1929 BTA LEXIS 2797">*2797 1. Where petitioner in 1922 loaned money to A corporation to cover advancements by A corporation to B corporation and where such advancements were made on the security of a surety bond running from B corporation to A corporation, and where such bond was in force at the end of the taxable year, held that no part of petitioner's debt was deductible under section 214(a)(7) of the Revenue Act of 1921.
2. Where in 1923 the right to sue on the bond had expired and where B corporation was a bankrupt and A corporation was in failing circumstances and where the assets of both were of very small value, and where in 1924 A corporation instituted a suit against the surety on a contract which it had not executed, and where it is apparent that there was no reasonable ground to expect success, held that petitioner has the right to deduct one-half of his debt in said year.
15 B.T.A. 774">*775 These proceedings were consolidated for hearing and decision and involve the redetermination of deficiencies in income taxes for the years 1922 and 1923 in the respective amounts1929 BTA LEXIS 2797">*2798 of $636.01 and $867.72. The only errors alleged are that respondent refused to permit the deduction by petitioner of certain debts which are alleged to have been ascertained to have been worthless and which were charged off during the years in question.
FINDINGS OF FACT.
Petitioner is an individual with his principal office at 204 Northwestern Bank Building in the City of Portland, State of Oregon. The Pacific Automatic Device Co., hereinafter called the Pacific Co., is a corporation which was organized under the laws of Oregon on January 17, 1922. Petitioner subscribed for 99 shares of capital stock of said corporation, C. S. Patterson subscribed for 96 shares, P. H. Green subscribed for 4 shares, and A. C. Ruckdeschel subscribed for 2 shares.
On January 10, 1922, P. H. Green loaned C. S. Patterson, who was vice president of the Pacific Co., $100, for which said Patterson executed to said Green his promissory note of said date, whereby he agreed to pay to the order of Green the sum of $100 on demand with interest at 7 per cent per annum from date. During the year 1922, but at a time not shown, Green endorsed the note in blank and delivered it to petitioner, who in turn1929 BTA LEXIS 2797">*2799 paid Green $100. On January 19, 1922, petitioner loaned to said Patterson the sum of $250 and on said date Patterson executed to petitioner his note in said amount payable 90 days after date, with interest at the rate of 8 per cent per annum from date until paid. By said note Patterson pledged to petitioner to secure the payment of said note 93 shares of the stock of the Pacific Co. On February 8, 1922, petitioner loaned to C. S. Patterson the sum of $100, for which said Patterson on said date executed his promissory note to petitioner for said amount, payable 30 days after date, with interest at 8 per cent per annum from date. No part of said notes has been paid and Green left the State of Oregon some time during the year 1923. With the exception of his earning capacity, the only assets possessed by said Green were the 96 shares of stock which he owned in the Pacific Co. Petitioner charged off said notes in the year 1922 and in his income-tax return for said year deducted the total amount of said notes from his gross income. This deduction was disallowed by respondent.
15 B.T.A. 774">*776 Petitioner charged off the following notes of the Pacific Co. payable to his order and in his1929 BTA LEXIS 2797">*2800 income-tax return for the year 1922 deducted the same from his gross income, to wit:
| Date of note | Payable | Interest | Amount of note |
| Per cent | |||
| Feb. 28, 1922 | On demand 90 days after date | 8 | $2,263.25 |
| Mar. 30, 1922 | do | 8 | 180.67 |
| Apr. 28, 1922 | do | 8 | 113.87 |
| May 31, 1922 | do | 8 | 225.27 |
| June 20, 1922 | do | 8 | 1,000.00 |
| June 30, 1922 | do | 8 | 55.17 |
| July 31, 1922 | do | 8 | 445.36 |
| Aug. 7, 1922 | do | 8 | 3,000.00 |
| 7,283.59 |
Respondent disallowed all said deductions.
