United States v. Hartford Accident & Indemnity Co.

• Citation: 15 F. Supp. 791
• Decision Date: 27 July 1936
• Docket Number: No. 5350,5369-5373.,5350
• Court: U.S. District Court — District of Maryland
• Parties: UNITED STATES v. HARTFORD ACCIDENT & INDEMNITY CO., and five other cases.

15 F. Supp. 791

UNITED STATES v. HARTFORD ACCIDENT & INDEMNITY CO., and five other cases.

Nos. 5350, 5369-5373.

District Court, D. Maryland.

July 27, 1936.

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Bernard J. Flynn, U. S. Atty., of Baltimore, Md. (Geo. W. Whiteside and Abraham Benedict, both of New York City, and James M. Hoffa, of Baltimore, Md., of counsel), for the United States.

Venable, Baetjer & Howard, of Baltimore, Md. (Edwin G. Baetjer, of Baltimore, Md., and Thos. D. Thacher and Sanford H. E. Freund, both of New York City, of counsel), for defendants.

CHESNUT, District Judge.

These six cases present a number of different questions, but there is one which is common to them all. In each case the Government sues the Surety alone (without joining the Principal) on bonds executed by the principal and surety to guarantee compliance with the terms of permits issued by the Government for various stages in the production of industrial alcohol, and a particular product (lacquer thinner) manufactured therefrom. In each of the cases the claim of the Government is that some part of the industrial alcohol dealt in by the principals under the permits and which itself was tax free, was diverted to beverage uses and was therefore properly taxable. The point that is common to all the cases arises on the defendants' contention that the facts alleged in the several declarations (which are all similar) do not show a breach of any of the conditions of the bonds; or more particularly stated, that such diversion of non-taxable industrial alcohol to taxable beverage alcohol, as is alleged in the declarations, occurred not by act of the principal in the bonds to whom the permits were issued, but by acts of third parties after the obligations of the bonds had been fully complied with by the principal with respect to tax-free alcohol.

The facts alleged in these cases by the Government in support of its charge of diversion of alcohol from tax-free to taxable purposes, are quite similar to the claim in that respect made in United States v. U. S. Industrial Alcohol Company, in this court, in which two opinions on the pleadings have been written, one reported in 8 F.Supp. 179, and the other just recently filed 15 F.Supp. 784. In these opinions there was a somewhat extended review of the applicable statutes and judicial decisions. To avoid repetition it will be assumed that the reader hereof has familiarized himself with those two opinions. The cases differ, however, in that in the former case the Government's suit is against the taxpayer individually and directly "as the person responsible" for the taxes, while in the present case the suits are not directly against the alleged taxpayer but against the surety on the bonds. Therefore, in order to properly determine whether there has been a breach of the bonds some further reference in this case should be made to the statutory authority for the particular bonds. But before doing this it will be well to now state just how the question is presented by the pleadings.

In each declaration there are several separate counts. Each count is based upon a separate bond. There are five different forms of bonds but for the purposes of this case they fall into only two different types. One may be described as a "general compliance bond," and the other is the so-called "$2.00 bond." The conditions of the general compliance bond are in substance that the principal, who has applied for a permit to deal in industrial alcohol, will comply with all the terms of the permit and with all the applicable laws and regulations affecting liquor and will pay all taxes that may become due and all fines and penalties incurred or imposed. The "$2.00 bonds," however, contain the additional condition that for all tax-free alcohol diverted to taxable purposes or otherwise unaccounted for, the principal shall pay at the rate of $2.00 per wine gallon, and the bond did not specifically otherwise stipulate for the payment of taxes. In the counts based on this type of bond, the Government seeks to recover the specific $2.00 rate only and treats it as taxes. But in the counts based on the general compliance bonds the Government seeks to recover, also as taxes, on some counts at the rate of $6.40 per proof gallon of diverted alcohol and in other counts, the so-called basic tax rate of $1.10 per gallon. In all cases, therefore, it is the Government's contention that what is recoverable under the bonds are unpaid taxes. In contrast therewith the defendants say that what is sought to be recovered in all cases (with the possible exception of the $1.10 rate) are penalties only, and further with reference to the $2.00 rate, it is contended that the penalty was inserted in the bond without statutory authority.

