Court Opinion

ID: 9455270
Source: CourtListenerOpinion
Date Created: 2023-08-04 19:17:15.591912+00
Date Added: 2024-06-11T17:34:32.106301
License: Public Domain

CELEBREZZE, Circuit Judge.
This is an appeal from a judgment of the United States District Court for the Western District of Kentucky against 15 taxpayers. In 1962, the Commissioner levied income tax deficiencies against the taxpayers, claiming that each had received a “constructive dividend” 1 in connection with the group’s purchase of the Lenk Manufacturing Company. Having paid the deficiencies the taxpayers brought suit for refund in the District Court. At the conclusion of the taxpayers’ evidence, the Court granted the Government’s motion for directed verdict.
In 1957 the Lenk Manufacturing Company [hereinafter “Lenk”] was a Kentucky corporation engaged in the manufacture of soldering irons and butane blowtorches, and the filling of aerosol cans. Colonel D. Allen Lenk, who shared 88.47% of the voting control of Lenk with certain members of his family and a private foundation, and Lenk’s president, Kenneth W. Burke, who shared 11.53% of the common stock with two other individuals, were at loggerheads as to policy matters concerning the corporation and the expenditure of its funds. Burke believed that unless Lenk kept abreast of its competitors by committing funds to expansion, Lenk would have no future.
Fully aware of Burke’s desire to expand the business, in May, 1961, Colonel Lenk indicated that he, his family and foundation [hereinafter the “Lenk Group”] would be willing to sell their interest in Lenk to Burke and his associates [hereinafter the “Burke Group”]. Before he could consider purchasing the Company, Burke required assurance that he could raise the capital necessary to purchase Lenk, whose net worth at the time was about $500,000. Precision Valve Corporation [hereinafter “P.V.C.”], one of Lenk’s suppliers, offered a $250,000 loan. P.V.C. was willing to lend to the Lenk corporation, *912rather than to the Burke Group, because Lenk could increase P.V.C.’s sales and provide it with adequate security for repayment.
On October 20, 1961, Burke mailed the following letter to Colonel Lenk:
[LETTERHEAD FOR THE LENK MFG. COMPANY]
Franklin, Kentucky October 20, 1961
Mr. D. Allen Lenk 12 Ferncroft Road Newton (Waban), Mass.
Dear Mr. Lenk:
In order that I may have an Offer and Acceptance in writing, confirming our oral agreement in Boston on October 13, 1961, to submit to the lending agency which will help finance the transaction, I am asking that you and other stockholders of The Lenk Mfg. Company of Franklin, Kentucky, named below confirm the agreement by signing the Acceptance of the following Offer:
I will pay $100.00 per share for the preferred stock and $120.66 per share for the common stock of The Lenk Mfg. Company now owned by you, the Lenk Foundation, Mortimer Lenk, Burton D. Lenk, and Manuel Nizel as follows:
D. Allen Lenk — 1881 shares preferred and 915 shares common
Lenk Foundation — -950 shares preferred
Mortimer Lenk — 220 shares preferred and 125 shares common
Burton D. Lenk — 220 shares preferred and 12 shares common
Manuel Nizel — 125 shares common
The prices for the shares are based on a total value of $550,000.00 for all outstanding shares of preferred and common stock.
You will continue to receive your pension of $125.00 per week for the remainder of your life.
It is my intention to complete this transaction not later than January 31, 1962.
Respectfully,
(s) Kenneth W. Burke
ACCEPTANCE
We, the undersigned, hereby accept the foregoing Offer, and agree to sell and properly deliver our shares of stock of The Lenk Mfg. Company to Kenneth W. Burke and his associates, free of any claim for distribution of earnings, upon being tendered $100.00 per share for our preferred stock and $120.66 per share for our common stock in accordance with said offer. This 3rd day of November, 1961.
(s) D. Allen Lenk Lenk Foundation By (s) D. Allen Lenk, Trustee (s) Mortimer Lenk (s) Burton D. Lenk (s) Manuel Nizel
It is noteworthy that Lenk’s attorney, Mr. Crow, acting for Burke, drafted both the “Offer” and the “Acceptance,” neither of which was in any way modified by the Lenk Group.
