*104 Decisions will be entered under Rule 50.
Finance company sold all of its assets under written agreements which provided that $ 37,000 of the total purchase price of $ 187,200 was allocated to covenants not to compete. Seller contends that said agreements were a nullity because its corporate resolution was in fact a prior written contract of sale with no covenant; because said resolution did not authorize sales to the buyers who in fact acquired; and (alternatively) because the written agreements were procured by fraud so that covenants were not in fact sold. Seller concedes that its reserve for bad debts is includable in income in the year all its assets were sold, but contends such reserve must be reduced by the difference (loss) between the sales price of its receivables and their book value. Held: Seller's resolution contemplated the execution of the written agreements which contained the covenants and other definitive provisions of the sales and said agreements were the sales contracts. Buyers who in fact acquired were wholly owned by the corporation named as buyer in seller's corporate resolution, and also seller ratified by acceptance of the benefits under the written*105 agreements, therefore the sales under the written agreements were in fact consummated. Held, further, there was no fraud under Virginia law and the amounts allocated to the covenants were in fact paid for them. Held, further, seller failed to prove any loss on sale of its receivables and in any event such a loss could not be used to offset a balance in a reserve for bad debts account.
*544 Respondent has determined deficiencies in petitioner Radford Finance Co.'s (hereinafter sometimes referred to as Radford) Federal income taxes as follows:
| Year | Deficiency |
| 1961 | $ 435.26 |
| 1962 | 281.21 |
| Jan. 1, 1964, to May 30, 1964 | 14,038.04 |
*545 *106 Respondent has also determined transferee liability against individual Radford shareholder-petitioners as follows:
| Docket No. | Petitioner | Liability |
| 4715-66 | John T. Dodson | $ 14,754.51 |
| 4716-66 | Ralph Patrick | 12,768.91 |
| 4717-66 | Carey A. Stone | 12,768.91 |
| 4718-66 | James P. King | 14,754.51 |
Concessions have been made by the respective parties so that only the following two issues remain for our consideration:
Whether $ 29,600 and $ 7,400 amounts received by Radford in connection with the sale of its assets represented payments for goodwill or for a covenant not to compete, and the amount of Radford's reserve for bad debts which is includable as ordinary income in the year of sale of its outstanding notes receivable. The individual petitioners concede that to the extent of their respectively determined liabilities, they are liable as transferees for any deficiency in Radford's Federal income taxes.
FINDINGS OF FACT
Some of the facts have been stipulated and they are so found. Only those facts relevant to the determination of the items remaining in issue are set out below.
Radford Finance Co., a Virginia corporation, had its principal office at 206 First Street, Radford, Va., when*107 its petition herein was filed. Its Federal income tax returns for the years in issue were filed with the district director of internal revenue for the district of Virginia.
Prior to its dissolution, Radford operated a small loan business with its principal office in Radford, Va. A second office was located in Blacksburg, Va. From its inception, Radford's president, John T. Dodson (hereinafter sometimes referred to as Dodson), was its president and general manager.
In January 1964, Radford had reached a hiatus in its operations. At that time, the company was providing its shareholders a substantial return on their investment and its 10 directors (who were also its sole shareholders) realized that to insure Radford's continued success additional capital was needed in its operations. Rather than invest additional capital themselves, the directors decided to sell the company's business to a third party. As a result of this decision they authorized Dodson to commence negotiations with potential purchasers of the corporation's assets.
Dodson proceeded to contact Kersey, a representative of Piedmont Finance Corp. Piedmont Finance Corp. and Piedmont Finance of Staunton, Inc. (hereinafter*108 sometimes referred to as the Piedmont corporations), at that time were Virginia corporations wholly owned by Interstate Finance Corp. (hereinafter sometimes referred to as *546 Interstate Finance or Interstate), an Indiana corporation. Subsequently Dodson negotiated with Eldo Taylor (hereinafter sometimes referred to as Taylor), an officer of Interstate, with regard to a bulk sale of Radford's assets.
On or about February 4, 1964, Taylor and Kersey examined Radford's accounts and, based on that examination, offered Dodson between $ 137,000 and $ 175,000 for its notes receivable and further offered to employ Dodson for 1 year at $ 1,000 per month. Since Dodson had been advised that it was to Radford's Federal income tax advantage to sell the entire business in bulk rather than piecemeal, he informed Taylor that any offer would have to include all of Radford's assets. In addition, he told Taylor that he felt that all amounts paid in connection with the sale should be for Radford's benefit, not his individually. Dodson then stated that the company's directors would entertain an offer of between $ 185,000 and $ 190,000. Eventually the parties agreed on the amount of $ 187,200*109 for Radford's assets but both contemplated the subsequent execution of a written agreement.
