DeFord v. Commissioner , 19 B.T.A. 339 ( 1930 )

UNION C. DEFORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DeFord v. Commissioner

Docket No. 28483.

United States Board of Tax Appeals

19 B.T.A. 339; 1930 BTA LEXIS 2419;

March 20, 1930, Promulgated

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Union C. DeFord, Esq., pro se.

John D. Kiley, Esq., for the respondent.

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VAN FOSSAN

This proceeding is for the redetermination of a deficiency of $326.78 in income tax for the year 1922.

The question presented is whether or not 100 shares of the Ohio Leather Co. owned by petitioner became worthless in 1922.

FINDINGS OF FACT.

The Ohio Leather Co. was incorporated on March 18, 1901, pursuant to the laws of the State of Ohio. It was engaged in the manufacture of leather products and its principal place of business in the State of Ohio was in Youngstown. At the end of 1922 there was outstanding $1,610,200 of preferred stock and $1,423,400 of common stock of the corporation, each share having a par value of $100.

The company was successful in its business operations up to about August, 1919, at which time it began to incur serious losses because of a large shrinkage in the inventory value of its raw materials and in the price of its manufactured articles. At the close of the year 1920 the corporation's books disclosed a deficit in the sum of $2,070,778.18. During 1921 the directors of the company formed a corporation for the purpose of loaning additional working capital to the Ohio Leather Co., and by use of this additional capital the deficit was reduced slightly so that at the end of 1921 it amounted to $1,941,446.11.

On December 10, 1921, the petitioner purchased in the open market 100 shares of the common stock of the Ohio Leather Co. at $19.50 a share. In August, 1922, an audit was made of the affairs of the company by a certified public accountant. In December, 1922, certain of the directors of the company, preferred and common stockholders, and certain individuals who were not stockholders in the Ohio Leather Co., together with the Youngstown Securities Co. as "syndicate manager," entered into an underwriting agreement for the purpose of furnishing new and additional capital to and reorganizing the Ohio Leather Co. under the no-par value stock law of the State of Ohio. In this underwriting agreement it was recited that the Ohio Leather Co. was indebted to various banks in the sum of $2,345,500, which indebtedness would mature for payment "and must be paid or secured to be paid on February 15, 1923," and that the said company, in addition to the funds necessary to liquidate said indebtedness, was in urgent need of additional working capital with which to prosecute its business successfully.

It was agreed in said underwriting agreement, among other things, that the Ohio Leather Co. would reorganize under the no-par value stock law of the State of Ohio with a capitalization of $1,500,000 7 per cent debenture notes, $1,500,000 of 8 per cent cumulative first preferred stock with a par value of $100 per share, $1,000,000 of 7 per cent cumulative second preferred stock with a par value of $100 per share and 75,000 shares of no-par value common stock. It was agreed that the $1,500,000 of 7 per cent debenture notes should be used or applied in the reduction of the bank indebtedness. It was further agreed that the preferred stockholders of the Ohio Leather Co. should each be assessed $50 on each share of their preferred stock and in return should receive for each share of preferred stock held by them one-half of one share of new 8 per cent first preferred stock, one-half of one share of new 7 per cent second preferred stock and one share of no-par value common stock. It was also provided that, on the company's reorganization, the old preferred stockholders who did not exchange their stock on the basis referred to should receive one-fifth of one share 7 per cent second preferred stock for each one share of the old preferred stock held by them. It was further provided in the said underwriting agreement that the holders of the outstanding shares of common stock should be assessed $20 on each share held by them and upon payment of such assessment should receive in exchange for each share of common stock two shares of the no-par value common stock presently to be issued by the reorganized company. The underwriting agreement also contained provisions for the distribution among the parties thereto of the proposed new stock not taken by old stockholders. The petitioner was one of the stockholders who signed the underwriting agreement subscribing for both preferred and common stock of the reorganized company.

At the end of 1922 there was no market for the common stock of the Ohio Leather Co. Some so-called "wash" sales of the common stock were made in order to establish a loss for income-tax purposes but there were no bona fide sales.