On the reverse side of the foregoing notes appear endorsements as follows:
| Note | Endorsement |
| February 28, 1922 | "Interest paid to 4/28/23 211.24 |
| "Interest paid to 12/28/23 120.80" | |
| March 30, 1922 | "Interest paid to 3/30/23 14.45" |
| Pacific Co. payable to his order: | |
| May 31, 1922 | "Interest paid to 4/30/23 16.50" |
| June 20, 1922 | "Interest paid to 4/20/23 66.70 |
| "Interest paid to 12/20/23 53.36" | |
| June 30, 1922 | "Interest paid to 4/30/23 3.70" |
| July 31, 1922 | "Interest paid to 4/30/23 26.73" |
| August 7, 1922 | "Interest paid to 5/ 7/23 180.00 |
| "Interest paid to 12/ 7/23 140.00" |
Petitioner charged off and in his income-tax return for the year 1923 deducted1929 BTA LEXIS 2797">*2801 from his gross income the following notes of the Pacific Co. payable to his order:
| Date of note | Payable | Interest | Amount |
| Per cent | |||
| Sept. 9, 1922 | 90 days after date | 8 | $1,000 |
| Sept. 25, 1922 | do | 8 | 4,000 |
| Nov. 13, 1922 | do | 8 | 3,500 |
| Dec. 27, 1922 | do | 8 | 6,500 |
| 15,000 |
Respondent disallowed all of said deductions.
On the reverse side of the foregoing notes appear endorsements as follows:
| Note | Endorsement |
| September 9, 1922 | "Interest paid to 5/ 9/23 53.36 |
| "Interest paid to 12/ 9/23 46.69" | |
| September 25, 1922 | "Interest paid to 4/25/23 186.69" |
| November 13, 1922 | "Interest paid to 4/13/23 116.70" |
| December 27, 1922 | (No endorsement) |
15 B.T.A. 774">*777 No part of the principal of the above notes has been paid and none of the interest thereon, except to the extent above shown. The endorsements of interest paid on all the above notes were made by a clerk of petitioner and without his knowledge and represent part of the proceeds of the sale by the Pacific Company of its junk and the collection of its bills receivable. This interest was reported for income tax in the year received. All said notes bearing date prior to August 7, 1922, represent1929 BTA LEXIS 2797">*2802 money loaned to or advanced for the benefit of the Pacific Co. All the remainder of said notes represent money paid to or for the benefit of the Olympic Products Co. and was paid at the instance of the Pacific Company and for its benefit. These latter amounts were paid in order that the Olympic Products Co. might comply with the following contract:
THIS AGREEMENT, made and entered on this 2nd day of August, 1922, by and between the Olympic Products Company, a Washington Corporation, hereinafter designated as Manufacturer and The Pacific Automatic Device Company, Inc., of Portland, Oregon, hereinafter designated as Purchaser:
WITNESSETH: The Manufacturer agrees to manufacture twenty-five thousand (25,000) Automatic Windshield Swipes to conform to the sample furnished by the purchaser; each of said Swipes to be complete with seven (7) feet of rubber hose and a device to attach the hose to the intake manifold of an automobile motor.
Each of said swipes is to be packed separately in a corrugated paper carton. The cost of said carton not to exceed Two and Three-fourths (02-3/4) cents each, and carton to be labelled, and a transfer name to be put upon each swipe. In the event1929 BTA LEXIS 2797">*2803 that the purchaser desires said swipes packed in a carton costing more than two and three-fourths cents each, it is agreed that the purchaser pay the difference between the actual price of said carton and two and three-fourths cents. Each swipe to be tested by the manufacturer and to operate on ten inches of vacuum; any changes in material or design of said swipes to be submitted in writing to the manufacturer and approved by him, and the purchaser agrees to reimburse the manufacturer for any increase in cost of material or labor due to changes made by said purchaser.
SHIPMENT.