On February 21, 1964, Carl Bosecker (hereinafter sometimes referred to as Bosecker), general counsel for Interstate, sent Dodson copies of a proposed agreement regarding Radford's disposition of its assets to Interstate's subsidiaries, whereby Piedmont Finance Corp. and Piedmont Finance of Staunton, Inc., would purchase the Radford office and the Blacksburg office, respectively. Interstate could not purchase Radford's assets itself, as it was not authorized to do business in Virginia. The cover letter reads as follows:
INTERSTATE MANAGEMENT CORPORATION
Post Office Box 59 Harrison 36261
Evansville 6, Indiana
February 21, 1964Via Air Mail
Mr. John T. Dodson
Station ARadford, VirginiaDear Mr. Dodson:
Enclosed herewith are copies of a proposed Purchase Agreement whereby the receivables, furniture and fixtures, etc. of the Radford office of Radford Finance Company will be sold to Piedmont Finance Corporation. Also enclosed is a copy of the Purchase Argeement whereby the receivables, furniture, fixtures etc. of your Blacksburg office of Radford Finance Company will*110 be sold to Piedmont Finance of Staunton, Inc.
Please examine these and if there are any necessary changes, please discuss them with Mr. Taylor or me. We will be in contact with you by long distance telephone on Monday afternoon February 24, 1964.
*547 We also will have prepared necessary copies of corporate resolutions authorizing and directing the sale of these receivables and will also have the appropriate Bills of Sale.
Very sincerely,
(S) Carl E. Bosecker
Carl E. Bosecker
General Counsel[Longhand] 405 Sycamore St.
Evansville, Ind.
CEB: mm
Encs.
On February 25, 1964, Bosecker and G. Garland Wilson (hereinafter sometimes referred to as Wilson), Radford's attorney, and also one of its shareholder directors had a telephone discussion regarding the proposed sale and pursuant to that discussion sent each other the following letters:
February 25, 1964
Mr. G. Garland Wilson
Attorney at LawChadwick BuildingRadford, VirginiaDear Mr. Wilson:
I am forwarding herewith copy of the Bill of Sale to be used by Radford Finance Company in selling the receivable of its Radford office to Piedmont Finance Corporation, and a copy of the Bill of Sale to permit Radford Finance*111 Company to sell the receivables at its Blacksburg office to Piedmont Finance of Staunton, Incorporated. These copies are forwarded for your information and examination in accordance with our long distance telephone conversation of this date.
I am also in the process of making the changes agreed upon to the respective purchase agreements.
Very sincerely,
(Signed) Carl E. Bosecker
Carl E. Bosecker, General Counsel
CEB: mm
Encs.
cc: Mr. John T. Dodson
206 First St., Chadwick Bldg.
Radford, Virginia
Eldo Taylor, V.P. & Director of Operations (Virginia)
February 25, 1964
Mr. Carl E. Bosecker
Interstate Management Corporation405 Sycamore Street
Evansville, IndianaRe: Radford Finance Co., Inc.
Dear Mr. Bosecker:
In accordance with our telephone conversation of today, I herewith enclose a certified copy of the resolution of the Board of Directors, who are also all *548 of the stockholders, accepting the offer of Interstate Management Corporation for the purchase of all the assets of Radford Finance Co., Inc., for $ 187,200.00.
This resolution is true and correct, and has been acknowledged, as well as sworn to, by the President and Secretary, respectively. *112 I trust the same meets with your approval.
With kind regards, and best wishes, I am,
Yours very truly,
G. Garland Wilson
GGW: jp
Encl.
The resolution referred to above reads as follows:
RESOLUTION OF STOCKHOLDERS AND DIRECTORS OF RADFORD FINANCE CO., INC.
"Be It Resolved, at a special joint meeting of the stockholders and directors of Radford Finance Co., Inc., held at its principal office in the Chadwick Building, 206 First Street, Radford, Virginia, February 13, 1964, commencing at 7:00 P.M., pursuant to written waiver of notice signed by all stockholders and directors, of the time, place and purpose of said meeting, that it was moved, seconded and unanimously carried that the Radford Finance Co., Inc., accept the offer of Interstate Finance Company of Evansville, Indiana, to purchase its entire assets, accounts and business, at both its Radford and Blacksburg office, for the sum of $ 187,200.00
Be It Further Resolved, that the President and Secretary be, and they hereby are authorized and directed to collect said purchase price of $ 187,200.00, and to sell and transfer unto said purchaser all the assets, accounts and business of the Radford Finance Co., Inc., and to execute *113 any and all instruments and documents necessary for this purpose, and that all acts of the President and Secretary in the execution of all instruments and documents for the aforesaid purposes be, and the same hereby are ratified, approved and made stable forever, to the end that the aforesaid purchaser shall have legal title to the entire assets, accounts, business and property of the Radford Finance Co., Inc., at both its Radford and Blacksburg offices, in the Commonwealth of Virginia.
Be It Further Resolved, that the President and Secretary, after collecting the aforesaid purchase price of $ 187,200.00, pay any debts and obligations due and owing by the Radford Finance Co., Inc., and distribute the balance therefrom to the shareholders, according to their respective shares, and to wind up the affairs of the Radford Finance Co., Inc., and secure from the State Corporation Commission a proper Certificate of Dissolution of the same."