The questions now before the court in these cases are directly presented by the Government's demurrer to the defendants' pleas of limitations. But the common question above referred to is presented to the court under the familiar Maryland rule of pleading that a demurrer at any stage of the case searches the record and mounts to the first error in pleading which in this case is said to lie in the several declarations in that they fail to state a case showing liability on the bond. Here it should be said that when the suits were first filed the defendants promptly interposed demurrers to each of the declarations. After hearing counsel these were respectively overruled, "without prejudice." The principal point urged in support of the demurrers to the declarations at that time (and the only point except as to the counts on the $2.00 bonds) was that the amounts sued for by the Government were penalties rendered unenforceable by the Twenty-first Amendment. As to the $2.00 bonds, additional grounds of demurrer were assigned, one including the general insufficiency of the declarations, but the point most stressed was the lack of authority for the $2.00 provision in the bond. As the subject matter was both novel and complex, in view of the extended statutory history and Treasury Regulations, and as there was other pending litigation thought possibly to involve similar points, the demurrers were overruled without prejudice, because I did not feel satisfied that the whole subject matter had been exhausted in the arguments then submitted, and the expression "without prejudice" was intended to indicate it was desired to more maturely consider the whole question of legal liability at a later stage of the cases. These further questions, particularly the common point above mentioned, have now been largely discussed by counsel in connection with the demurrers now before the court, the plaintiff's counsel having been notified in advance of the oral argument that the sufficiency of the declarations would again be attacked on the ground indicated. Both sides have submitted extended briefs, the plaintiff submitting four separate briefs consecutively, and the defendants' counsel having submitted three separate briefs. The question as to the effect of the Twenty-first Amendment repealing National Prohibition has, however, not been further reargued.¹

Plaintiff's counsel makes the technical point of pleading that, as the defendants have filed general issue pleas, (in general denial of liability) in this case in addition to the special pleas now demurred to, the rule of pleading which otherwise permits a general demurrer to mount to the first error is not applicable. Authorities are cited in support of this from some other state jurisdictions but it is clear that such limitation does not exist in Maryland practice. Gusdorff v. Duncan, 94 Md. 160, 166, 50 A. 574; Parks v. Griffith & Boyd Co., 117 Md. 494, 498, 499, 83 A. 559; Poe on Pleading and Practice, vol. I, § 706, p. 732 (Tiffany's Edition). The point also overlooks the fact that the original demurrers to the declarations were overruled without prejudice which meant, of course, that permission was given to revive the contention at a later stage of the cases. And in addition it may be pointed out that it would be a waste of time and expense to permit the parties to prepare for and undergo what is foreshadowed to be a very lengthy trial if the court is convinced that the declarations as drawn are not sufficient to permit recoveries from the defendants of the sums sued for.

Before stating just what is charged in the declarations as constituting diversion of tax-free alcohol, it will help to an understanding of the matter if reference is made to the statutory background for the bonds. It is to be borne in mind that for many years prior to, during and subsequent to National Prohibition, there has been a Government tax (the so-called basic tax) on distilled spirits including, of course, ethyl alcohol. For the period here involved (1929-1930) this was at the rate of $1.10 per proof gallon, (approximately $2.00 per wine gallon for the alcohol here involved). This tax was imposed by the Revenue Act of Feb. 26, 1926, c. 27, § 900, 44 Stat. 104, 26 U.S. C.A. § 245 (1926 Ed.) (see 26 U.S.C.A. § 1150 note). For convenience the applicable sections are quoted in the margin.² But also prior to, during and after National Prohibition, Congress, to promote the industrial arts, legislated to make alcohol for industrial purposes, as distinct from beverage purposes, tax free, under regulations, however, meticulously designed to prevent diversion from one purpose to another, and to protect the revenue, and doubtless also during the era of National Prohibition to discourage violations of law. This policy of Congress with respect to industrial alcohol began as early as 1894.³ A more important act on the subject was the Act of June 7, 1906, c. 3047, 34 Stat. 217, commonly known as the Denatured Alcohol Act. 26 U.S.C. A. (1926 Ed.) §§ 481 and note, 485, 486 (see 26 U.S.C.A. §§ 1320 (a) and note, 1322, 1323). Quite parallel legislation was contained in chapter 3, title 3, of the National Prohibition Act of October 28,...