The manufacturer agrees to make shipments as directed and to make charge for such service on the basis of actual shipping cost including cost of crating, labelling, billing, cartage, in fact any and all usual shipping costs.
Deliveries of such swipes are to be made and accepted at the rate of One Thousand Swipes per week beginning in sixty days after the signing of this contract.
TERMS OF PAYMENT.
The purchaser agrees to pay the manufacturer One and 25/100 ($1.25) Dollars net each for said swipes, F.O.B. plant Olympic Products Company, Seattle, Washington; purchaser agrees to pay to the manufacturer1929 BTA LEXIS 2797">*2804 Three Thousand (3,000) Dollars cash on the execution of this contract, said sum being an advance on the entire contract price and to be deducted as hereinafter stated. The purchaser agrees to guarantee to the manufacturer or any person 15 B.T.A. 774">*778 designated by the manufacturer Five Thousand Dollars additional bank credit for said manufacturer, said guarantee to be furnished when requested.
All goods shipped in the first half of any month to be paid for by the purchaser on or before the fifth of the following month, and all goods shipped in the last half of any month to be paid for by the purchaser on or before the twentieth day of the succeeding month at One and 25/100 ($1.25) Dollars net per swipe less proportionate amount of total cash advanced by the purchaser in the ratio that the number of swipes delivered bears to the total number contracted for in this agreement.
It is agreed that the manufacturer will furnish a bond to insure performance of this contract, said bond to be in the sum of $31,250.00.
Time of delivery to be as above stated, subject to fires, strikes, floods, acts of God and other contingencies beyond the control of the manufacturer.
The purchaser agrees1929 BTA LEXIS 2797">*2805 that in the event of a cancellation of this contract becoming necessary for any cause not at the present time foreseen to reimburse the manufacturer on the basis of the manufacturers actual loss as shown by the books and the manufacturer hereby agrees to an adjustment on that basis.
AGREEMENT.
It is agreed that the purchaser will protect, indemnify and hold harmless the manufacturer from any loss arising, directly or indirectly, through any infringement or claim infringements of any existing claim or patents on device similar to the windshield swipe to be manufactured under the terms of this contract.
All disputes which may arise under the terms of this contract to be decided by arbitration and each of the parties hereto to choose one representative; said representatives to choose a third party, the three to act as arbitrators.
During the life of this contract, the purchaser has the option to increase its order from Twenty-five Thousand ($25,000) swipes to One Hundred Thousand (100,000), and in the case of the exercise of the option the purchaser agrees to protect the manufacturer in the case of increase in material costs.
IN WITNESS WHEREOF, the respective parties hereto1929 BTA LEXIS 2797">*2806 have this day set their hands and seals this 2nd day of August, 1922.
OLYMPIC PRODUCTS COMPANY,
By W. H. BORROW, President.
PACIFIC AUTOMATIC DEVICE CO.,
By R. M. FOX, Prest.
I, R. M. Fox, have personally read and understand the contract of the Olympic Products Company with the Pacific Automatic Device Company, and do hereby approve and stand sponser for the Automatic Device Company's faithful performance of their part of same.
R. M. FOX.On August 9, 1922, the United States Fidelity and Guaranty Company executed and delivered to Pacific Company the following contract:
KNOW ALL MEN BY THESE PRESENTS, That Olympic Products Company, a corporation organized under the laws of the State of Washington (hereinafter called the Principal) and the United States Fidelity and Guaranty Company, a corporation created and existing under the laws of the State of Maryland, and whose pricipal office is located in Baltimore City, Maryland (hereinafter called the Surety), are held and firmly bound unto The Pacific Automatic Device 15 B.T.A. 774">*779 Company, Inc., of Portland, Oregon (hereinafter called the Obligee), in the full and just sum of Thirty-one Thousand Two Hundred Fifty1929 BTA LEXIS 2797">*2807 and no/100 ($31,250.00) Dollars, lawful money of the United States, to the payment of which sum, well and truly to be made, the said Principal binds itself, its successors and assigns, and the said Surety binds itself, its successors and assigns, jointly and severally, firmly by these presents.