I, the undersigned Secretary, of Radford Finance Co., Inc., do hereby certify that all of the directors of the Radford Finance Co., Inc., are all of its stockholders, and that all of said stockholders are all of its directors, and that the names of said*114 stockholders and directors are D. L. White, Cary [sic] Stone Ralph Patrick, H. H. Holland, G. G. Wilson, John Dodson, Earl Ireson, G. Roy Weaver, James P. King and D. D. Chiles; that the officers of Radford Finance Co., Inc., are John Dodson and H. H. Holland, President and Secretary, respectively.
I do further certify that there have been no subsequent votes or action of the stockholders, board of directors, or officers of said corporation, annulling, or in any wise modifying the foregoing resolution, and that the same is now operative, and in full force and effect.
*549 In Witness Whereof, I have hereunto set my hand and affixed the Corporate Seal of this Corporation, this 25th day of February, 1964.
(S) John T. Dodson, President
Attest:
(S) H. H. Holland
Secretary[CORPORATE SEAL]
On February 29, 1964, Dodson, Wilson, and Henry Holland (hereinafter sometimes referred to as Holland), secretary of Radford, representing Radford, and Bosecker and Taylor representing the two Piedmont corporations, met to close the sale. After Bosecker and Taylor completed verification of Radford's notes receivable, they presented two separate agreements to Dodson, Holland, and Wilson*115 for their perusal and signature. With the exception of certain amounts and language changes not relevant to the instant issues, the agreements were substantially identical to those Bosecker had previously discussed with Wilson on February 25.
The agreement between Radford and Piedmont Finance Corp. read in relevant part as follows:
AGREEMENT
This Agreement executed in triplicate this 29 day of February 1964, by and between PIEDMONT FINANCE CORPORATION, a corporation duly organized and existing under and by virtue of the laws of the State of Virginia, hereinafter called "Purchaser", and RADFORD FINANCE COMPANY, a corporation duly organized and existing under and by virtue of the laws of the State of Virginia, hereinafter called "Seller", and JOHN T. DODSON, of Radford, Virginia, officer, manager and stockholder of the Seller, hereinafter called "Officer", Witnesseth:
Whereas, said Seller is the owner and operator of a small loan business under authority granted by the Virginia Small Loan Act, at 206 First Street, Chadwick Building, Radford, Montgomery County, State of Virginia, hereinafter referred to as "Seller's Office", and is the holder of Virginia Small Loan License No. 464, *116 and now desires to sell to the Purchaser certain selected interest bearing small loan note receivables of Seller's business, hereinafter referred to as "Receivables", which receivables were created and acquired at Seller's Office and which are and were in existence at Seller's Office as of the close of business on February 1, 1964, hereinafter referred to as "Closing Date"; and
Whereas, the Seller also agrees to sell the furniture, fixtures and personal property which Seller heretofore utilized in the conduct of its said business at Seller's Office, to the Purchaser; and
Whereas, the Seller and Officer are each desirous of arranging for the sale by the Seller of the selected receivables of said business, together with the furniture, fixtures and personal property thereof, to the Purchaser and in connection with said sale the Seller and Officer each agree to refrain from operating a small loan business in Montgomery, Giles, Pulaski and Floyd Counties, Virginia for a period of five (5) years from the date of this agreement, all as hereinafter set forth; and
* * * *
Now, Therefore, for and in consideration of the payment of the consideration and purchase price hereinafter set forth to*117 be paid by the Purchaser to the *550 Seller for said Receivables, furniture and fixtures and the agreements of the Seller and of the Officer not to compete with Purchaser, as hereinafter set forth, the receipt and sufficiency of which is hereby acknowledged by the Seller and Officer, the parties now covenant and agree as follows, to-wit:
1. The Seller, for and in consideration of the payment to it of the sum of One Hundred Eighteen Thousand, Eight Hundred Ninety and 54/100 Dollars ($ 118,890.54) by Purchaser, receipt of which sum is hereby acknowledged by the Seller, hereby agrees as follows:
(a) The Seller hereby sells, assigns, transfers, sets over and delivers to the Purchaser "without recourse" but subject to the warranties hereinafter set forth, 432 interest bearing small loan note receivables acquired by the Seller in the operation of its small loan business at Seller's Office, said Receivables being owned by the Seller and created under authority of the Virginia Small Loan Act and, having outstanding balances on the Closing Date aggregating One Hundred Eighteen Thousand, Seventy Nine and 32/100 Dollars ($ 118,079.32), said note receivables hereby sold being more particularly*118 described in the list thereof which is attached hereto, made a part hereof, marked "Exhibit A", consisting of 8 pages; the sale of said interest bearing small loan Receivables by Seller includes in each instance the promissory note, chattel mortgage, accrued interest, wage assignments, if any, and all collateral securing the same, together with all ledger cards and records pertaining thereto; the Seller further agrees to execute an appropriate Bill of Sale, concurrently herewith, to evidence the sale, assignment, transfer and delivery of said Receivables listed in the attached "Exhibit A", to the Purchaser, a copy of said Bill of Sale being attached hereto, made a part hereof, marked "Exhibit D".