The corporation's financial condition of December 31, 1922, is shown by the following condensed financial statement, based on an audit made by certified public accountants:

ASSETS
Real estate, plant and equipment		$695,306.85
Prepaid interest, insurance, and expense		45,721.33
Inventory, raw stock, work in process and
finished leather		1,786,947.84
Accounts and notes receivable		789,496.43
Cash		315,799.74
		3,633,272.19
LIABILITIES
Capital stock - common		1,423,400.00
Capital stock - preferred		1,610,200.00
Notes payable		2,345,500.00
Accounts payable		160,326.00
Reserve for discount and taxes		34,157.83
Reserve for Federal taxes		78,256.90
Reserve for contingencies		75,000.00
Loss for year	-90,606.65
Deficit	-2,002,961.92
		2,093,568.57
		3,633,272.19

The income-tax return for 1922 filed by the corporation stated as the total deficit for the year 1922 the sum of $2,093,568.57, which corresponds with the amount of total deficit stated in the foregoing condensed financial statement.

On February 9, 1923, the president of the Ohio Leather Co. addressed and sent to the stockholders of the company a letter relating to the financial condition of the company and its proposed reorganization under the no-par value stock law of the State of Ohio. In this letter the president of the Ohio Leather Co. stated, among other things, as follows:

Commencing with December 31, 1919, this company, due to the rapid decline in the market price of its raw materials and finished products, has charged off $2,659,497.00. As a result of this, the surplus account of the company was entirely wiped out, the value behind the common stock entirely wiped out, and about 40% of the value behind the preferred stock wiped out. In other words, according to our statement to-day, the preferred stock has assets behind if of about $60.00 per share, and the common stock has no assets whatever behind it. This very heavy loss on the raw material and manufactured product of the company was caused, as above stated, by a rapid decline in the market prices thereof, which was not anticipated or expected by either the leaders in the leather industry, and was suffered in common by all other companies in the leather industry. While, as above stated, the assets back of the preferred stock, as shown by our present statement, amount to approximately $60.00 per share, it must be remembered that this is true only if the company is to remain a going concern. If it is not, but is to be liquidated, it is possible that upon liquidation, the value back of the preferred stock would be entirely wiped out and the creditors of the company would receive less than the full value of their claims.

The president's letter stated further that $2,345,500 was due banking creditors of the company on notes maturing February 15, 1919, and that if the company was to continue a going concern enough new money must be put into it to reorganize it adequately.

The letter asserted in substance that less new capital could be secured from the common stockholders than from the preferred stockholders because the common stockholders had "nothing to save." The president thereupon proceeded to outline in said letter the same plan of reorganization set out in the underwriting agreement before referred to, except that the president stated that the proposed debenture notes were to bear 6 per cent interest. He stated that the shares of common stock would be assessed $20 per share and that "common stockholders paying this assessment will receive two (2) shares of no-par value common stock for each one share of present common stock held by them." The president of the company also stated in the letter that the proposed plan of reorganization, if successfully carried into effect, would, in addition to providing $1,500,000 worth of debenture notes to be used to pay off banking creditors, furnish the company with $1,100,000 worth of new capital.

As reasons for urging stockholders to take part in the proposed reorganization which was recommended by the president and board of directors of the company, the president made the following statement:

Your board of directors feel that it is very much to the advantage of the stockholders that the company be saved and maintained as a going concern. In the nineteen years, from 1901 to 1919, inclusive, the Company made average earnings per year upon its common stock of 17.7%, notwithstanding a loss of $200,000.00 taken in 1911. In the eight years from 1912 to 1919, inclusive, it made average earnings per year of 29.4% on the common stock. It has a well equipped plant, its product is well and favorably known, and its management, in the opinion of the Board of Directors is efficient. Furthermore, it is engaged in a basic business, because its products are a common necessity and must continue to be. Mr. Lumbard, our Vice President, has developed a new product, which has met with favor in the trade, and the company is now operating practically at the capacity of 1,000,000 feet of finished leather per month.