Signed, sealed and delivered this 9th day of August, A.D. 1922.
WHEREAS, said Principal has entered into a certain written contract with the Obligee, Dated August 2d, 1922: For the manufacture of Twenty-five Thousand (25,000) Automatic Windshield Swipes to conform to the sample furnished by the Pacific Automatic Device Company, Inc. of Portland, Oregon, in accordance with specifications fully set forth in the contract which is attached hereto and made a part hereof. IT BEING FURTHER UNDERSTOOD AND AGREED that this bond covers only the original contract for Twenty-five Thousand (25,000) swipes.
Now THEREFORE, The condition of the foregoing obligation is such that if the said Principal shall well and truly indemnify and save harmless the said Obligee from any pecuniary loss resulting from the breach of any of the terms, covenants and conditions of the said contract on the part of the1929 BTA LEXIS 2797">*2808 said Principal to be performed, then this obligation shall be void; otherwise to remain in full force and effect in law: PROVIDED, however, that this Bond is issued subject to the following conditions and provisions:
FIRST. That no liability shall attach to the Surety hereunder unless, in the event of any default on the part of the Principal in the performance of any of the terms, covenants or conditions of the said contract, the Obligee shall promptly, and in any event not later than thirty days after knowledge of such default, deliver to the Surety at its office in the City of Baltimore, written notice thereof with a statement of the principal facts showing such default and the date thereof; nor unless the said Obligee shall deliver written notice to the Surety at its office aforesaid, and the consent of the Surety thereto obtained, before making to the Principal the final payment provided for under the contract herein referred to.
SECOND. That in case of such default on the part of the Principal, the Surety shall have the right, if it so desire, to assume and complete or procure the completion of said contract; and in case of such default, the Surety shall be subrogated and1929 BTA LEXIS 2797">*2809 entitled to all the rights and properties of the Principal arising out of the said contract and otherwise, including all securities and indemnities theretofore received by the Obligee, and all deferred payments, retained percentages and credits, due to the Principal at the time of such default, or to become due thereafter by the terms and dates of the contracts,
THIRD. That in no event shall the Surety be liable for a greater sum than the penalty of this Bond, or subject to any suit, action or other proceeding thereon that is instituted later than the 9th day of August, A.D. 1923.
FOURTH. That in no event shall the Surety be liable for any damage resulting from, or for the construction or repair of any work damaged or destroyed by an act of God, or the public enemies, or mobs, or riots, or civil commotion, or by employes leaving the work being done under said contract, on account of so-called "strikes" or labor difficulties.
FIFTH. (a) That the Surety shall not be liable for damages for injuries to the person of anyone, under or by authority of any statutory provision for damages or compensation to any employe, or otherwise; and
(b) Shall not be obligated to furnish any1929 BTA LEXIS 2797">*2810 bond or obligation other than the one executed.
15 B.T.A. 774">*780 IN TESTIMONY WHEREOF, the said Principal has caused these presents to be sealed with its corporate seal, attested by the signature of its duly authorized officers, and the said Surety has caused these presents to be sealed with its corporate seal, duly attested by the signature of its Attorney-in-fact, the day and year first above written.
