1941 BTA LEXIS 1332">*1332 Taxpayer corporation applied to the R.F.C. for a loan July 2, 1935. In February 1936 R.F.C. approved the application in a lesser amount, subject to numerous conditions, one of which was that the taxpayer corporation should not declare or pay any dividends as long as it should be in debt to the R.F.C. without the latter's permission. In September 1936 the taxpayer executed a note to R.F.C. in the amount of the loan, which was received September 25, 1936. held, there existed no written contract between R.F.C. and the taxpayer executed prior to May 1, 1936, within the meaning of section 26(c)(1) of the Revenue Act of 1936, and taxpayer is, therefore,
Frank M. Thompson, Esq., for the respondent.
44 B.T.A. 436">*436 This proceeding involves a deficiency in income and excess profits tax liability of petitioner for the fiscal year ended August 31, 1937, in the respective amounts of $4,684.87 and $30.90. The sole question presented is whether a contract between petitioner and the Reconstruction Finance Corporation was executed prior to May 1, 1936, within the1941 BTA LEXIS 1332">*1333 meaning of section 26(c)(1) of the Revenue Act of 1936, so as to afford petitioner the credit set forth in that section.
FINDINGS OF FACT.
Petitioner is a corporation organized and existing under the laws of Alabama, having its principal place of business at Florence, Alabama. Petitioner is engaged in the manufacture of cotton textiles.
On July 2, 1935, petitioner filed an application for a loan of $125,000 from the Reconstruction Finance Corporation, hereinafter referred to as R.F.C.
The application, which was in writing on a form provided therefor by R.F.C., contained, inter alia, certain warranties and agreements:
11. Applicant will, on demand, reimburse R.F.C. for any expenses incurred by R.F.C. in connection with or arising out of this application and/or any loan made pursuant thereto or in connection therewith, * * *
14. So long as applicant shall be indebted to R.F.C. applicant will not, without the prior written consent of R.F.C.: (a) if applicant is a corporation, * * * declare or pay any dividend or make any distribution upon its capital stock, or purchase or retire any of its capital stock, or authorize or issue any additional shares of stock, or reclassify1941 BTA LEXIS 1332">*1334 any outstanding shares, * * *
16. This application, as hereafter amended or supplemented, together with all conditions imposed by and all agreements required by or entered into with or for the benefit of R.F.C. in connection with the making of the loan hereby applied for and the note or notes of applicants evidencing such loan (all of 44 B.T.A. 436">*437 which are incorporated herein and made a part hereof), shall constitute a contract between applicant and R.F.C. * * * Such contract shall become binding upon the parties thereto only when all or any part of the loan applied for is paid to applicant by check or draft or is unconditionally credited to or for the account of applicant, and only with respect to the amount so paid or credited. The validity, interpretation, legal effect, and performance of such contract shall be governed by the law of the place of payment of the note.
17. Applicant shall not claim any modification, rescission, waiver, release, or annulment of any part of such contract, except, pursuant to a written agreement subscribed by a duly authorized officer of R.F.C. * * *
Appended to this application was a copy on the proposed note, a footnote to which read:
1941 BTA LEXIS 1332">*1335 NOTE. - Corporate applicants must execute note in corporate name, by duly authorized officer, and seal must be affixed and duly attested; * * *. Blanks in note annexed to application should be filled in, but such note should not be executed. Formally executed note is to be delivered at the time of disbursement of loan. [Italics supplied.]
The application stated that the loan should be secured by collateral listed in Exhibit B of the application, except as otherwise required by R.F.C. The application further provided:
19. The charter, by-laws, and other regulations of applicant (if applicant is a corporation) and the laws governing its operation permit and authorize applicant (a) to incur the indebtedness in the manner and in the amount herein proposed and in the total amount which applicant will have outstanding upon the granting of the loan herein applied for, and (b) to secure such indebtedness by collateral in the amount and of the character offered by this application in Exhibit B or otherwise.
