United States v. Van Schaack Bros. Chemical Works

• Decision Date: 31 July 1940
• Docket Number: No. 43062.,43062.
• Citation: 33 F. Supp. 822
• Parties: UNITED STATES v. VAN SCHAACK BROS. CHEMICAL WORKS, Inc., et al.
• Court: U.S. District Court — Northern District of Illinois

33 F. Supp. 822

UNITED STATES v. VAN SCHAACK BROS. CHEMICAL WORKS, Inc., et al.

No. 43062.

District Court, N. D. Illinois, E. D.

April 24, 1940.

Petition for Rehearing Denied July 31, 1940.

COPYRIGHT MATERIAL OMITTED

Wm. J. Campbell, Dist. Atty., of Chicago, Ill., Samuel O. Clark, Jr., Asst. Atty. Gen., and Andrew D. Sharpe, Frederick G. Rita, and Paul Mickey, Special Assistants to the Atty. General, all of Washington, D. C., for the United States.

Collins, McKenna & McCullough, of Chicago, Ill., for defendant.

HOLLY, District Judge.

The defendant, Van Schaack Bros. Chemical Works, Inc., as principal, and the defendants, United States Guarantee Company, as surety, on April 21, 1927, made, executed and delivered to plaintiff a bond in the penal sum of $100,000. The obligation of the bond was as follows:

"Whereas, the above-bounden Principal has made application for the issuance of a permit to use specially denatured alcohol, under regulations issued pursuant to Title III of the National Prohibition Act, in the manufacture of articles enumerated in the application (Form 1479) submitted herewith, or in any such applications subsequently filed, and for which specific approval has been given, the said alcohol so denatured to be obtained from denaturing plants or bonded dealers' storerooms established under law and regulations made pursuant thereto.

"Now, therefore, the condition of this obligation is such that if there be no material false statement in the application for such permit, and the said principal shall not violate the terms of such permit, and shall transport, store and use such denatured alcohol in accordance with the law and regulations made pursuant thereto, and shall in all respects fully and faithfully comply with all provisions of law now or hereafter enacted and all regulations promulgated thereunder respecting such transportation, storage and use, and shall pay for all such denatured alcohol illegally or unlawfully diverted, lost, or unaccounted for in violation of such permit and law and regulations at the rate of $4.50 per wine gallon, and in addition thereto shall pay all penalties and fines imposed, then this obligation to be void; otherwise to remain in full force and virtue."

Several permits were issued during the ensuing years. The two pertinent to this suit dated March 25, 1929, and December 2, 1929, respectively, were both expressly conditioned upon the observance by the Van Schaack Bros. Chemical Works, Inc., of "all the laws of the United States relating to the manufacture, taxation, and control of, and traffic in, intoxicating liquors, (and) all regulations made pursuant to laws which are now, or may hereafter be in force." The one which became effective on December 2, 1929, further provided:

"8. That the sale of thinners, solvents and ethyl acetate manufactured under this permit is restricted to only those corporations, firms, or individuals which use these products for their own manufacturing purposes, and only in quantities according to their own requirements and not in any event for resale as such.

"In the event of sales of thinners, solvents or ethyl acetate by the permittee to jobbers, wholesalers, or dealers the permittee guarantees to assume all responsibility for all sales by the jobbers, wholesalers, or dealers."

In count I of its amended complaint filed herein on May 4, 1936, the United States alleges in substance that during the period commencing September 30, 1929, and ending June 30, 1930, the defendant, Van Schaack Bros. Chemical Works, Inc., purchased 727,977.5 wine gallons of specially denatured alcohol, Formula 2-3; that of this amount 697,141.5 wine gallons were employed in the manufacture of ethyl acetate; that the said specially denatured alcohol had been produced for industrial use in compliance with Title III of the National Prohibition Act, 27 U.S.C.A. § 71 et seq., and regulations promulgated thereunder; that this statute exempted distilled spirits applied to legitimate industrial purposes and rendered unfit for consumption as a beverage from the basic tax of $1.10 per proof gallon imposed by Revenue Act 1926, § 900(3), 26 U.S.C.A.Int. Rev.Acts; that between October 10, 1929, and June 16, 1930, the defendant Van Schaack Bros. Chemical Works, Inc., sold to various concerns a total of 2,973,763.9 pounds of ethyl acetate, the manufacture of which required 249,336.6 wine gallons of specially denatured alcohol, Formula 2-B containing 467,619.7 proof gallons of distilled spirits on which no tax had been paid; that the plaintiff had been induced to permit the defendant Van Schaack Bros. Chemical Works, Inc., to acquire the said specially denatured alcohol by the false representation that it was to be employed only for legitimate industrial purposes; that the fact was that the defendant, Van Schaack Bros. Chemical Works, Inc., manufactured and sold the said 2,973,763.9 pounds of ethyl acetate with the "design, knowledge and intent" that the purchasers thereof, "and other persons" would recover the distilled spirits therein contained for beverage purposes; that, in other words, the production and sale of ethyl acetate was a step in a fraudulent scheme for the diversion of distilled spirits in the said 249,336.6 wine gallons of specially denatured alcohol, Formula 2-B to beverage uses and for the evasion of the aforesaid basic tax; that the latter was imposed upon the distiller or importer but, as pointed out above, was waived in the case of industrial alcohol; that by reason of the fraudulent conduct of the defendant, Van Schaack Bros. Chemical Works, Inc., the plaintiff lost and was deprived of the revenue to which it was entitled on 467,619.7 proof gallons of distilled spirits at the rate of $1.10 per proof gallon, or a total of $514,381.67; that the defendants became indebted in damages to the plaintiff in that amount; that, however, recovery must be limited to the maximum penal sum of the land which is $100,000.

