*1260 The petitioner was placed in receivership by order of a United States District Court in 1925. The deposed officers and stockholders employed attorneys and accountants to conduct litigation seeking an annulment of the receivership proceedings. The Circuit Court of Appeals in 1929 reversed the District Court and ordered the receivership vacated ab initio. The expenses of the litigation were paid by the petitioner during its taxable years 1929, 1930, 1931, and 1932, after restoration to the petitioner of its assets. The petitioner kept its books and made its returns upon the accrual basis. Held, that the petitioner is not entitled to any deduction in the taxable year ended August 31, 1928, on account of the expenses of the litigation, in the absence of proof as to what part, if any, of the expenses was a liability incurred by it in that year.
*1029 The respondent has determined a deficiency in the petitioner's income tax for the fiscal year ended August 31, 1928, in the amount of $524.73. The amount*1261 of the tax in controversy, however, is $4,933.22, the petitioner claiming an overpayment. The petitioner contends that it is entitled to a deduction in that year of a portion of the legal fees and other expenses incurred by the officers and stockholders in vacating the receivership under which it had been unlawfully placed by order of a United States District Court.
FINDINGS OF FACT.
The petitioner is a New Jersey corporation, with its principal place of business at Newark. It is engaged in the business of manufacturing and selling metal polish and other related products. The business was begun in 1913 by Ralph Nottebaum, who has served as the petitioner's president since its incorporation in 1919.
On February 25, 1925, William J. Robb, one of the petitioner's officers and stockholders, filed a bill of complaint in the United States District Court for the District of New Jersey alleging that it was necessary, for the protection of the complainant and of the creditors of the petitioner, that the petitioner's business and assets be operated by receivers appointed by the court. The court, without any notice to the petitioner and without giving the petitioner any opportunity*1262 to be heard on the petition, issued an order on that date, February 25, 1925, placing the petitioner in temporary receivership and enjoining the petitioner's officers from any further participation in the business. One of the receivers appointed by the court and a marshal appeared at petitioner's offices on the afternoon of February 25, 1925, and took possession of the petitioner's assets and business.
Ralph Nottebaum immediately consulted the petitioner's attorney, Harry Unger, who advised him that nothing could be done because the court had issued an injunction order prohibiting the petitioner and its officers from interfering in any way with the receivership.
The temporary receivership was made permanent by an order of the court issued on August 6, 1925. This order provided in part as follows:
* * * that the said defendant corporation, its officers and agents, and all persons claiming under it, shall be and they hereby are restrained from interfering with said receivers taking possession of, and managing said property, and that all persons whosoever, including sheriffs and marshals and their officers, agents, attorneys, proctors, representatives, servants and employees, *1263 whether creditors or claiming to be creditors or having or claiming to have any *1030 right, title or interest of, in and to any property or properties of the defendant, be and they hereby are enjoined and restrained from instituting or prosecuting or continuing the prosecution of any action at law or action or proceeding in equity against the defendant in any court of law or equity, or otherwise, * * *
Notwithstanding the injunction, the petitioner's officers and stockholders met at frequent intervals to discuss the situation and to try to devise some means of having the receivership vacated. Upon the advice of the stockholders, Ralph Nottebaum appealed to the Chamber of Commerce and the Credit Men's Association and was advised by them to employ their own firm of attorneys, Blanchard & Carey. In September 1926, the following written agreement was entered into:
Messrs. Arlington Bensel and Ralph Nottebaum hereby jointly and severally obligate themselves and do hereby guarantee to use their best efforts to obtain for Robert Carey, Jr., the payment of Five Thousand Dollars ($5000.00) from the Noxon Chemical Products Co., Inc., in payment of the services rendered by Mr. Carey*1264 in the case of William J. Robb v. Noxon Chemical Products Co., Inc., and in all proceedings connected therewith as soon as and upon the return of the said Noxon Chemical Products Co., Inc., from the custody of the U.S. Circuit Court Receivers to the directors and/or stockholders of said company and in the event that they are unable to effect the payment of the said Five Thousand Dollars ($5000.00) within three months after the return of the said company then the said Arlington Bensel and Ralph Nottebaum obligate themselves jointly and severally to personally pay the said amount of Five Thousand Dollars ($5000.00).
RALPH NOTTEBAUM.
ARLINGTON BENSEL.
At that time also, Joseph H. Kraus, who had been employed by the petitioner as an accountant since 1924, was employed to assist Blanchard & Carey in preparing a petition to the court for annulment of the receivership. He was to receive $500 for his services.
In March 1927, Ralph Nottebaum, acting for the stockholders, employed two other attorneys, George F. Seymour, Jr., and Isidor Unger, both of New York, agreeing to pay them $30,000 and $12,500, respectively. About the same time, Joseph H. Kraus was engaged to perform other*1265 services of an accounting nature for which he was to receive $6,000. Other persons who were employed about that time to render various services to the petitioner in connection with the receivership were Arlington Bensel, investigator, who was to receive $7,500; Alfred J. Roehrs, accountant, and Patrick J. Ganley, investigator, who were to receive $3,500 each; Dyke and Schaines, patent attorneys, who were to receive $2,000; Harry Unger, attorney, who was to receive $1,500.
After their efforts to obtain favorable action on behalf of the petitioner had failed, the above named attorneys on March 18, 1927, *1031 filed an affidavit of bias and prejudice seeking the removal from the case of the District Court judge who had ordered the receivership. In April or May, 1927, the Circuit Court of Appeals ordered the substitution of another judge to conduct the proceedings. Finally, on February 28, 1929, after several years of continuous litigation, described by the appellate court as "this interminable conflict and confusion," the Circuit Court of Appeals of the Third Circuit handed down an opinion reversing the District Court and ordering that:
The appointment of the Receivers*1266 without notice or an opportunity to be heard, and the resulting divestiture of defendant's property and business, was a taking of their property without due process of law, and therefor, illegal and void from the beginning.