Under the above contracts, the Pacific Co. advanced to the Olympic Products Co. the following amounts on the following dates:
| August 7, 1922 | $3,000 |
| September 9, 1922 | 1,000 |
| September 25, 1922 | 4,000 |
| November 13, 1922 | 3,500 |
| December 23, 1922 | 6,500 |
| January 26, 1923 | 2,500 |
| January 29, 1923 | 1,500 |
| 22,000 |
The amount of $2,500 advanced on January 26, 1923, represented the amount paid by the Pacific Co. on a sight-draft of the Olympic Products Co. dated January 20, 1923, and the amount of $1,500 advanced January 29, 1923, represented by a 90-day note of the Pacific Co., payable to the Olympic Products Co., which was used by the Olympic Products Co. for the purpose of raising funds. On the date said draft for $2,500 was paid, the Pacific Co. executed to petitioner1929 BTA LEXIS 2797">*2811 its note for said amount and on the day it issued the above note for $1,500, to wit, January 29, 1923, it executed to petitioner its note for said amount. None of the above amounts was advanced on the credit of Olympic Products Co. and all were advanced on the security of the surety bond. Petitioner was president and the financial backer of the Pacific Co. The Olympic Products Co. began to make deliveries of the swipes for which they had contracted in November, 1922, and continued to make deliveries during January, 1923. Said swipes were unsatisfactory through no fault of the Pacific Co., but the reason of the way in which they were made. The Pacific Co. at once placed the swipes upon the market, but sales were unsatisfactory and many of those which were sold were returned.
During the year 1922 the Pacific Co. borrowed from petitioner including the notes above set forth, the total amount of $25,083.59, and during the year 1923 the Pacific Co. borrowed from petitioner the total amount of $5,106.13. The total amount borrowed by said company during both years from petitioner was $30,189.72, of which amount he charged off $7,283.59 in 1922 and $15,000 in 1923. On December 31, 1922, the1929 BTA LEXIS 2797">*2812 total indebtedness of the company, including the amounts owing to petitioner, was around the sum of $35,000. At the end of 1922 the Pacific Co. had on its books accounts receivable and swipes of the approximate value of $4,000. The swipes were 15 B.T.A. 774">*781 eventually sold in the year 1924 for the total sum of $2,427.04. In a proceeding in the courts of the State of Washington a receiver was appointed for the Olympic Products Co. in February, 1923, and in March, 1923, it was adjudged a bankrupt in proceedings instituted in the District Court of the United States in and for the Western District of Oregon, Northern Division. The Pacific Co. did not engaged in active business subsequent to the failure of the Olympic Products Co. The financial condition of the Pacific Co. was worse at the end of the year 1923 than it was at the end of 1922.
On February 15, 1923, the United States Fidelity & Guaranty Co. wrote the following letter to the Pacific Co.:
GENTLEMEN:
Re: Olympic Products Company our bond dated August 9, 1922.
This company hereby consents that you may further advance to the olympic Products Company the sum of $7,000 under contract dated August 2nd, 1922, to which1929 BTA LEXIS 2797">*2813 contract our bond dated August 9th, 1922, refers, it being understood that neither yourselves nor the undersigned are to be deemed prejudiced in any way by such advancement, and that excepting as above agreed yourselves and ourselves reserve all rights under said contract and said bond.
The Pacific Co. refused to make further advances to the Olympic Co.
On the 25th day of February, 1924, the Pacific Co. filed its complaint in the District Court of the United States in and for the District of Oregon against the United States Fidelity & Guaranty Co.The Olympic Products Co. was not a party to said action. The Pacific Co. in said complaint made the following allegations:
That between the 1st and 15th days of August in the year 1922 aforesaid Olympic Products Company and the United States Fidelity & Guaranty Company, the defendant herein, jointly and severally promised, covenanted and agreed in writing with the plaintiff that they, or one of them, would, and both should, but neither of them did, assemble all raw material and therefrom manufacture and deliver twenty-five thousand (25,000) automatic windshield swipes, to conform to the sample furnished by Pacific Automatic Device1929 BTA LEXIS 2797">*2814 Company, of Portland, Or., in accordance with the specifications thereabout fully set forth therein and attached thereto and made a part thereof; that said swipes were known as the Brownie windshield swipe and when so delivered were to be packed separately in paper carton boxes at the rate of one thousand (1,000) swipes per week from and after the 2d day of October, 1922, for the sum of one dollar and 25/100 ($1.25) each, with the privilege and option to increase the number of swipes to be furnished to one hundred thousand (100,000), upon and pursuant to which plaintiff was to advance, and did advance, certain and various sums of money which were received and accepted at the dates and times as hereinafter mentioned, but the said defendant did not, and Olympic Products Company did not make and deliver said swipes or any of them.