(b) The Seller hereby sells, assigns, transfers, sets over and delivers to the Purchaser, all of its right, title and interest in and to certain furniture, fixtures, equipment and personal property, herein for convenience referred to as "Personal Property", with which the Seller's Office is furnished as of the date of this agreement, said Personal Property being more particularly described in the list thereof which is attached hereto and made a part hereof, marked "Exhibit B", said personal*119 property being valued at $ 811.22; the Seller agrees concurrently with the execution of this agreement to deliver to Purchaser an executed Bill of Sale to evidence the transfer of title to said personal property to the Purchaser.
(c) The Seller hereby transfers and delivers to the Purchaser all records pertaining to Receivables heretofore owned by Seller in the Seller's Office and now closed for any reason and heretofore accumulated in Seller's Office.
* * * *
7. In consideration of the payment of the additional sum of Twenty Nine Thousand, Six Hundred Dollars ($ 29,600.00) by the Purchaser to the Seller, the Seller and the Officer hereby jointly and severally covenant and agree with the Purchaser that for a period of five (5) years from and after the date of this agreement, neither the Seller, the Officer, nor Seller's successors or assigns, will engage directly or indirectly either for itself or himself, as the case may be, or as a representative, agent or employee of any other person, firm, partnership or corporation, or through any third party, in the licensed small loan business in Montgomery, Giles, Pulaski and/or Floyd Counties, Virginia, unless specifically permitted and authorized*120 to do so in writing by the Purchaser. The Officer further agrees during said five-year period to actively cooperate with the Purchaser in the event any application for a small loan license is made or filed for the Cities of Radford, or Blacksburg, Virginia. The Purchaser agrees that the Officer may be employed as an Officer or Director of a bank; provided, however, the Seller and the Officer each covenant and agree with the Purchaser that they or either of them will not in any capacity at any time disclose or *551 furnish, or permit or authorize the disclosure or furnishing of the names of any customers or borrowers of the Seller, to any person, firm or corporation whatsoever including any bank at which Officer is employed as an officer or as a director, during said five-year period from the date of this Agreement.
8. The Seller agrees that it will relinquish for cancellation to the Corporation Commission of the State of Virginia at such time hereafter as requested by Purchaser, its Virginia Small Loan License hereinabove referred to, within thirty (30) days of the date of this Agreement.
* * * *
13. The Seller authorizes the Purchaser, at Purchaser's sole discretion, to advertise*121 itself as the successor to Radford Finance Company, and Seller further agrees not to use the name Radford Finance Company nor to permit any other person, firm, entity or corporation to use the name Radford Finance Company in any type of lending or finance business activity conducted in Montgomery County, Virginia for a term of five (5) years from the date of this agreement; provided, however, that if the Seller surrenders its Charter prior to the expiration of said five-year term, then Seller shall no longer be responsible for any use of said name contrary to the provisions of this paragraph.
14. The parties agree that Seller is attempting to sell certain receivables etc. heretofore held by it at its Blacksburg, Virginia office to Purchaser's affiliated corporation, Piedmont Finance of Staunton, Incorporated. The parties agree that if for any reason the Purchaser's affiliated corporation, Piedmont Finance of Staunton, Incorporated, is unable to secure a Small Loan License permitting it to do a small loan business in Blacksburg, Virginia, then this agreement shall be of no further force and effect and each of the parties hereto shall be placed in the position the respective parties*122 hereto were in, immediately prior to the execution of this agreement, including therein, without limiting the same to the Seller agreeing to return the purchase price and all consideration received from the Purchaser, and Purchaser returning all receivables and personal property to the Seller.
15. This Agreement shall bind the respective parties and their respective representatives, successors and assigns, as the case may be.
16. The Seller agrees that it will furnish to the Purchaser the following:
(a) A duly certified copy of the Resolution of its Board of Directors recommending the sale of the Receivables and personal property herein agreed to be transferred to the Purchaser and directing the submission thereof to a vote at a special meeting of shareholders;
(b) A duly certified copy of the Resolution adopted at a special meeting of the shareholders of the Seller, upon proper notice, authorizing the sale of the Receivables and personal property herein agreed to be transferred to the Purchaser, and authorizing the Board of Directors to fix and agree to the terms and conditions thereof, and the consideration to be received by the corporation therefor;
(c) A duly certified copy of*123 the Resolution of its Board of Directors passed after authority has been received from the shareholders, authorizing the sale of the Receivables and personal property herein agreed to be transferred to the Purchaser, and empowering Seller's officers to execute and deliver this Agreement together with any and all other agreements, assignments, bills of sale, and other instruments in connection therewith;
(d) A duly certified copy of a Resolution of its Board of Directors ratifying and confirming the execution of this contract by the Seller and the sale and transfer of the Receivables and personal property herein agreed to be sold.
