Gilt Edge Textile Corp. v. Commissioner

Gilt Edge Textile Corporation, Formerly Gilt Edge Silk Mills of New Jersey, Petitioner, v. Commissioner of Internal Revenue, Respondent Gilt Edge Textile Corp. v. Commissioner Docket No. 10447 United States Tax Court 9 T.C. 543; 1947 U.S. Tax Ct. LEXIS 86; September 30, 1947, Promulgated *86 Decision will be entered for the petitioner. In 1929 petitioner made a loan of $ 30,000 to an estate of which petitioner's president was a coexecutor. In 1931 the estate was in a precarious financial condition and, in order to enable petitioner to collect its debt, its president arranged for the purchase by petitioner from the estate of certain shares of stock, with the debt to be credited against the purchase price. Several years later the heirs and legatees and the other executors of the estate brought suit against petitioner's president, claiming mismanagement rendered the estate insolvent and alleging that the $ 30,000 payment in 1931 was a preference. The chancery court entered its final decree in the action in 1942, ordering the defendant to repay the $ 30,000 as an alleged preference. Petitioner issued its check for $ 30,000 to its president, and he endorsed and delivered it to the estate. Held, petitioner is entitled to deduct $ 30,000 as a loss under section 23 (f), I. R. C. William Surosky, Esq., for the petitioner. John E. Mahoney, Esq., for the respondent. Arundell, Judge. Hill, J., dissenting. Turner, Disney, Kern, and Opper, JJ., agree with this dissent. ARUNDELL *543 The respondent determined a deficiency of $ 13,348 in petitioner's income tax for 1942. On brief, respondent has conceded error on his part as to two minor adjustments made in determining the deficiency. That leaves for consideration the question whether petitioner is entitled to a deduction under section 23 of the Internal Revenue Code for an amount of $ 30,000 paid out by it in the taxable year under the circumstances hereinafter appearing. FINDINGS OF FACT. The petitioner, Gilt Edge Textile Corporation, formerly Gilt Edge Silk Mills of New Jersey, is a corporation of the State of New Jersey, with*88 principal office at Paterson. Its return for the year involved was filed with the collector of internal revenue for the fifth district of New Jersey. On June 15, 1929, Minnie Spitz, Jacob Spitz, and Philip Dimond became duly qualified executors of the estate of Louis Spitz, deceased. Philip Dimond served as such executor until July 31, 1942, when by a decree of the Orphans' Court of the County of Passaic, New Jersey, he was discharged as such executor, leaving Minnie Spitz and Jacob Spitz as remaining executors and trustees after that date. Dimond was at all times from June 8, 1929, to June 8, 1943, president, treasurer, and a director of the petitioner. In the taxable year he owned 53.58 per cent of the stock of petitioner. *544 In 1929 petitioner made a loan of $ 30,000 to the estate of Louis Spitz and received the estate's note in that amount, dated October 31, 1929, payable one month from date. The note was not paid at maturity, but a renewal note dated November 30, 1929, and payable on demand, was substituted. Interest was paid on the note from time to time. In February 1931 the estate of Louis Spitz was experiencing some financial difficulties, and petitioner was worried*89 about the collection of its loan. Dimond and another officer of petitioner discussed the matter; and Dimond, acting on behalf of petitioner, arranged for it to purchase certain shares of stock from the estate at an agreed price, with the loan to be collected as part of the transaction. On or about February 16, 1931, petitioner gave its check to the estate in the amount of $ 91,927.50 in payment for 1,313 1/4 shares of stock in Quebest Investing Co. at $ 70 a share, and at the same time the estate gave petitioner its check for $ 31,140 in payment of the $ 30,000 note and accrued interest of $ 1,140 thereon. Several years later the heirs and legatees of Louis Spitz and the other executors of the Spitz estate commenced a suit against Dimond, alleging, among other things, that the estate was rendered insolvent by Dimond's mismanagement and that the payment of $ 30,000 in 1931 constituted a preferential payment. Six separate causes of action were set forth in the complaint, alleging various acts of mismanagement. The $ 30,000 item here involved was covered in the first cause of action. The second cause of action claimed a loss to the estate of $ 250,000 through Dimond's failure to*90 allow the sale of pledged stock to pay debts of the estate. In the third cause of action claim was made for a loss of $ 231,312.04 as a result of Dimond's involving the estate in certain stock-trading pools. The fourth cause of action alleged a loss of $ 1,500,000 through Dimond's failure to liquidate marketable securities in the declining stock market. In the fifth cause of action complainant Jerome Spitz, one of the heirs of Louis Spitz, claimed conversion of trust funds in the amount of $ 48,997.13 held by the estate for his benefit. Complainant Minnie Spitz, in the sixth cause of action, made claim for $ 15,000 of insurance proceeds due to her and allegedly used by Dimond to pay debts of the estate. Although the petitioner was not made a party defendant in the suit, it was named in the bill of complaint as one of the parties who had gained; and petitioner employed counsel to represent its interests in the outcome of the litigation, paying him a fee of $ 5,000 for legal services in that connection. Dimond also employed other counsel to represent him. After the suit had been