By its complaint the Pacific Co. sought to recover of the defendant the total sum of $51,330.66, made up of the following items: advancements, 15 B.T.A. 774">*782 $22,000; other money expended, $2,247.27; interest, $2,083.39; and damages for loss of profits, $25,000.
Said cause came on to be heard in the said United States District Court in December, 1925, whereupon1929 BTA LEXIS 2797">*2815 a jury was impaneled and evidence was heard. At the conclusion of complainant's evidence, the defendant moved for a directed verdict and on December 22, 1925, the court granted said motion and adjudged that complainant take nothing by its action. Thereafter, the Pacific Co. took its cause on writ of error to the United States Circuit Court of Appeals, Ninth Circuit. Said cause was heard, and on October 25, 1926, the judgment of the District Court was affirmed. Thereafter, the Pacific Co. filed its petition for rehearing and said petition was denied November 15, 1926. See . At the time said suit was filed in the District Court the Pacific Co. had no cash and the entire expense of the suit was paid by petitioner.
OPINION.
MILLIKEN: Petitioner's only complaint is that respondent has determined that he was not entitled to deduct, as worthless debts, certain debts which he alleges to have been worthless in the years 1922 and 1923, respectively, which he charged off during said years. The applicable part of the Revenue Act of 1921 is section 214(a)(7), which reads:
SEC. 214. (a) 1929 BTA LEXIS 2797">*2816 That in computing net income there shall be allowed as deductions:
* * *
(7) Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.
The burden rests on petitioner to establish by the preponderance of the evidence that respondent has erred. Petitioner alleges that his debt against the Pacific Co., to the extent of $7,283.59, became worthless in the year 1922 and that he charged off that amount in that year.
Testifying as to the debts of the Pacific Co. which he sought to deduct in his return for the year 1922, petitioner said:
Q. What the court is interested in is what you did about these items and how. How do you know these are worthless? How did you ascertain them to be and what are the surrounding facts which cause you to take it off as you did as taxapayer?
A. The Pacific Automatic Device Co. along before the time they made up that report was absolutely insolvent. They had no money and the device that had been manufactured for1929 BTA LEXIS 2797">*2817 them was unworkable because of the manufacturers making a change in the model without our knowledge, and by refusal to accept 15 B.T.A. 774">*783 them that way and insisting on him remanufacturing them, he did not have the money to do it, could not manufacture them and he had gone in the hands of the receiver, and the company had no money to pay any men to continue the business, and they owed me a large lot of money, and there was no expectation at that time we could get any salvage.
Here it appears that the most vital fact with respect to the alleged worthlessness of these notes did not happen until after the close of the taxable year. It is absolutely essential under the facts of this case that petitioner should have ascertained these debts to be worthless prior to January 1, 1923. What may have occurred in 1923 in this respect is immaterial to the question involved.
It appears that, prior to the date of the contract with the Olympic Products Co., petitioner had advanced to the Pacific Co. amounts which reach the total of $4,283.59, and that of this amount the sum of $2,263.25 was advanced to that company in the month following its incorporation. We are not informed as to the basis1929 BTA LEXIS 2797">*2818 of these credits. This corporation had a capital stock represented by 200 shares, and yet we are not advised as to the par value of each share, much less what was the value of its paid-in or subscribed capital, all of which was liable for the debts of the corporation. The books of the company do not appear to have been lost, and simple balance sheets as of the date of its incorporation and as of December 31, 1922, would have cleared up at least some of the doubts which hang over these transactions. Petitioner was not dealing with the corporation at arm's length. He owned 99 out of 200 shares of its capital stock, was at all times its president and was, as he testified, its "financial backer." All necessary information was readily accessible to him.