* * * *
*552 A separate receipt was attached to the Radford contract, which provided in part as follows:
The undersigned, RADFORD FINANCE COMPANY, a Virginia corporation, with its office in Radford, Virginia, hereby acknowledges receipt from PIEDMONT FINANCE CORPORATION, of the following sums in accordance with the above and foregoing Agreement:
| 1. For interest bearing small loan note receivables listed in | |
| "Exhibit A", and for furniture, fixtures and personal | |
| property listed in "Exhibit B" | $ 118,890.54 |
| 2. For Agreement Not To Compete | 29,600.00 |
*124 The Piedmont Finance of Staunton contract was in most relevant parts virtually identical to the Radford contract. Paragraph 15 of the contract reads as follows:
15. The Seller and the Officer each agree to actively assist the Purchaser in obtaining a small loan license from the Banking Department of the State Corporation Commission of the Commonwealth of Virginia, for the premises known as 214 Main Street, Blacksburg, Virginia. The Seller agrees to relinquish for cancellation its Small Loan License No. 521 concurrent with the issuance of a Small Loan License to the Purchaser for said Blacksburg, Virginia premises. The Seller further agrees, if permitted by law, to permit the Purchaser to conduct a small loan business under Seller's Small Loan License at 214 Main Street, Blacksburg, Virginia while Purchaser's Small Loan License application is pending and until Purchaser's Small Loan License is issued, and Seller agrees to cooperate with the Purchaser in such event. If for any reason the Purchaser is unable to secure a Small Loan License permitting it to do a small loan business at 214 Main Street or at some other address in Blacksburg, Virginia, that this Agreement shall be of *125 no further force and effect and each of the parties hereto shall be placed in the position the respective parties were in immediately prior to the execution of this Agreement, including therein, without limiting the same to the Seller agreeing to return the purchase price and consideration received from the Purchaser and Purchaser returning all Receivables, personal property and possession of the premises to the Seller.
The following amounts were to be paid for the items conveyed by the agreement:
| Paragraph | Item | Amount |
| 1(a) | 115 notes receivable | $ 28,809.46 |
| 1(b) | Personal property | 2,500.00 |
| 7 | Covenant not to compete | 7,400.00 |
A separate receipt was attached to the Piedmont Finance of Staunton contract, which provided in part as follows:
The undersigned RADFORD FINANCE COMPANY, a Virginia corporation, with its office in Blacksburg, Virginia, hereby acknowledges receipt from PIEDMONT FINANCE OF STAUNTON, INCORPORATED, of the following sums in accordance with the above and foregoing Agreement:
| 1. For interest bearing small loan note receivables listed in | |
| "Exhibit A", and for furniture, fixtures and personal | |
| property listed in "Exhibit B" | $ 31,309.46 |
| 2. For Agreement Not To Compete | 7,400.00 |
*126 *553 During the negotiations Dodson and Wilson believed that of Radford's various assets, its licenses to do business in Radford and Blacksburg, Va., were each worth approximately $ 10,000, as such licenses were difficult to obtain without having a prior granted license surrendered in connection with a small loan business application. Since they were of the opinion that, apart from its accounts receivables, Radford's licenses were the company's only valuable asset, they were concerned that a total of $ 37,000 had been allocated to covenants not to compete and expressed their concern over the inclusion of the covenants and the amounts allocated to them by Taylor and Bosecker.
Bosecker and Taylor believed that covenants not to compete from Radford, and especially Dodson, were essential in the transaction since otherwise there was no guarantee that either the company or Dodson would not attempt to regain the clients conveyed by the agreement or to compete for new business. They therefore stated to Dodson and Radford's representatives that the covenants were necessary for the transaction and that for record-keeping purposes the transaction had to be consummated on the basis of *127 the terms and amounts specified in the agreement. They did not mention any possible tax consequences of the allocation and neither Dodson, Wilson, nor Holland was aware of any possible tax consequences.
Despite their reluctance to sign the agreements in the form presented to them, Dodson and Holland agreed to and did execute the above agreements and all of the other documents presented to them by Taylor and Bosecker for their signature. At that meeting they also received two checks totaling the agreed $ 187,200 purchase price which checks were drawn on Interstate's account.
Subsequent to entering into the agreements and receiving the amount specified, no further meetings of Radford's board of directors were held for the purpose of ratifying the agreements with the Piedmont corporations. Shortly thereafter Radford proceeded to liquidate, pursuant to section 337 of the Code, 2 with its final distribution being made on December 30, 1964.
On its*128 Federal income tax return for the year ending May 30, 1964, Radford reported the transfer of its assets to the Piedmont corporations as a nontaxable transaction under section 337 of the Code which had generated a net gain of $ 40,019.19.
At the time Radford sold its assets its books reflected a reserve for bad debts in the amount of $ 3,722.29, while its books and records showed $ 148,743.64 as the notes receivable available for transfer to the Piedmont corporations. Supporting material making up the later amount is not known, as Radford's books and records were unavailable at the time of trial. Radford actually received $ 146,146.46 from the corporations for its notes and showed a book loss of $ 2,597.18 on their sale.