On November 3, 1961, having signed the “Acceptance,” the Lenk Group returned it to Burke. The testimony of the parties was that the sole purpose of this letter was to provide P.V.C. with a tangible basis for its offer of a loan; not to create an agreement between the signatories. The taxpayers also point out subsequent letters and safeguards which were built into the sale transaction which they argue would have been unnecessary had there been a firm commitment on the part of the Lenk Group to sell its stock.
Colonel Lenk would not permit the use of Lenk’s name by any new corporation until the Lenk Group had received its money; and he did not want to “get involved” in liquidating Lenk. Burke, therefore, found it necessary to create Franklin Manufacturing Company to act as a holding company for the capital to *913be used by the Burke Group to purchase Lenk. In addition, since the Burke Group still lacked $300,000 of the $550,-000 purchase price, assuming the P.V.C. loan could be consummated, Franklin could be used as a vehicle to attract subscription capital to raise part of that sum.
Franklin was duly incorporated on January 12, 1962. To its capital, Burke and 18 other subscribers contributed $155,000, in exchange for stock in Franklin. Burke and two other Lenk shareholders contributed their 11.43% voting and preferred stock (total value: $66,-996) to the capital of Franklin, in exchange for stock in Franklin.
P.V.C. had, by this time, consummated its $250,000 loan to Lenk, which Lenk would then make available to Franklin for the purchase transaction.
Still lacking the necessary capital, Franklin negotiated an $80,000 loan from Lenk to be used by Franklin to purchase the Lenk Group’s shares.
The mechanics of the transfer included the deposit of the $155,000 contribution and the $80,000 loan to a bank account opened by Franklin. The $250,-000 loan from P.V.C. to Lenk was deposited to the account of Franklin by an escrow agent. Simultaneously with the deposits, Franklin was required to draw certified checks to each member of the Lenk Group, these checks being given to the escrow agent. The escrow agent then exchanged the certified checks for the stock of the Lenk Group, which was can-celled only after the P.V.C. loan was secured by a mortgage on Lenk’s physical assets. Franklin was issued new certificates, and Lenk became Franklin’s wholly-owned subsidiary.
On January 27, 1962, Franklin merged downstairs into Lenk, pursuant to Kentucky statute, and on January 31st, Franklin, having been organized only 19 days earlier, went out of existence.
After the merger, Lenk assumed the debts of Franklin. At all times herein relevant, Lenk had earnings and profits of $327,752.
In the ordinary “bootstrap” acquisition, the purchaser recognizes no income where he purchases a corporation from which the seller has withdrawn any of the post-1913 earnings and profits. Ray Edenfield, 19 T.C. 13 (1952). See generally, B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, § 7.25 (2d ed. 1966 & 1969 Supp.). However, where the purchaser personally obligates himself to buy the whole corporation, and uses part of the corporation’s assets or capital to discharge his obligation, he receives a constructive dividend to the extent of the liabilities so assumed by the corporation, provided the corporation has sufficient earnings and profits. Wall v. United States, 164 F.2d 462 (4th Cir. 1947). Thus, a finding of dividend equivalency is required where the following elements coexist: First, a personal obligation of the taxpayers to purchase the corporation ; second, a discharge by the corporation, out of its earnings and profits, of the taxpayers’ personal obligation.
The question of dividend equivalency is one of fact, requiring thorough analysis of the facts and circumstances of each case. H. S. D. Co. v. Kavanagh, 191 F.2d 831 (6th Cir. 1951); Rheinstrom v. Conner, 125 F.2d 790 (6th Cir. 1942); Commissioner v. Champion, 78 F.2d 513 (6th Cir. 1935). Nevertheless, where both the facts and the inferences to be drawn therefrom point so strongly in favor of one party that reasonable men could not come to a different conclusion, a verdict should be directed.
“When the evidence is such that without weighing the credibility of the witnesses there can be but one reasonable conclusion as to the verdict, the court should determine the proceeding by non-suit, directed verdict or otherwise in accordance with the applicable practice without submission to the jury, or by judgment notwithstanding the verdict. By such direction of the trial the result is saved from the mischance of speculation over legally unfounded claims.” Brady v. Southern *914Ry. Co., 320 U.S. 476, 479-480, 64 S.Ct. 232, 234, 88 L.Ed. 239 (1943).