The only witnesses introduced at the hearing were petitioner, himself, and the secretary of the Pacific Co. The secretary testified that the total loans by petitioner to the Pacific Co. during the year 1922 amounted to $25,083.22, and that petitioner's loans to the Pacific Co. during 1923 amounted to $5,106.13. On direct examination this witness testified:
Q. Tell the court briefly what you know about these transactions were1929 BTA LEXIS 2797">*2819 handled which culminated into notes in 1922 of the amount you read, of $25,000 odd. Just state briefly and openly what happened and what you did.
A. Well, this was money that was advanced to the company to buy merchandise in stock or trade that we had to advance money, or to buy raw material for the factory to manufacture.
Q. Was that relative to swipes of the Olympic Products Company?
A. Yes.The above testimony is in direct conflict with the purport of certain of the notes filed in this proceeding, which show that petitioner advanced to the Pacific Co. the amount of $4,283.59 before any contract 15 B.T.A. 774">*784 was entered into between that company and the Olympic Products Co. The record in the Circuit Court of Appeals shows that the Pacific Co. in its complaint against the United States Fidelity & Guaranty Co., hereafter called the Surety Co., alleged that the total advances made by the Pacific Co. to the Olympic Products Co. during 1922 amounted to $18,000. It may be that the remainder of the loans was used in some way in connection with that contract, but if so and how, we are not informed.
Petitioner is insistent that all advances made by him were occasioned1929 BTA LEXIS 2797">*2820 by the payment of trade acceptances of the Olympic Products Co. upon which he became liable before maturity, and in this connection stated that he advanced no money to the Pacific Co. in 1923 for which he was not obligated in the year 1922. The facts as found show that at least a large part of the money advanced by petitioner to the Pacific Co. was not by reason of prior obligations, but was advanced concurrently with the execution of the notes to him and without prior obligation on his part. Besides, the record in the Circuit Court of Appeals clearly indicates that as late as December 23, 1922, the Pacific Co. advanced to the Olympic Products Co. the sum of $6,500, without previous obligation, and that petitioner's note which represents this amount is dated December 27, 1922, or four days after the money was advanced. Thus we find that petitioner as late as December 27, 1922, was advancing to the Pacific Company for the benefit of the Olympic Products Co., as much as $6,500, or about 36 per cent of the total amount of advancements made to the Olympic Products Co. during the whole of the year 1922. This is not all that is disclosed by the record of the Circuit Court of Appeals. 1929 BTA LEXIS 2797">*2821 In the proceeding in the District Court, the Pacific Co. alleged in its complaint that it had advanced to the Olympic Products Co. the total amount of $4,000 in January 1923, and that record further discloses that this was advanced without any previous obligation on its part. In fact, $1,500 of this amount was advanced on a sight draft.
The reason why these advancements were made in December, 1922, and January, 1923, despite the fact that the swipes which had been furnished during November and December were not up to contract specifications, is of easy ascertainment. Petitioner was relying on the bond of the surety company. Relative to this, he testified on cross-examination as follows:
Q. Tell me about this bond that has been mentioned here.A. Before I would enter into a contract with this concern, because they were not strong financially, the Olympic Products Company, they had been in business for years in Seattle, but they needed money to buy the material. we were entering into a contract for 25,000, and in order to get the price they had to buy, to buy the material in large quantities.
15 B.T.A. 774">*785 Q. Yes.
A. They required more capital than he had, and if1929 BTA LEXIS 2797">*2822 we will give either money or credit to a certain extent so we can buy this raw material, we will make you this price. I did not advance the money until I had secured it. I did have a bond from them, what I assumed to be, and it is so taken by a responsible bond house, and they went on investigating the workability of the model, but the possibility of the people to manufacture - they agreed to give me a bond for the performance of that contract to the extent of some $31,000, which was the cost to me of the swipes and in the event I advanced them the full cost of manufacture I would still be protected.