*554 In his statutory notice of deficiency, addressed to Radford, respondent, inter alia, determined that Radford received $ 37,000 for a covenant not to compete and that that amount was includable in Radford's gross income for the year ended May 30, 1964. He also determined that the $ 3,722.29 reserve for bad debts balance was includable in Radford's income for that period. Based on his adjustments he further denied Radford net operating loss carrybacks*129 to the calendar years 1961 and 1962. His determination was explained in the statutory notice as follows:
(a) The balance of $ 3,722.29 in your reserve for bad debts as of May 30, 1964, is restored to income since you had no need for said reserve after selling your accounts receivable and other assets pursuant to a plan of complete liquidation.
(b) It is held that the amount of $ 37,000.00 received for a covenant not to compete is includible in gross income and it does not qualify for the nonrecognition provided in Section 337 of the Internal Revenue Code of 1954 for gain from the sale or exchange of property within the 12-month period beginning on the date of adoption of a plan of liquidation.
In addition, respondent also determined (as regards a claimed deduction for the difference between the accounts receivable, as shown on Radford's books, and the amount received pursuant to the February 29, 1964, agreement) as follows:
The issue which was raised during the examination of your return for 1964 concerning a deduction not claimed on your return in the amount of $ 1,587.10 for an unexplained difference between accounts receivable as determined on February 1, 1964, and as determined, *130 after adjustments, on May 30, 1964, has been considered. It has been determined that no deduction is allowable since you have not established that you are entitled to a deduction for such unsubstantiated discrepancy in accounts receivable.
ULTIMATE FINDINGS OF FACT
The $ 37,000 amount allocated to covenants not to compete in the agreements represented payments for covenants not to compete and as such were taxable to Radford as ordinary income for the period ended May 30, 1964.
The difference between the book value of the notes receivable and their sales price to the Piedmont corporations did not constitute a bad debt deduction from Radford's reserve for bad debts account and thus Radford's $ 3,722.29 reserve for bad debts account constituted ordinary income to Radford in that amount for the period ended May 30, 1964.
OPINION
In 1964 Radford Finance Co. simultaneously sold all of its assets to the two Piedmont corporations in separate transactions and subsequently *555 liquidated under section 3373 of the Code. Respondent has determined that when the assets were sold Radford realized ordinary income derived from the receipt of cash for a covenant not to compete on the part*131 of Radford and its president and general manager, John Dodson. Respondent also determined that when Radford sold its outstanding notes receivable, its need for a reserve for its bad debts account terminated and it had ordinary income in the amount of the reserve's book value.
*132 Petitioners, while admitting that Radford is taxable on any amounts it may have received for a covenant not to compete, deny that it did in fact receive any such amounts. They contend that all amounts Radford received in excess of the values assigned to its physical assets represented payments for its licenses and goodwill. They admit that Radford's reserve for bad debts is includable in income in the years its notes receivable were sold, but contend that the reserve is to be decreased by the difference between the notes value per books and the amount it actually received. We find for respondent on both issues.
As regards the covenant not to compete issue, we preliminarily note that the Fourth Circuit (to which this case would go on appeal) has adopted the "economic reality test" in determining whether any amounts received in the sale of a business represent payment for a covenant not to compete. In General Insurance Agency, Inc. v. Commissioner, 401 F. 2d 324, 329-330 (C.A. 4, 1968), affirming a Memorandum Opinion of this Court, the court defined the test as follows:
The test or legal standard which we elect to apply in resolving this issue *133 is what has been called the "economic reality" test. n2 Both the Ninth and Third Circuits have held that the determination of whether a part of the purchase price represents payment for a non capital item, i.e., a covenant not to compete, *556 depends upon whether the parties to the agreement intended to allocate a portion of the purchase price to such covenant at the time they executed their formal sales agreement. n3 It is necessary also to establish that the covenant "have some independent basis in fact or some arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for such an agreement." Schulz v. C.I.R., 294 F. 2d 52, 55 (9 Cir. 1961).
The "economic reality" test is to be contrasted with a test seemingly favored by other Courts of Appeals which has been characterized as the "severable-non severable" rule. See Montesi v. C.I.R., 340 F. 2d 97 (6 Cir. 1965); Barran v. C.I.R., 334 F. 2d 58 (5 Cir. 1964); Ullman v. C.I.R., 264 F. 2d 305 (2 Cir. 1959). These circuits take the position that if *134 the covenant can be segregated in order to show that the parties were actually dealing with a separate item then so much as is paid for it is ordinary income. Stated in other words, whether any portion of the sales price is attributable to a covenant not to compete depends upon whether the parties treated the covenant as a separate and distinct item. * * * [Footnotes omitted.]
And see J. Leonard Schmitz, 51 T.C. 306 (1968), on appeal (C.A. 9).
In the instant case, we have little difficulty in finding that when the two agreements between Radford and the Piedmont corporations were signed, the parties intended to allocate $ 37,000 for the covenants and that the covenants had an independent basis in fact.
We have found, though the testimony was conflicting, that intense discussions between the parties surrounded the covenants not to compete. When Radford's representatives and Dodson, individually, signed the agreements, they were aware that the purchaser was requiring the covenants and also aware of the precise amounts allocated to them. Thus, there is no question but that the covenants in the amounts enumerated were bargained for at arm's length.