Subdivision 2 of Exhibit A of the application stated the purposes of the loan to be for replacement of obsolete machinery, repair to buildings, maintenance during repair1941 BTA LEXIS 1332">*1336 period, and working capital.
On February 26, 1936, R.F.C. mailed petitioner a resolution adopted by R.F.C.'s executive committee on Rebruary 19, 1936, authorizing R.F.C. to loan $100,000 to petitioner, upon the terms of its application subject, however, to numerous conditions; among them:
1(A). The note of Borrower (hereinafter called the "Note") executed on R.F.C. Form L-180, in the amount of this loan, dated not more than thirty days earlier than the date of the first disbursement on account of this loan, payable on or before seven years from the date of the note, * * *
A mortgage was also required on certain properties. Clause 1(c) (3) required evidence that, prior to the first disbursement, petitioner had obtained additional assets in cash of not less than $35,000 by way of contributions to petitioner, issuance of unguaranteed capital stock or unsecured loans. Clause 1(c)(4) required evidence that, prior to the first disbursement of the loan, petitioner had spent the $35,000 mentioned in clause 1(c)(3) for improvements to petitioner's plant, and that plans, contracts, etc., for further work are satisfactory to 44 B.T.A. 436">*438 R.F.C.'s agency manager and counsel. After imposing1941 BTA LEXIS 1332">*1337 a great many more conditions, the resolution concluded:
Third, That the General Counsel, or counsel designated by him, be and hereby is authorized to modify this resolution and aforesaid closing schedule, by making such changes therein, as to details or as to legal requirements, as said General Counsel or designated counsel, respectively, shall deem advisable.
Fourth, That the Treasurer be and hereby is authorized to disburse this loan in accordance with the foregoing resolution and aforesaid Closing Schedule; provided, however, that the first disbursement shall be made not later than sixty days after the date of adoption of this resolution and that no disbursement shall be made later than six months after such date of adoption of this resolution.
On February 27, 1941, counsel for petitioner wrote R.F.C. acknowledging receipt of a copy of the resolution of February 19 and commenting on an assignment of life insurance policy to R.F.C. In conclusion the letter stated:
I am sure you will find the application discloses these facts and i am only taking the precaution to call them to your attention so that there may be no delay on this account at the last moment.
Yours1941 BTA LEXIS 1332">*1338 very truly,
BRADSHAW & BARNETT, by H. A. BRADSHAW
On March 7, 1936, petitioner's directors met and adopted a resolution that it was desirable to borrow $100,000 from R.F.C.; that it was desirable to amend its charter to authorize the issuance of $35,000 of preferred stock, and called a meeting of the stockholders to be held on April 27, 1936, to take final corporate action on such proposals.
On April 15, 1936, petitioner entered into three contracts for machinery and repairs, the aggregate amount being approximately $90,000.
On April 24, 1936, R.F.C. adopted another resolution slightly amending the resolution on February 19, 1936. By this amendment petitioner was allowed to pay dividends not in excess of 5 percent per annum on the proposed $35,000 preferred stock issue, provided petitioner should not be in default on any obligation to R.F.C. and dependent upon petitioner's current operating surplus. Certain other immaterial changes were also made.
The stockholders met April 27. 1936. and passed a resolution authorizing and directing petitioner: (1) To borrow $100,000 from R.F.C. and execute a note evidencing such loan upon such terms, conditions, and provisions as R. 1941 BTA LEXIS 1332">*1339 F.C. should require; (2) to execute a mortgage on all petitioner's real and personal property, now held or to be acquired; and (3) to issue 5 percent cumulative preferred stock in the amount of $35,000.
On May 20, 1936, a further amendatory resolution was adopted by R.F.C. in connection with the mortgage on petitioner's realty and personalty.
44 B.T.A. 436">*439 On September 1, 1936, petitioner executed the note referred to supra for $100,000 to R.F.C. The note contained a rider providing for method of repayment.
On September 8, 1936, R.F.C. adopted a further resolution relative to the mortgage, specifically releasing certain properties from coverage under the mortgage.
