Petition for Review from the United States Board of Tax Appeals.
Before WOOLLEY and DAVIS, Circuit Judges, and JOHNSON, District Judge.
Samuel F. Houston deducted a loss in his income tax return for 1920 as though sustained in that year. The Commissioner disallowed the deduction on the ground that there was not at any time a deductible loss, or, if such a loss in substance, it was not deductible because not sustained in that year and assessed a corresponding deficiency tax. The United States Board of Tax Appeals approved the action of the Commissioner. Thereupon Samuel F. Houston, by petition, brought the case here for review.
This is the outline of a case, exceptional in law because arising out of unusual circumstances, which, to understand the questions involved, must be stated at length.
The Real Estate Trust Company of Philadelphia closed its doors in the year 1906 because of financial embarrassment arising from misuse of its funds by Frank K. Hipple, its president, in financing projects of Adolph Segal, which consisted mainly in an attempt, through the Pennsylvania Sugar Refining Company, to contest the dominant position of the American Sugar Refining Company in the sugar trade. In this adventure the Trust Company became involved by accepting on its loans to Segal collateral of uncertain value and of a character that did not admit of ready liquidation. The Trust Company's affairs were further complicated by an unlawful withdrawal, with Hipple's permission, of collateral pledged on one of its loans to Segal and repledged by him as collateral for a loan of $1,250,000 made to him by Gustav E. Kissel. Included in this collateral were bonds and shares of the Pennsylvania Sugar Refining Company which had an importance beyond their money value because in connection with the loan there was an agreement between Kissel and Segal that until the loan was repaid, Kissel, or his nominee, should have the right to select four of the seven directors of the Pennsylvania Sugar Refining Company and that its refinery should not be operated.
It soon became apparent that the Trust Company's financial embarrassment amounted to positive insolvency in that its capital and surplus had been swept away together with much of its deposits.
George H. Earle, Jr., was appointed receiver. The situation was desperate. And this was so not only in respect to depositors but to the company itself, which had an extensive trust business, a substantial good will, and a valuable business location. It was plain that, if possible, these should be saved for all concerned. The receiver immediately looked about for ways to reorganize the company, calling upon the eleven directors, who were charged by some with financial responsibility and who themselves felt a moral responsibility in the premises. There also arose a question of double liability upon the common stock. To bridge the situation the directors offered their notes in the sum of $3,000,000 on which to raise money and operate the company until its capital and surplus should be repaired. As obligations of this character were regarded an unsound basis for the re-establishment of a banking institution, the plan fell through. Finally the receiver evolved a plan -- the one ultimately carried out -- wherein each depositor should be paid one-third of his deposits in cash and in lieu of the balance he should be given shares of preferred stock of the company, especially issued for that purpose, and the Board of Directors should raise a fund, informally called the "guaranty fund," to which they should contribute $2,500,000 in cash and securities "to restore the present supposed capital and surplus." The character of the "guaranty fund" or of the directors' "contributions" will develop as we go along.
At the time of its failure the Trrst Company held what became known as the "Segal securities," or, because of a necessary generalization, the "Segal matters," which designation included not only securities and transactions in the name of Adolph Segal but also other transactions brought about by him or in which he, in some way, directly or indirectly, was interested or had been concerned, aggregating about $5,300,000 and then having a value, so far as any one could guess, somewhere between $300,000 and $775,000. In these Segal matters, that is, among the Segal intangibles, was a claimed right of action against and a hoped-for substantial recovery from the American Sugar Refining Company in a proposed suit for damages under the Sherman Anti-Trust Law (15 USCA §§ 1-7, 15). Perhaps as an inducement to the directors, or certainly by a representation made to them, the receiver's plan contemplated that all "Segal matters," tangible and intangible, should be retained by, and should constitute a part of the assets or capital of, the Trust Company, subject only to the provisional payment to the contributors to the guaranty fund to be stated presently, and that it should be administered by its receiver, and later by itself, to realize an amount which would make the capital and apparent surplus whole, stated at $3,000,000, and that any excess of moneys realized and of profits earned thereon should, "from time to time, be paid said contributors in proportion to the amounts by them respectively contributed."
The eleven directors contributed to the guaranty fund in varying sums until finally it amounted to $2,505,000.
Samuel F. Houston, on a basis of 512 shares, contributed $755,000.Of this amount, he contributed $305,000 personally on his individual share holding; he contributed $200,000 on behalf of his sister, Sallie H. Henry; and the balance on behalf of his mother and another sister.
All this was done under a formal agreement between the Trust Company and the contributing directors bearing date October 24, 1906, the stockholders assenting.
With this fund and with relief from paying the depositors more than one-third of their deposits, the Trust Company opened its doors. George H. Earle, Jr., its previous receiver and its newly-elected president, proceeded immediately to liquidate the Segal matters. Suit under the Sherman Anti-Trust Law (15 USCA §§ 1-7, 15) was instituted against the American Sugar Refining Company for triple damages -- $10,000,000 -- on the ground that Kissel, as agent for the American Sugar Refining Company, had made a contract with Segal in restraint of trade. This suit was compromised in 1910, and in 1911 or 1912 most of the other assets, with one very important exception, had been cleared up. That one -- the major asset -- was the Trust Company's interest in the Pennsylvania Sugar Refining Company, represented by 7,268 of its shares. Just what the Trust Company did in the business of the Pennsylvania Sugar Refining Company during the intervening years is not clear. At all events it held its stock, and its stock acquired a value.
In 1915 a difference of opinion arose among the contributors to the fund as to their rights in the Segal assets which resulted in an opinion by John G. Johnson, Esquire, evidently acquiesced in by all parities, indicating that the whole title to the Segal assets was vested in the Trust Company, to be handled and liquidated solely within its discretion conformably with honesty and intelligent judgment; and that all the contributors had in the ...