Insofar*135 as it is required that there be a showing that the covenants had independent significance, the evidence established that without the covenants of Radford and especially its president and general manager, Dodson, there was a possibility that Radford and/or Dodson would attempt to reacquire the accounts which were to be transferred and also to compete for new business. Dodson testified that he did not intend to stay in the small loan business, but no evidence was introduced which showed that this intention was caused by anything other than his own preference at the time, which could have subsequently changed.
Petitioners' contention that the $ 37,000 amount paid was actually for Radford's licenses to do business in Radford and Blacksburg, Va., is unsupported by the record. The agreements do state that the entire transaction hinged on Piedmont Finance of Staunton being able to obtain a license to do business in Blacksburg, Va., but neither the agreements nor any other evidence shows that Radford received any additional amount for helping Piedmont obtain the license. 4
*136 *557 Petitioners alternatively contend that, even if the above agreements have economic reality, the agreements themselves were invalid to convey property -- either because Radford's officers had no authority to enter into any agreement calling for any amount to be allocated to covenants not to compete or because the agreements were obtained by fraud. They first point out that the corporate resolution authorizing the sale of Radford's assets included an acceptance only of Interstate Finance's offer, not that of the Piedmont corporations. Further, the resolution authorized the president and secretary to execute instruments and documents to sell the corporation's assets for the agreed purchase price. It did not specifically authorize them to enter into covenants not to compete or to accept any part of the agreed price for such a covenant. Petitioners also argue at length that the resolution itself constituted an acceptance of an offer by Interstate Finance and that all assets were transferred pursuant to the terms of the resolution -- not the subsequent agreements. Their conclusion is that since the resolution itself does not allocate any part of the purchase price to a covenant*137 not to compete, or even provide for one, there was no receipt of any amount for such a covenant.
Whether the corporate resolution created a contract of any sort with Interstate Finance, we need not decide, as we find and hold that the definitive provisions of the sale were embodied by the subsequent written agreements with the Piedmont corporations. The testimony of, and the letters exchanged between the individuals representing the principals to the transactions, as well as the language of the resolution itself, establish that the resolution adopted by all of Radford's directors and stockholders contemplated the execution of the agreements with Piedmont, with the provisions therein being binding on all contracting parties.
Wilson (Radford's attorney) testified that he could not remember seeing any copies of the proposed agreements until the day of their signing and that he felt that the transaction was consummated upon the execution of the resolution authorizing Radford's sale to Interstate. However, Bosecker's (Interstate's general counsel) letter to Dodson indicating that a copy of the proposed agreement was enclosed, his notes prepared shortly after a conversation with Wilson, *138 and his testimony at trial, established that Wilson received copies of the proposed agreements with the Piedmont corporations prior to his drawing up the resolution in question. The evidence also established that Wilson and Bosecker had discussed the exact language to be used in the agreements prior to the adoption of the resolution. Furthermore, we cannot believe that any party represented by counsel would intend that the sale of a business, whose assets fluctuated daily, was consummated by a bare agreement on the total consideration to be given and received. As we noted in our findings of fact, both parties felt that a written *558 agreement was needed in order to consummate the sale of Radford's assets. Dodson's testimony was:
Q. You knew there would be a written contract with this transaction, did you not?
A. That is correct.Nor can we agree that Dodson and Holland acted in excess of the authority granted to them by the resolution of the stockholders and directors when they agreed to the covenants as written. The authorizing language of the resolution reads as follows:
Be It Further Resolved, that the President and Secretary be, and they hereby are authorized and directed*139 to collect said purchase price of $ 187,200.00, and to sell and transfer unto said purchaser all the assets, accounts and business of the Radford Finance Co., Inc., and to execute any and all instruments and documents necessary for this purpose, and that all acts of the President and Secretary in the execution of all instruments and documents for the aforesaid purposes be, and the same hereby are ratified, approved and made stable forever, to the end that the aforesaid purchaser shall have legal title to the entire assets, accounts, business and property of the Radford Finance Co., Inc., at both its Radford and Blacksburg offices, in the Commonwealth of Virginia.
Though entering into a covenant not to compete does not constitute the sale of a capital asset, Cox v. Helvering, 71 F. 2d 987 (1934), affirming a Memorandum Opinion of this Court, its execution does constitute a transfer of an intangible asset -- namely the power to earn income from future business operations. Since an intangible asset is an asset of a business as much as any other, its transfer by Dodson and Holland on behalf of Radford is certainly within the scope of the above-cited*140 provision.
Dodson and Holland did sell Radford's assets to the Piedmont corporations rather than to Interstate as the resolution provided. But this action is not necessarily inconsistent with the resolution since both Piedmont corporations were wholly owned by Interstate. Even if the agreements were executed in violation of the resolution, the acceptance of the agreements' benefits by Radford's directors, who were also its shareholders, cures any lack of authority on the part of Dodson and Holland. Eastern Finance Co. v. Gordon, 179 Va. 674, 20 S.E. 2d 522 (1942); Fanney v. Virginia Investment and Mortgage Corp., 200 Va. 642, 107 S.E. 2d 414 (1959).