The second and last count reiterates the same facts but presents an entirely different theory of damages. One of the conditions of the bond was that the principal "pay for all such denatured alcohol illegally or unlawfully diverted, lost or unaccounted for in violation of such permit and law and regulations at the rate of $4.50 per wine gallon * * *". Under this clause the plaintiff claims the defendants to be obligated to it as follows: "249,336.6 wine gallons specially denatured alcohol, Formula 2-B, diverted to beverage uses at $4.50 per wine gallon ($1,122,014.70 but limited to the amount of the bond) $100,000." Seventeen alleged defenses are advanced in the answer of the defendants. Their subsequent amended answer raises several additional questions of fact and attempts to impugn the legal validity of that portion of the permit issued on December 2, 1929, which is quoted above. A motion to strike filed by the plaintiff on January 6, 1939, seeks the elimination of section 8 of paragraph I, paragraphs II to XIV, inclusive, section 3 of paragraph X, and paragraphs XVI and XVII of the answer. The scope of this opinion is restricted to the disposition of this last pleading.

Counsel for the defendants have condensed their numerous contentions into the following eight points:

"1. The bond does not cover the payment of taxes.

"2. The use by the permittee of all specially denatured alcohol withdrawn by it under its permit in the manufacture of ethyl acetate, the product authorized by the permit, is in full compliance with the bond and permit.

"3. Neither the bond nor the permit covers sales of ethyl acetate.

"4. No taxes could be assessed against permittee for alleged diversion to beverage purposes under the statute mentioned in the amended complaint.

"5. No assessment of taxes was made against permittee within four years, and the amended complaint filed May 4, 1936, seeking to recover loss of taxes was filed more than four years after the alleged taxes became due and payable, and the action is therefore barred by the statute of limitations.

"6. The amended complaint, in so far as it seeks to recover penalties, is barred and unenforceable by reason of the repeal of the Eighteenth Amendment to the Constitution.

"7. The claim for so-called taxes and the $4.50 unit rate are all penalties asserted under authority of the Eighteenth Amendment to the Constitution.

"8. The inclusion of paragraph 8 in the permit (dated December 2, 1929) was without legal authority and not binding upon either of the defendants."

These defenses will be considered in the order enumerated, but the second and third will be treated as one.

First. To understand the legal effect of the bond here in question, it is necessary to delve somewhat into the statutory background. Until 1894 distilled spirits destined for industrial processing were subject to the same basic tax as those intended for consumption as a beverage. In that year, however, Congress for the first time provided for a rebate of the tax to any "manufacturer finding it necessary to use alcohol in the arts, or in any medicinal or other like compound." Act of Aug. 27, 1894, C. 349, sec. 61, 28 Stat. 509, 567. This legislation was repealed in 1896. After a lapse of ten years, Congress enacted a much more important and comprehensive statute known as the Denatured Alcohol Act, 34 Stat. 217, 26 U.S.C.A.Int.Rev.Code §§ 3070, 3072, 3073. This authorized the withdrawal of alcohol for industrial purposes from bonded ware houses without the payment of the basic tax, and empowered the Commissioner of Internal Revenue to prescribe such regulations as he deemed expedient and essential to prevent fraudulent diversion of distilled spirits to beverage uses and a consequent loss of revenue. As a means to that end, persons withdrawing alcohol tax-free under this Act were required to keep such records and post such bonds as the Commissioner, with the approval of the Secretary of the Treasury, might direct.

The substance...