pending for some time, the several parties entered into a stipulation in settlement and, pursuant thereto, *91 on *545 July 31, 1942, the New Jersey Chancery Court entered its final decree in the suit, ordering Dimond, inter alia, to: * * * pay or cause to be paid in cash to Minnie Spitz and Jacob Spitz, as remaining executors and trustees under the last will and testament of Louis Spitz, deceased, over, above and in addition to any commissions to which he, as executor of said Estate, might be entitled, the following amounts, namely: (a) $ 30,000.00, by way of return to the Estate of Louis Spitz, deceased, of, and in payment of any liability by reason of, the allegedly preferential repayment by defendant as Executor, in February, 1931, of a loan to the Estate in that amount, as complained of in paragraph 13 of the first cause of action of the amended amended bill of complaint. (b) $ 20,000.00, in payment of any liability to the Estate of Louis Spitz, deceased, predicated on any careless or negligent action of the defendant in connection with any matters or things (other than those referred to in succeeding subsection (c)) alleged or referred to in the second cause of action of the amended amended bill of complaint. (c) $ 20,000.00, in payment of any obligation to the Estate *92 of Louis Spitz, deceased, by reason of the acquisition by defendant from Linray Investment Co. of 6,300 shares of Hahn Department Stores, Inc. stock, complained of in paragraphs 12, 13 and 14 of the second cause of action of the amended amended bill of complaint, and his retention, as owner thereof, of said shares and any present or future proceeds thereof, and any right or interest of the Estate of Louis Spitz, therein and thereto. (d) $ 10,000, in payment of any liability to the Estate of Louis Spitz, deceased, predicated on any careless or negligent action by the defendant in connection with any matters or things alleged or referred to in the third cause of action of the amended amended bill of complaint. (e) $ 20,000.00, in payment of any liability to the estate of Louis Spitz, deceased, predicated upon careless or negligent action by defendant in connection with any matters or things alleged or referred to in the fourth cause of action of the amended amended bill of complaint, and also in satisfaction and discharge of any other possible claim of any kind or nature of the estate of Louis Spitz, deceased, and of the executors and trustees thereof, and of all of the complainants, *93 against defendant, except as limited in paragraph 3 hereof. The fifth and sixth causes of action were dismissed with prejudice. The decree also ordered all the complainants in the suit to execute general releases in favor of Dimond, Gilt Edge Silk Mills, and Quebest Investing Co., and ordered Dimond, individually, to execute general releases to all the complainants and to cause to be executed and delivered general releases from Gilt Edge Silk Mills and Quebest Investing Co. to the complainants. With respect to the $ 30,000 involved in paragraph (a) of the decree, petitioner's officers believed that, since Dimond had acted in its interests in securing payment of the debt due it from the estate and had received no personal benefit therefrom, petitioner was obligated either to repay the money or to reimburse Dimond. On July 30, 1942, with *546 the consent and approval of Irving Abrash, the secretary and a director of petitioner since 1929, petitioner issued its certified check to Dimond in the amount of $ 30,000; and he in turn endorsed and delivered it to the remaining executors of the estate of Louis Spitz and their counsel. Dimond paid the remaining $ 70,000 ordered by the court*94 with respect to the other causes of action and fully satisfied the provisions of the decree. The releases called for by the decree, running from the petitioner to the estate and the other complainants, were duly executed and delivered. In its return for the taxable year petitioner claimed deduction for the $ 30,000, which respondent disallowed. OPINION. Respondent disallowed the claimed deduction of $ 30,000 on the ground that it was a payment made to satisfy a personal liability of Philip Dimond. It appears from the evidence before us, however, that the item in question originated as an interest-bearing loan from petitioner to the estate of Louis Spitz in 1929. Philip Dimond, petitioner's president, was also a coexecutor of the estate. In 1931, when it appeared that the estate was having financial difficulties, Dimond, acting in petitioner's behalf, sought to obtain repayment of the loan from the estate to petitioner by arranging for the petitioner to purchase from the estate certain shares of stock in Quebest Investing Co. Although separate checks were exchanged, the net effect of the transaction was that petitioner took credit upon the purchase price of the stock for the debt*95 owing to it from the estate and paid the estate the cash difference. Later, in the suit brought against Dimond by the heirs and legatees of Louis Spitz and the other executors of the Spitz estate, it was alleged that the $ 30,000 payment constituted a preference. The final decree of the chancery court entered pursuant to a stipulation of the parties in settlement of the suit ordered Dimond, among other things, to repay or cause to be paid in cash the $ 30,000 by way of return to the estate of Louis Spitz. Petitioner thereupon issued its check to Dimond in that amount and he in turn endorsed it to the estate. Dimond paid the remaining $ 70,000 called for by the decree in connection with the second, third, and fourth causes of