Court Opinion

ID: 9446025
Source: CourtListenerOpinion
Date Created: 2023-08-03 21:44:17.022582+00
Date Added: 2024-06-11T17:30:29.825887
License: Public Domain

MOORE, Circuit Judge.
I dissent. The assumption of the majority that mere “naked contract rights” form the basis of this transaction is, in my opinion, contrary to the undisputed facts and the law applicable thereto.
The only question involved upon this appeal is whether the sum of $500,000 paid by Russell to Pittston on October 14, 1949 for which Russell “acquired all *349of our [Pittston’s] right and interest in and to the agreement dated January 25, 1944 between us,” should be taxed as a long-term capital gain or as ordinary income. The answer to this question depends upon a precise analysis of the rights and interests then existing between the parties.
In 1944 Russell held a lease on certain real estate in Pike County, Kentucky. In order to enable it to install a coal mining plant thereon Pittston, pursuant to a contract with Russell dated January 25, 1944, agreed to loan Russell $250,000 to be advanced in such amounts as required for “the installation by it of a coal mining plant, and for the operation thereof” (Exh. 1-A). Pittston was given the right to designate a director or directors to the extent of one-third of the board and Russell’s expenditures of the proceeds of the loan had to be approved by him or them. Restrictions were placed upon the payment of salaries to Russell’s officers and the use of net earnings. Notes evidencing the loan were to be secured by a mortgage upon the lease and structures to be placed upon the property. At the same time Russell and Pittston made a second contract whereby Russell agreed to sell to Pittston “all of the coal which shall be mined and sold for resale from the mining plant or plants which the Seller expects to install or does install upon its leased property in Pike County, Kentucky, as set forth in the agreement executed simultaneously herewith,” i. e., the loan agreement, for a period of ten years. Ten cents per ton was to be deducted by Pittston from all coal sold “pursuant to the coal sales agreement entered into simultaneously herewith” to be applied on the loan. By reason of these provisions the $250,000 loan was repaid by the end of 1948.
Thus, the business arrangement between these companies was not confined to a “naked contract right” (as the majority holds) to buy coal but was an integrated transaction whereby Pittston financed the construction of a coal mining plant on Russell’s leasehold and agreed to take the entire output, f. O. b. the mine, for ten years with conditional extension possibilities. The two simultaneous agreements, each referring to the other, evidenced the transaction. These contract rights can only be rendered “naked” by stripping from them and discarding the raiments which the parties found to be essential. To say that Russell despite its commitment could sell to anyone responding only in damages on the assumption that similar coal could have been obtained elsewhere (as to which there is no proof in the record) is, first, to suggest that these companies would not honor their mutal obligations and, second, that the courts in view of the investment of Pittston in the Russell operation and the nature of the agreement (entire output for a period of years) would restrict relief to damages. “Contracts for the delivery of goods will be specifically enforced, when by their terms the deliveries are to be made and the purchase price paid in installments running through a considerable number of years” (Eastern Rolling Mill Co. v. Michlovitz, 157 Md. 51, 145 A. 378, 383). Specific performance is particularly applicable to a contract “to continue over a period of years without rigidity of price” (Hunt Foods v. O’Disho, D.C.N.D.Cal.1951, 98 F.Supp. 267, 270, a contract to sell to plaintiff defendant’s entire peach crop for a period of five years at prices to be fixed by a Canning Association). See also Michigan Sugar Co. v. Falkenhagen, 243 Mich. 698, 220 N.W. 760 (a contract to sell entire output of sugar beets grown in a given area — specific performance decreed against vendor); Pittenger Equipment Co. v. Timber Structures, 189 Or. 1, 217 P.2d 770.
The mutual rights and obligations created by these two agreements were most substantial. Russell as effectively deprived itself of any other use of its property for ten years as the owner of a building granting a leasehold for ten years to a tenant who had loaned the money to construct it. Russell could only regain for itself the unrestricted use of its property by a surrender by Pittston *350tantamount to the voluntary termination of a leasehold prior to the expiration date. Pittston, in turn, not only had an investment in Russell’s lease, plant and equipment but had a property right to acquire the entire output of the Russell mine which proved to be a right of substantial value.
