United States v. Morris & Essex R. Co.

• Decision Date: 07 May 1943
• Docket Number: No. 240.,240.
• Citation: 135 F.2d 711
• Parties: UNITED STATES v. MORRIS & ESSEX R. CO. et al.
• Court: U.S. Court of Appeals — Second Circuit

135 F.2d 711 (1943)

UNITED STATES v. MORRIS & ESSEX R. CO. et al.

No. 240.

Circuit Court of Appeals, Second Circuit.

May 7, 1943.

Frederick M. Schlater, and DeForest & Elder, all of New York City (Robert D. Elder and Frederick M. Schlater, both of New York City, of counsel), for Morris & Essex Railroad Company et al.

Edwin M. Slote, of New York City, for appellant Dryfus.

Frank J. Dufficy and Mathias F. Correa, U. S. Atty., both of New York City, for appellee.

Before L. HAND, SWAN, and FRANK, Circuit Judges.

L. HAND, Circuit Judge.

This is an appeal from an order, enjoining the Delaware, Lackawanna & Western Railroad, from making any further payments to the shareholders of the Morris & Essex Railroad Company which fall due as rent under a lease of its railroad to the Lackawanna. The facts which are undisputed are as follows: In 1868 the Morris & Essex leased its property of every kind for the duration of its charter to the Lackawanna, in consideration of a semi-annual direct payment to the lessor's shareholders of "interest at the rate of seven per cent per annum, upon the par value of said stock." (To this there was later added a contingent payment of one per cent, later reduced to an absolute promise to pay three quarters of one per cent). The lessee assumed all the debts of the lessor, and agreed to pay "all taxes and assessments * * * levied or assessed on any of the property hereby granted, leased, or demised, or on the business or any of the business, done on or with the said property, or on the income or profits of the said business"; it also granted a right of reentry to the lessor for breach of the covenant just mentioned. Since the beginning of the lease, the lessee has regularly paid to the lessor's shareholders the amounts reserved, and has incorporated an express agreement to do so in their certificates. The only possible income of the lessor is the payments themselves and the lessee's further promise to pay any income taxes "on the income or profits of the said business." The Treasury assessed income taxes against the lessor for 1933-1941, inclusive, based upon the amount of both promises. Neither the lessor nor the lessee having paid these taxes, the United States brought this action against both, praying judgment that the lessee be restrained from paying any dividends to the shareholders until the collector can levy upon them, and that after such levy, the lessee pay all dividends to the plaintiff until all arrears of income taxes have been extinguished. Three shareholders have intervened in the suit in their separate interests. The plaintiff moved for a temporary injunction on the authority of our decision in United States v. Warren Railroad Company, 2 Cir., 127 F.2d 134, which the judge held to be controlling; he also thought that the situation was also within United States v. Joliet & Chicago Railroad Co., 315 U.S. 44, 62 S.Ct. 442, 86 L.Ed. 658, and United States v. Long Island Drug Co., 2 Cir., 115 F.2d 983. The defendants then appealed.

If the lessor be regarded as a jural person separate from the shareholders, the order was clearly wrong. On that view the taxes levied against the lessor were not levied against the shareholders; and the property of the shareholders — their claims against the lessee — was their property and not the lessor's. It would be plainly unlawful for the lessor's creditor to seize property of the shareholders, who are not its debtors, to pay the lessor's debts. Moreover, if that be the right way to look at the lease, the lessor has never had any income to tax, for the only income which can be attributed to it is the dividends payable to the shareholders, and perhaps the promise to pay the income taxes themselves. On the other hand, if those payments can be imputed to the lessor as income so that an income tax can properly be imposed upon them, it must follow that they are available to satisfy the tax; for it would be absurd at once to hold that the dividends were the lessor's income for the purpose of assessing a tax against it, but were the shareholders' income for the purpose of collecting that very tax. We start therefore with the premise that, if the shareholders are to be identified with the lessor in one aspect, they must be in the other; and now it has been authoritatively decided that such guaranteed dividends, though payable directly to the shareholders, are income of the lessor and may be taxed as such. United States v. Joliet & Chicago Railroad Co., 315 U.S. 44, 62 S. Ct. 442, 86 L.Ed. 658. The reason for this is clear. The shareholders did not disband as a group, or dissolve the corporation; they could not, for they needed it for the future. If they had done so, they would have become shareholders or creditors of the lessee which would not have served their purpose; the lessee might default, and they would then wish to retake their railroad, for whose operation a corporation would be essential. For these reasons ...