See generally, Moore, Federal Practice § 50.02 [1] (1968 ed.).
The holding of the District Court was warranted only if reasonable minds could not differ: (a) that the October 20 “Offer” from Kenneth W. Burke to the Lenk Group, and the signed “Acceptance” of the offer of “Kenneth W. Burke and his associates” which was returned on November 3, established a personal obligation on the part of the Burke Group to purchase the stock of the Lenk Group; and (b) that the Lenk Corporation discharged the taxpayers’ obligations for them.
With respect to the first issue, the taxpayers argue that the October 20 letter was not intended to create a contractual obligation, but was solely intended to provide P.V.C. with evidence of Lenk’s willingness to sell, in order to “firm up” P.V.C.’s offer of a loan. Insofar as members of the Lenk Group testified to the same effect, the taxpayers argue that the question of whether the October 20 letter and the November 3 acceptance created a contractual obligation on their part to purchase the Lenk Group’s stock was a question of fact that should have been submitted to the jury. In the alternative they argue that if the letter did establish a personal obligation, only those taxpayers who knew of or were involved in the transaction prior to October 20 were bound. We cannot agree.
The October 20 letter, and the acceptance, contain offer and acceptance, identify the parties, subject matter, price, and time for performance. That letter is the only document in evidence which purports to memorialize an agreement for sale of stock totaling nearly half a million dollars. The subsequent performance of the parties breathed life into this document by executing it in full. If all the taxpayers had wanted was evidence for P.V.C. to firm up its offer, they could have obtained a letter of intent from the Lenk Group. This would have given rise to no obligation to purchase. They could have secured an option to purchase or a unilateral offer to sell from the Lenk Group. This would have given rise to no obligation to purchase. See Holsey v. Commissioner, 258 F.2d 865 (3d Cir. 1958). They could have inserted a clause into the letter indicating that it was assignable. That would have given rise to no personal obligation under the facts of this case. Arthur J. Kobacker, 37 T.C. 882 (1962) (Acq.).
From a reading of the record, particularly as to what transpired prior to the October 20 letter, we believe that letter created a personal obligation on the part of the Burke Group.
Several of the taxpayers herein became involved in this transaction after the October 20-November 3 contract was entered, having subscribed for stock in Franklin after December 4,1961. Nevertheless, from a reading of the record, reasonable minds could not differ that Burke, prior to the incorporation of Franklin, was negotiating on their behalf. As Mr. Dodd, one of the taxpayers testified:
q. * * * Franklin Manufacturing Company never even came into existence until January the 17th, the day you wrote your check?
A. That’s correct.
Q. So prior to that, [Burke and his accountant] could not have been representing Franklin, could they?
A. No.
Q. They must have been representing somebody other than Franklin. Who were they representing, do you know?
A. The people who originally, later became the stockholders of Franklin Manufacturing Company.
Burton Lenk, one of the sellers, testified that Burke’s associates were consulted at each stage of the negotiations, even before October 20:
Q. Now, at the October 13th meeting, this is October 13th, 1961, meet*915ing, which you attended with Mr. Burke, your father and Mr. Nizel, was Mr. Burke told the price that your father would be willing to sell?
A. Yes, he was.
Q. A price basis?
A. Yes, he was.
Q. And he mentioned one other thing that your father and you and your brother wanted?
A. Yes, this was, he wanted — he was told about the pension that would continue for the rest of my father’s life for $125 a week.
Q. Now, was there anything else discussed or said or agreed to in this meeting of October 13th?
A. No, sir. Ken indicated that he would have to go back to his people and see what he could do, he could not make any — could not make any commitment at that meeting.
Q. Did he tell you why he could not or would not make any commitment?
A. Well, I know he didn’t have the money, that was mentioned at the time, and just, he just kept saying, T will have to go back and discuss it with my people. I don’t know what to say.’
From this and other testimony, and each of the taxpayers’ signatures on the escrow agreement, it is clear that even those taxpayers who were not parties to the October 20-November 3 contract ratified it as a matter of law.