Nor can the $500,000 payment be regarded as anticipated income for the five remaining years of the contract. As the majority concede, the large amount paid bears no relationship to future income projected on the basis of the gross income realized by Pittston for the previous five and one-half years. Pittston’s income was not assured or guaranteed; it was entirely dependent upon its ability to conduct its business operations at a profit. The $500,000 paid was the value to Russell to get its property back and also represented Pittston’s opinion of the contract’s worth. If the contract were assigned to a third party there would be no question that the consideration received would reflect the value of the asset sold. Yet for all practical purposes Pittston by such assignment would thereby have terminated or cancelled its right to purchase coal from Russell.
In endeavoring to find a guide as to the type of transaction which will be con-trued as resulting in a capital gain as distinguished from ordinary income, the decisions reveal uniform consistency in holding that the surrender, termination or cancellation for monetary consideration of a capital asset results in a capital gain. Neither the petitioner nor the majority assail the correctness of the Tax Court’s conclusion that the contract right here was in itself a capital asset. For this reason I must disagree with the majority that “the termination of the right-duty relationship between the two parties” results in ordinary income to the taxpayer; particularly since they concede that “the same might be said of the termination of the lessee’s or life tenant’s rights” which clearly produces a capital gain. Judge Goodrich noted the fallacy of this approach when he wrote “To call the transaction a cancellation or termination of a lease and not a sale is, we think, to assume the point to be decided.” Commissioner of Internal Revenue v. Golonsky, 3 Cir., 1952, 200 F.2d 72, 73. In Golonsky a tenant had surrendered possession of leased premises prior to the expiration of the lease upon the payment of a sum of money. Holding this to be a capital gain the court said “Undoubtedly there is a cancellation of the lease when the tenants voluntarily surrender the premises to a landlord in accordance with an agreement, but the fact that the cancellation occurs does not negative the fact, that the. transaction may constitute a sale.”
Searching for a firmer support, an attempt is made to find in the words “substance” or “substantial rights” whether a capital asset is involved and then give uniform treatment regardless of whether the asset is “sold” or “terminated.” Prior to the decision of the majority in this case there seemed to be consistency among the various Courts of Appeals in applying .this test. In 1950 the Tenth Circuit (Jones v. Corbyn, 10 Cir., 1950, 186 F.2d 450) held that the surrender of an exclusive life insurance agency to an insurance company for a lump sum payment of $45,-000 was a long-term capital gain and not ordinary income. Answering the Collector’s argument that the contract was not a capital asset the court said “The contract or franchise had at all times substantial value. It was capable of producing income for its owner. It was enforceable at law and could be bought and sold” (at page 452). The court’s conclusion was that “By terminating the contract and transferring the business to the company, there was a sale and transfer of a capital asset within the meaning of the statute” (at page 453). In the Fifth Circuit a lessee merely surrendered to his lessor a restriction against renting any space in the block to a Variety Store for which surrender he received $20,000. Despite the fact that this was the surrender of only one of the many rights granted under the lease the court affirmed a decision of the Tax *351Court in holding the amount received to be a capital gain (Commissioner of Internal Revenue v. Ray, 5 Cir., 1954, 210 F.2d 390). In the same year this Court in Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., 2 Cir., 1954, 210 F.2d 752, held that the payment of $22,500 to a lessee to vacate store premises to enable another tenant to occupy the space constituted a capital gain and affirmed a Tax Court decision to that effect. This Court agreed both with the Ray decision and the decision of the Third Circuit in Commissioner of Internal Revenue v. Golonsky, 3 Cir., 1952, 200 F.2d 72, certiorari denied 345 U.S. 939, 73 S.Ct. 830, 97 L.Ed. 1366. The court distinguished its previous decisions in Commissioner of Internal Revenue v. Starr Bros., Inc., 2 Cir., 1953, 204 F.2d 673, and in General Artists Corp. v. Commissioner of Internal Revenue, 2 Cir., 1953, 205 F.2d 360, certiorari denied 346 U.S. 866, 74 S.Ct. 105, 98 L.Ed. 376. The court felt that the surrender by the tenant and the cancellation and termination of his right to stay in possession “seems closer to those cases holding that gain derived by the holder of a life interest upon sale to the remainderman is to be taxed as a capital gain” (210 F.2d 752, 753) citing McAllister v. Commissioner of Internal Revenue, 2 Cir., 1946, 157 F.2d 235. In the same year the Third Circuit again considered a problem of the surrender of contract rights to the exclusive product of four machines in exchange for stock in Commissioner of Internal Revenue v. Goff, 3 Cir., 1954, 212 F.2d 875, 876, the Commissioner contending that the transfer of these rights constituted ordinary income relied on the Starr Bros, and General Artists cases in this Circuit but Judge Goodrich pointed out that “the last word on the subject in the Second Circuit is Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., [2 Cir.], 1954, 210 F.2d 752, which held that payment made by a lessor to a lessee so that he would vacate the premises was a capital gain.” He found that “[T]he Starr and General Artists decisions were distinguished on the ground that the rights therein involved were less substantial.” Referring to McCue Bros. & Drummond he recognized this decision as being “in aecord with the cases cited above, and we think it is right” but that “whether the Second Circuit cases are in harmony is not a matter for us to decide” (212 F.2d 875, 876). The court affirmed the Tax Court decision saying “there is certainly no doubt that the right that Saxon had to the exclusive product of these four machines was a substantial right and, if it is important, it was a right connected with the use of specific tangible property, that is, the machines themselves” (at pages 876, 877).
