mr. Hopper's invitation, James R. Thornberry and James M. Thornberry then went to AMAX's office in Indianapolis, Indiana, where they were introduced to, and met separately with, Mr. Talbert. After discussion of Mr. Talbert's no. 9 coal requirements for a 2-year period (some 800,000 tons), and with access to the results of geological surveys of AMAX's no. 9 coal reserve conducted by AMAX prior to January 1973, James M. Thornberry concluded that plaintiff could profitably operate a mine based on what Mr. Talbert indicated he was willing to pay for no. 9 coal at that time.

Prior to February 14, 1973, James M. Thornberry and Mr. Talbert entered into an oral agreement for the sale by plaintiff to Mr. Talbert of approximately 400,000 tons of no. 9 coal per year, for 2 years, at a stated, mutually agreeable, price per ton. The oral agreement included a "cost escalation" provision, but, because coal prices were then relatively stable, possible price increases due to changes in market conditions were neither anticipated nor discussed.¹ AMAX took no part in the negotiations between James M. Thornberry and Mr. Talbert, nor was it even aware of the terms and conditions of the oral agreement between them. In particular, AMAX played no part whatever in the determination of the per ton price Mr. Talbert would pay to plaintiff for coal mined and sold to Mr. Talbert. Thereafter, James R. Thornberry and James M. Thornberry advised Mr. Hopper that they had reached an agreement with Mr. Talbert, and that th...