Petitioners next argue that Taylor's and Bosecker's statements to Dodson, Holland, and Wilson prior to the time the agreements were signed, to the effect that the covenants were only required for record-keeping purposes when in fact they supposedly knew that there were significant tax consequences attached to the allocation of an amount to the covenant, constituted a deliberate misstatement of fact upon which Radford relied to its detriment.
*141 First we do not find that Taylor's or Bosecker's remarks constituted a misstatement of fact. At worst their comments may have led Radford's *559 representatives to believe that there were no relevant tax consequences attached to the covenants' allocation when their opinion was that the allocation was to the Piedmont corporations' Federal income tax advantage and to Radford's Federal income tax disadvantage. As we pointed out in Carl L. Danielson, 50 T.C. 782, 796 (1968), statements pertaining to the ultimate taxation of any particular covenant not to compete can only be opinions in an area of law that is quite complicated. Under such circumstances an individual advising another as to the ultimate tax consequences of a specific covenant is not dealing with a matter of fact and consequently cannot misstate one.
Even if Taylor and Bosecker were misstating a matter of fact, there would still be no fraud. Under Virginia law, which petitioners admit controls in this case, there can be no fraud where the means of ascertaining a fact is equally available to both parties. If a party to an agreement elects to rely on one whose interest it is to mislead*142 him, instead of ascertaining the available information for himself, the law generally will leave him where he has been placed by his own imprudent confidence. Horner v. Ahern, 207 Va. 860, 153 S.E. 2d 216 (1967); Costello v. Larsen, 182 Va. 567, 29 S.E. 2d 856 (1944); Harris v. Dunham, 203 Va. 760, 127 S.E. 2d 65 (1962). As to the issue under consideration, the relevant "facts" pertained to Federal income taxation, and were available to Radford's representatives. This is especially so as to Wilson, its attorney, who had advised Dodson to sell Radford's assets in bulk for tax purposes. Consequently, under Virginia law, there was no fraud.
We thus find and hold that the $ 37,000 allocated to covenants not to compete represented payments for covenants not to compete and were thus ordinary income to Radford in the year ended May 30, 1964. In reaching our decision we have applied the strong-proof rule. See J. Leonard Schmitz, supra. We note, however, that under the more stringent "Danielson rule" enunciated*143 by the Third Circuit in Danielson v. Commissioner, 378 F. 2d 771 (C.A. 3, 1967), reversing and remanding 44 T.C. 549 (1965) (urged upon us by respondent), the result would be the same. See Edmond E. Maseeh, 52 T.C. 18 (1969); Henry P. Wager, 52 T.C. 416 (1969).
Turning to the bad debt issue, petitioners contend that that portion of Radford's income which was generated by the termination of its need for a reserve for bad debts is to be reduced by the difference between the sales price of its notes receivable and their book value. This claim must fail.
We have consistently held that when accounts or notes receivable are sold at less than their face value, the difference cannot be considered a bad debt loss offsetting any balance in a reserve (allowance) for bad debts account. Max Schuster, 50 T.C. 98 (1968), on appeal (C.A. 2, July 11, 1968); Bird Management, Inc., 48 T.C. 586 (1967); J. E. *560 ., 44 T.C. 705 (1965), and the cases cited therein. As we*144 pointed out in Bird Management, Inc., supra at 595, any deductibility of the loss on the sale would be governed by those provisions of the law dealing with the tax consequences of sales or exchanges.
It appears clear that, under section 337(b), the bulk sale of Radford's assets prevents it from recognizing any loss on the sale of its notes receivable. J. E. Hawes Corp., supra at 709. But we need not reach that issue here, as we find and hold that petitioners failed to establish their basis in the notes receivable. Radford's books and records were not produced at the trial and in their absence we cannot find that the notes receivables' basis was any less than the amount for which they were sold. We thus uphold respondent's determination on this point.
To reflect the concessions by the respective parties,
Decisions will be entered under Rule 50.
Footnotes
1. Cases of the following petitioners are consolidated herewith: Ralph Patrick, docket No. 4716-66; Carey A. Stone, docket No. 4717-66; James P. King, docket No. 4718-66; and Radford Finance Co., docket No. 4719-66.↩
2. All references to the Code refer to the Internal Revenue Code of 1954.↩
3. SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS.
(a) General Rule. -- If --
(1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and
(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims,
then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.(b) Property Defined. --
(1) In General. -- For purposes of subsection (a), the term "property" does not include --
(A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year, and property held by the corporation primarily for sale to customers in the ordinary course of its trade or business,
(B) installment obligations acquired in respect of the sale or exchange (without regard to whether such sale or exchange occurred before, on, or after the date of the adoption of the plan referred to in subsection (a)) of stock in trade or other property described in subparagraph (A) of this paragraph, and
(C) installment obligations acquired in respect of property (other than property described in subparagraph (A)) sold or exchanged before the date of the adoption of such plan of liquidation.↩
4. If the proof were otherwise, such amount would seem to have been paid for services, and thus still be ordinary income.↩