On September 25, 1936, R.F.C. paid over to petitioner's credit the full amount of the loan.
On October 15, 1936, the petitioner's annual stockholders' meeting was held. According to the manutes of that occasion:
Mr. H. A. Bradshaw was asked to give a report on the negotiations for and closing of the loan of $100,000.00 which was secured from the Reconstruction Finance Corporation on September 25, 1936.
Subsequent to the report a resolution was adopted approving the acts of petitioner's officers in connection1941 BTA LEXIS 1332">*1340 with the R.F.C. transaction.
On August 5, 1937, petitioner applied to R.F.C. for permission to declare the 5 percent annual dividend on the $35,000 issue of preferred stock, as per the terms of R.F.C.'s amendatory resolution of April 24, 1936, and also for leave to pay a 6 percent dividend on its common stock. R.F.C. replied to petitioner's request August 26, 1937, consenting to petitioner's paying and declaring with respect to the taxable year ended Autust 31, 1937, a dividend in an amount not to exceed $1,750 on its outstanding preferred stock; but declined to consent to any dividend payment on the common stock. Dividends in the amount of $1,750 were forthwith declared and paid on the preferred stock.
Petitioner operates on the basis of a fiscal year from September 1 through the following August 31. The deficiency letter discloses undistributed net income in the amount of $25,336.34 existing at the close of business August 31, 1937.
OPINION.
KERN: The issue in this proceeding is whether a contract was executed by petitioner prior to May 1, 1936, which expressly dealt with the payment of dividends in compliance with the provisions of section 26(c)(1) of the Revenue1941 BTA LEXIS 1332">*1341 Act of 1936, set out in the margin. 1
44 B.T.A. 436">*440 Respondent contends that no such contract can be considered as executed by the petitioner prior to May 1, 1936, because the application for the loan specifically provided that the "contract shall become binding upon the parties1941 BTA LEXIS 1332">*1342 * * * only when * * * the loan applied for is paid to applicant." Such loan was not paid to petitioner until September 1936.
Petitioner, on the other hand, contends that a contract was executed by it by virtue of its signing the application which was accepted by R.F.C., subject to certain conditions, on Febryary 19, 1936, and that the clause in the application above quoted was a condition precedent not to the existence of the contract but to the liability of the parties under the contract.
Petitioner, in advancing this argument, stresses the following language in the application:
This application, as hereafter amended or supplemented, together with all conditions imposed by and all agreements required by or entered into with or for the benefit of R.F.C. in connection with the making of the loan hereby applied for and the note or notes of applicants evidencing such loan (all of which are incorporated herein and made a part hereof), shall constitute a contract between applicant and R.F.C. * * *.
We are inclined to the conclusion that the parties intended all of their written agreements, together with amendments and supplements, beginning with the application for the loan1941 BTA LEXIS 1332">*1343 and ending with the actual disbursement of the loan, to constitute the contract between the parties, such contract not to come into being as such until all of the negotiations had been definitely completed by the payment of the loan. That this is a reasonable construction of the language used by the parties is demonstrated by the dealings between the parties here with the many facets of the transaction requiring extended negotiations which lasted for over a year.
However, even if we assume arguendo, as petitioner contends, that a contract existed between petitioner and R.F.C. prior to May 1, 1936, and that only the condition precedent to liability under the contract remained to be fulfilled after that date, we are, nevertheless, of the opinion that petitioner is not entitled to credit under section 26(c)(1) of the Revenue Act of 1936, which refers to "amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936." (Emphasis supplied.) This language assumes a binding contract, the breach of which would constitute a violation. Unless a contract, binding upon both1941 BTA LEXIS 1332">*1344 parties, existed prior to May 1, 1936, the section of the act granting the credit claimed can not be considered as having been complied with, and therefore, petitioner is not entitled to credit thereunder.
Decision will be entered for the respondent.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -
* * *
(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS.
(1) PROHIBITION ON PAYMENT OF DIVIDENES. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. ↩