Legal rights should not be adjudicated by mere choice of words. “There surely cannot be that efficacy in lawyers’ jargon that termination or cancellation or surrender carries some peculiar significance vastly penalizing laymen whose counsel have chanced to use them” (McAllister v. Commissioner of Internal Revenue, supra, 157 F.2d at page 236). Moreover, here the parties did not even use the word “surrender” but said that Russell had “acquired all of our right and interest.” That “there was a ‘surrender’ to' the remainderman, rather than a ‘transfer’ to third persons * * * does not change the essentially dispositive nature of the transaction so far as the former property owner is concerned” (McAllister, supra, at page 237). So here Pittston had effectively disposed of its property interest. Whether by surrender or' transfer or acquisition the legal consequences should be the same.
“Setting the bounds to the area of tax incidence involves the drawing of lines which may often be of an arbitrary nature. But they should not be more unreal that the circumstances necessitate” (McAllister, supra, at page 237). Accepting as sound the proposition “that distinctions attempted on the basis of the various legal names given a transaction, rather than on its actual results between the parties, do not afford sound basis for its delimitation” (McAllister, supra, at page 237), what distinction *352should be applied here? Obviously, the $500,000 was not in “anticipation of income payments over a reasonably short period of time” (at page 237) because income was not assured. But even the surrender of life estates to the remaindermen has received consistent recognition by the courts as placing profit in the category of capital gains (Blair v. Commissioner of Internal Revenue, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465; McAllister, supra; Bell’s Estate v. Commissioner of Internal Revenue, 8 Cir., 1943, 137 F.2d 454). The suggestion of the majority that the lump sum payment of $500,000 was made “for tax avoidance purposes” and therefore should be considered as ordinary income would be equally applicable to the life estate surrender, leasehold cancellation and agency termination cases.
The Commissioner bases his argument almost exclusively on Commissioner v. Starr Bros., supra, which he asserts “is not distinguishable in any material aspect.” The majority finds the facts of the present case closer to those in Starr Bros, than in the cases involving the surrender of the insurance agency contract, the release of a covenant not to rent to a specific type of store, the surrender of a leasehold and a life estate.
To test the applicability of a decision relied upon as a precedent it is always useful to substitute the facts in a reciprocal manner. First applying the Pittston facts to Starr Bros., it would be necessary to assume that Starr Bros., a drug store in a city of some 30,000 population, had agreed to build a factory for the United Drug Company and to purchase its entire output of drugs and distribute them throughout the country for a period of ten years. Conversely, had Russell paid a small amount to Pitts-ton for the privilege of selling some of its coal to others while keeping its contractual relationship with Pittston otherwise in force then an analogous situation might have existed. The mere statement of these hypothetical situations, however, illustrates how lacking they are in factual similarity. The same is true of the General Artists case.
I cannot agree that the property rights created by the two agreements between Pittston and Russell were mere “naked contract right” but find them clothed not only with a mortgage interest in the Russell leasehold until the repayment of the loan but also with sufficient substance to justify specific performance. Nor do I think that the Starr Bros. case, [204 F.2d 674] which by the court’s own analysis was restricted to a small payment for “the taxpayer’s release of United’s negative covenant,” should be determinative or even persuasive here.
In no branch of the law is it more important that there be as much certainty as possible than in the field of taxes. Businessmen and < their corporations must often make decisions involving future plans and the expenditure of large sums of money upon the advice of counsel as to the tax consequences of the contemplated transactions. The decision of the majority in the present case injects an unwarranted inconsistency into this field. In my opinion the Tax Court correctly construed the decisions in this as well as the other circuits referred to and its judgment below should be affirmed.