action. In view of these circumstances, we think respondent's disallowance of the deduction of $ 30,000 claimed by petitioner was improper. Two of the complainants in the suit were contending that they were preferred creditors of the estate. If all the facts alleged in the complaint could be proved, it may well be that petitioner, as the recipient of a preferential payment, could have been legally compelled to make *547 direct restitution to the estate. *96 It may also be that other liabilities could have been asserted directly against the petitioner, based on its transactions with the estate. Apparently, petitioner considered that its risks of incurring losses were substantial, because it retained separate counsel and paid him a $ 5,000 fee to represent its interests in the outcome of the litigation. But whether petitioner could have been proceeded against directly and compelled to return the money to the estate is not, we think, controlling of the right to the deduction. Petitioner contends that it was legally obligated to reimburse Dimond for his loss when it later developed that he was answerable to the estate for the money he had collected for petitioner's benefit. There appears to be considerable merit in the contention, for, under the general principles of the law of agency, an agent is entitled to reimbursement from his principal for expenses and losses incurred in the course of the principal's business and to indemnity from liability to third parties arising from the agent's acts where the principal has received the benefit of such acts. See Bibb v. Allen, 149 U.S. 481, 498; Admiral Oriental Line v. United States, 86 Fed. (2d) 201, 202;*97 Irving Trust Co. v. Townsend, 1 Fed. Supp. 837; Restatement Agency, § 439; C. J. S., Agency, §§ 196, 197. Dimond was no less petitioner's agent in arranging for the collection of petitioner's debt merely because the same act, in his other capacity as executor, formed the basis of one of the liabilities asserted against him in the suit. And petitioner received the benefit of that act. Nevertheless, we need not rest our decision on a holding that petitioner, as principal, was legally liable to indemnify Dimond, as its agent. We have said before that even a moral obligation arising out of a business transaction will suffice to support a loss deduction. Herschel V. Jones, 1 B. T. A. 1226; Abraham Greenspon, 8 T. C. 431. The petitioner here was no mere volunteer. In equity and good conscience it was obliged to satisfy that part of the decree against Dimond calling for the repayment of the $ 30,000 to the estate. After making the payment, there was no possibility for petitioner to recover any part of it from the estate or the heirs, because, in exchange for releases from all the complainants, *98 petitioner executed cross releases to them. The payment in the taxable year marked the ultimate conclusion of the transaction entered into in 1929 and fixed the petitioner's loss. We think it fully qualifies for deduction as a loss under section 23 (f) of the code, and we so hold. Decision will be entered for the petitioner. HILL *548 Hill J., dissenting: It is my opinion that the record in this case discloses neither a legal nor a moral obligation on the part of petitioner to release its claim for debt against the Spitz estate. If it be assumed that petitioner was either legally or morally obligated to refund the $ 30,000 paid to it in 1931 in full settlement of its debt against the Spitz estate because such payment was improperly preferential to it as a general creditor, petitioner by such refundment was restored to its former status of a general creditor of the Spitz estate. As a general creditor, it had the legal right to payment of its debt proportionately with other general creditors out of assets of the estate available for payment to general creditors. It does not appear that there were no such assets. In fact, the contrary is indicated. After such refundment*99 was made by petitioner, neither the Spitz estate nor the creditors thereof, nor the heirs of Louis Spitz, deceased, had any claim or claims whatever against petitioner. The general releases by petitioner of claims against the above named parties were executed solely for the purpose of enabling Dimond, petitioner's president, treasurer, and controlling stockholder, to settle on a compromise basis for $ 100,000 actions for damages against him in the claimed aggregate amount of more than $ 2,000,000 for alleged negligence and mismanagement as executor of the Spitz estate. The pending action against Dimond did not involve any alleged liability of the petitioner to the complainants therein. Petitioner was not a party to the action and there is nothing in the record to indicate any obligation or duty, legal or moral, on the part of petitioner either to Dimond or to the complainants in the action to execute such releases. It does not appear that it was within the scope of petitioner's business to contribute to the payment or settlement of Dimond's obligations, nor does it appear that such contribution was a nonbusiness transaction entered into for profit. It does not appear that petitioner*100 was to be reimbursed by Dimond for releasing its claim of debt against the Spitz estate. If, however, a claim for such reimbursement did arise out of the transaction, there is no showing that Dimond was not financially able to discharge such obligation. Therefore, as I see it, under the facts of the case and the law applicable thereto, petitioner is not entitled either to the deduction claimed for a business or nonbusiness loss or to a deduction for bad debt.