The court further ordered:
* * * that the receivership created by the order of February 25, 1925, and continued by order of August 6, 1925, is annulled and set aside, and the office of Receivers of said corporation is vacated, and the Receivers are directed to turn over and return to the Noxon Chemical Products Co., Inc., all its property and assets of every kind in their hands, and to make full and complete accounting to the court of their said trust.
The petitioner's officers regained control of the petitioner's assets about March 1, 1929. On April 15, 1929, the board of directors held a formal meeting and voted to reimburse Ralph Nottebaum for the amount of his personal funds which he had expended in behalf of the petitioner in opposing the receivership and also to pay to him his regular salary of $100 per week, with interest, for the period February 25, 1925, to March 30, 1929, inclusive, during which the receivers were in control of the business. The*1267 action of the directors was approved by the stockholders at a meeting held April 27, 1929.
In addition to the agreed compensation which the attorneys were to receive under their employment agreements with Ralph Nottebaum, which amounts were all paid by the petitioner after it recovered its assets, further claims were made by some of them and a suit was brought by Isidor Unger, resulting in a judgment against the petitioner for $20,000 additional compensation.
During the petitioner's taxable years 1929, 1930, 1931, and 1932 it paid out the following aggregate amounts on account of the attorneys' and accountants' fees and other expenses of the receivership:
| Mar. 1929, to Aug. 31, 1929 | $4,184.99 |
| Sept. 1, 1929, to Aug. 31, 1930 | 96,382.77 |
| Sept. 1, 1930, to Aug. 31, 1931 | 29,748.53 |
| Sept. 1, 1931, to Apr. 30, 1932 | 16,739.50 |
| Total | 147,055.79 |
*1032 Prior to June 27, 1930, the petitioner entered suit in the Supreme Court of New York against the William J. Robb Estate et al., defendant, seeking to recover damages for the injury resulting to it from the unlawful receivership.
The receivers filed an income tax return for the petitioner on Form 1120 A for*1268 the fiscal year ended August 31, 1928, showing a tax liability for that year of $4,408.49, which amount was increased in the respondent's deficiency notice to $4,933.22. The petitioner on September 1, 1930, filed an amended return for that year which showed a net loss of $15,069.94. The only change in the amended return is the claimed deduction of $50,000 representing a portion of "legal expenses" incident to the receivership.
OPINION.
SMITH: The petitioner contends that it is entitled to deduct in the taxable year ended August 31, 1928, as a business expense of that year, the amount of $50,000 representing a portion of the cost of the litigation to remove the receivership under which it had been placed by order of the United States District Court in 1925. The respondent opposes the deduction on the grounds that the cost of the litigation does not represent an ordinary and necessary expense of the corporation, but was either a personal expense to the stockholders or was a capital expenditure, and that in any event the amount claimed is not deductible as an ordinary and necessary business expense of the taxable year ended August 31, 1928.
*1269 It is generally recognized that attorneys' fees and other expenses incident to litigation occurring in the regular course of business and directly connected with the business, except those incurred illegally or in relation to some unlawful act, are deductible as ordinary and necessary expenses of the year when paid or incurred. ; ; ; ; ; .
The costs of the receivership were paid by the petitioner after the taxable year 1928 and during the years 1929, 1930, 1931, and 1932. The petitioner contends, however, that since its books were kept on an accrual basis, it is entitled to deduct the amount claimed, $50,000, as an accrual of the year 1928. The facts do not support this contention, even if we assume that the petitioner's ousted officers were authorized legally to bind it in the period during which the receivership held the petitioner's assets and that the acts of Ralph*1270 Nottebaum and the stockholders in employing attorneys and contracting other obligations on behalf of the petitioner were, for the purposes *1033 of the present question, the acts of the petitioner. The evidence does not show that the agreements with any of the attorneys were entered into during the taxable year ended August 31, 1928, or that there was ever any understanding that any definite amounts were to be paid to them for their services in that year. The evidence does not show, either, what part of the services of these persons was performed during the taxable year 1928 or what portion of the compensation was paid to them for services performed in that year.
It appears, too, that some of the attorneys' fees were contingent and were to be paid only when the petitioner had recovered its assets. This is true of the $5,000 which was to be paid to Robert Carey, Jr., under the agreement set forth above. Clearly, no liability for this contingent fee accrued either to the petitioner or to the individual officers until after the close of the taxable year 1928. We do not know whether the fees under the agreements with any of the other attorneys were contingent or not.
*1271 At the hearing of this proceeding, petitioner's counsel stated as follows:
If your Honor asks me how we arrived at the $50,000 and asks me to say that I know the $50,000 can be absolutely applied to the year 1928, I say we cannot prove it; but, taking the entire picture as a whole, we say that we are entitled, by virtue of the evidence adduced here, to say that $50,000 of the $140,000 is properly applicable to the year in question. We have no other way of determining it; we have no way of saying when a certain piece of work was started and when it was concluded; we have no way of saying how much of Mr. Seymour's work, for instance, was performed prior to August 31, 1928, or how much of my work or of Mr. Unger's work, but we do know that a certain portion had been done by that particular time and for that particular portion the legal obligation had been incurred at that same time * * *.
Upon the facts of record, we can not determine that any part of the expenses of the receivership is deductible by the petitioner in the taxable year ended August 31, 1928.
Judgment will be entered for the respondent.