With respect to the stock issue, the proposed reorganization was carried out in the manner stated in the underwriting agreement and recommended in the president's letter. The new stock was issued and delivered to persons subscribing therefor in amounts proportionate to their subscriptions and as a result approximately $1,100,000 new capital was put into the treasury of the Ohio Leather Co.

On March 21, 1923, the petitioner received from the Ohio Leather Co. a document, of which the following is a copy, acknowledging receipt for a subscription covering his holdings of 110 shares of the old common stock of the company.

We are in receipt of your subscription covering your present holdings of 110 shares of the common stock of this Company. Under this subscription you will be required to make the following payments:

Apr. 1, 1923	$550
July 1, 1923	550
Oct. 1, 1923	$550
Jan. 1, 1924	550

Any or all of these payments may be anticipated, if you so desire.

Please forward your check to the Dollar Savings & Trust Company, Youngstown, Ohio, by April 1st, delivering with it, properly endorsed, the certificates of stock which you now hold. As soon as possible thereafter receipts covering your payments will be forwarded to you.

THE OHIO LEATHER CO.

The petitioner thereafter delivered to the company his par value common stock for cancellation, paid in full the assessment of $20 per share on the 110 shares of the old common stock held by him and received two shares of the new no-par value common stock for each share of his old stock. At the time of the hearing he still owned the no-par value common stock in the reorganized company.

At the time the underwriting agreement referred to was entered into and up to the time, namely, about March 21, 1923, when the petitioner made a subscription covering his holdings of old common stock, the right to subscribe for the no-par value common stock had no market value. Persons other than stockholders were parties to the underwriting agreement and persons who were neither holders of the old common stock, nor parties to the underwriting agreement were offered and subscribed for new common stock in the reorganized company at the price of $20 for two shares of the no-par value common stock.

In his income-tax return for the year 1922 the petitioner deducted the sum of $1,923 as representing a total loss in 1922 on the 100 shares of the common stock of the Ohio Leather Co. purchased by him in December, 1921. The respondent disallowed the deduction.

OPINION.

VAN FOSSAN: The sole question for our decision is whether or not 100 shares of the common stock of the Ohio Leather Co. owned by the petitioner in 1922 became worthless in that year.

We think it is apparent from the facts that at the end of 1922 the stock in question was valueless. The statement of the corporation's financial condition as of December 31, 1922, disclosed that at that time there was common stock outstanding of the par value of $1,423,400, and that there was a total deficit of $2,093,568.57. The equity of the common stockholders in the assets, therefore, was wholly extinguished. If at that time the corporation had been liquidated there would have been nothing to be distributed among the common stockholders. The common stock had a market value of $19.50 per share in December, 1921, but in December, 1922, the facts concerning the financial condition of the company had become public knowledge, and there was no market for the said stock. The only known sales of common stock at that time were "wash" sales made for the purpose of establishing a loss.

Under the plan of reorganization initiated in December, 1922, and later substantially carried out, the preferred stockholders not paying the assessment on their stock were to be given a fractional share of the new second preferred stock, but if a common stockholder failed to pay the assessment of $20 per share on his common stock he would have no interest in the company when reorganized. The reason for this discrimination against the common stockholder is clear. The preferred stockholders still had a considerable equity in the assets of the company, but, as the president of the company stated in his letter of February 9, 1923, referred to in the statement of facts, the common stockholder had "nothing to save." Moreover, it appears that in December, 1922, and up to the time the reorganization of the Ohio Leather Co. was carried out, the right of the common stockholders to exchange one share of common stock for two shares of the new no-par value common stock upon payment of an assessment of $20 had no market value. It also appears that persons not then common stockholders could and did subscribe for and receive two no-par value shares in the reorganized company at the price of $20 for the two shares. It follows that at the end of December, 1922, and subsequently, ownership of the par value common stock of the company conferred no benefit or valuable privilege with respect to the reorganization of the Ohio Leather Co.

For the foregoing reasons it is our opinion that it is established that the 100 shares of the Ohio Leather Co. common stock in question in this proceeding became worthless in 1922. The deduction claimed in petitioner's return for 1922 on account of such loss is allowed.

Decision will be entered for the petitioner.