Having found that each of the taxpayers was personally obligated, as a matter of law, on the October 20-Novem-ber 3 contract, we now turn to the issue whether or not Lenk discharged the taxpayers’ personal obligation for them, thereby generating a constructive dividend. Sections 302 & 301, Internal Revenue Code of 1954, 26 U.S.C. §§ 302, 301.
The taxpayers argue that Franklin existed as a de jure corporation, that it was the purchaser in form as well as substance, Arthur J. Kobacker, 37 T.C. 882 (1962); Cromwell Corp., 43 T.C. 313 (1964); Princess Coals, Inc. v. United States, 239 F.Supp. 401 (S.D.W.Va. 1965), and that the October 20-November 3 contract made by them was in their capacity as agents of Franklin, John A. Decker, 32 T.C. 326, aff’d by order, Commissioner v. Decker, 286 F.2d 427 (6th Cir. 1960).
Franklin’s tax return indicated that during its 19-day existence it had no gross receipts; no money came into the corporation by way of doing business. Franklin had no expenses; it had no employees, thus paid no salaries to employees; it paid no salaries to officers; it engaged in no industrial or commercial activity whatever; it kept no stock certificate book, and issued no stock certificates. Although no taxpayer testified that he was subscribing for stock in Lenk directly, most freely admitted subscribing to Franklin, never expecting to receive Franklin stock, as a means of acquiring stock in Lenk. On cross-examination, Mr. Lashlee, one of the taxpayers, put it this way:
Q. And you used Franklin as a means to [acquire the Lenk stock] ?
A. As a matter of a vehicle to get our moneys together was my interpretation of it, sir.
Taxpayer Endress testified:
Q. What made you decided to [buy Franklin stock].
A. Because I knew that they were going to try to buy the Lenk Mfg. Company and if they were successful in doing so, I thought it would be a good investment.
Q. Based upon what you knew about Lenk?
A. Based upon what I knew about Lenk and the people that were running Lenk, yes.
Q. It was the purpose of that group to obtain control of the Lenk Corporation, is that right?
A. To buy it yes.
Q. To buy it, right?
A. Right.
*916Q. Did you have any other purpose in investing in Franklin Mfg. Company, other than the fact that Franklin Mfg. Company would be used to purchase Lenk Mfg. Company?
A. I had no other reason.
Q. No other reason. You never re-received any stock in Franklin Mfg. Company, did you ?
A. No, I didn’t expect to.
Q. The only stock you got was in Lenk?
A. Lenk, right.
Kenneth W. Burke testified:
Q. * * * Was .there any business reason for creating Franklin, other than as some of the plaintiffs have testified, a device by which this could be accomplished?
A. I believe I testified, Mr. Fain, that the Franklin Mfg. Company had to be established because this was the only method that could be developed to satisfy the desires of Colonel Lenk and his group to sell their stock or for the purchase.
******
Q. Well, let’s take it up to the point of the merger then. [Was there] any business reason other than accomplishing this desired end [the purchase of Lenk] for the creation of Franklin, without considering which would survive the merger?
A. You mean was there any other business purpose?
Q. Right.
A. No, sir.
We find that Franklin’s only function was to act as a conduit for the purchase of Lenk with a substantial amount of Lenk’s own funds, and, as such, it was merely a corporate extension of the acquiring shareholders’ personalties. Cf. Commissioner v. Court Holding Company, 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981 (1945). In view of our disposition of this case it is unnecessary for us to consider the de jure character of Franklin, the legitimacy of the merger, or the valid business reasons of the taxpayers for wishing to purchase Lenk. The discharge of the Burke Group’s personal obligation by Franklin, using a substantial amount of Lenk's funds, resulted in a constructive dividend of $327,752.
We reject, as have other Circuits, the Government’s contention that the taxpayers in this case have received any more substantial “economic benefit” than they would have had this transaction assumed some other form. See, e. g., Holsey v. Commissioner, 258 F.2d 865 (3d Cir. 1958).
The judgment of the District Court is affirmed.

. Section 301, Internal Revenue Code of 1954, 26 U.S.C. § 301.