Q. In other words, so that you could not lose this money you were advancing?
A. That was exactly it. Q. So that the advances you made were not really unsecured? A. No. Q. You had a bond of a responsible surety company? A. Yes. Q. U.S. F & G? A. Yes.Again, he testified on cross-examination:
Q. So that I may be clear in my own mind and counsel may understand for purposes of redirect examination, you had the Pacific Automatic Device Company responsible to you for the money you had advanced first, did you, and later the surety company? Is that so?
1929 BTA LEXIS 2797">*2823 A. I do not follow you exactly. You mean not as to time but so far as the security, I had the Pacific Automatic Device Company and second the bond?
Q. Yes. A. Yes. Q. You had a dual security? A. Yes. Q. Or guarantee for the money you had advanced? A. Yes.It is true that the swipes which Olympic Products Co. began to deliver in November, 1922, did not prove salable, but this was the fault of the Olympic Products Co. and a default which was protected by the surety bond. There is nothing in the record that indicates that at any time during the year 1922 the surety company in any way denied its liability. On the contrary, as late as February, 1923, it was offering to grant to the Pacific Co. authority to advance to the Olympic Products Co. the additional amount of $7,000.
Petitioner cites , and . These cases bear no analogy to the questions here involved. In the White Dental Co. case the property of the taxpayer had been sequestered by the German Government, with which our country was then at war. The White Dental Co. did not1929 BTA LEXIS 2797">*2824 rely on the German Government for payment. In fact, it at that time expected no payment. The property, as pointed out by the Supreme Court, was to all intents lost to the White Dental Co. in the year 1918, and what the taxpayer might then 15 B.T.A. 774">*786 expect to recover was largely a matter of grace on the part of the German Government. In the Hart-Wood Lumber Co. case we said:
In the year 1920, Rae owed the petitioner $9,999, and had no resources. He disappeared in May and sent the petitioner a message that he proposed to commit suicide. The petitioner held an insurance policy on the life of Rae taken out in March of 1920, in which it was designated as the beneficiary. The Commissioner does not dispute that Rae was unable to pay or that, as to him, the debt was worthless, but contends that the life insurance policy was security for such debt in the amount of $5,000, and that, to that extent, the debt was not worthless in the taxable year. The ultimate recovery of any part of the debt by the collection of the insurance policy depends on so many contingencies that it is hardly possible to regard such policy as security of any value. There may be a clause in the policy providing1929 BTA LEXIS 2797">*2825 for cancellation in the event of suicide within twelve months of its issue. If death is not proved, seven years must elapse before it can be conclusively presumed. Calif. Code of Civil Procedure, 1923, sec. 1963, subdiv. 26. During such seven years the petitioner must keep the policy alive by the payment of annual premiums. Rae may not be dead or may reappear before the end of the seven-year period. We are of the opinion that the petitioner is entitled to deduct the entire amount of $9,999 from its gross income in its income and profits-tax returns for 1920.
In the instant case, petitioner was relying on the surety bond, the premiums for which had been paid. It is at once obvious that there is a vast difference between relying on a policy of life insurance, the premiums on which are payable annually, and where it was not known whether the debtor was dead or alive, and in relying upon a policy of insurance which was in full force and effect and without which no contract would have been executed with the Olympic Products Co. Since petitioner advanced money to the Pacific Co. on the faith of the bond of surety company, and since that bond was in full force and effect at the1929 BTA LEXIS 2797">*2826 end of 1922, we are unable to find on the evidence adduced at this proceeding that respondent erred in denying these deductions.
What we have said with reference to the debts of the Pacific Co. applies to a large extent to the debts of Patterson. Patterson was vice president of the Pacific Co. and owned 96 shares of its capital stock, and of this amount 93 shares were pledged to secure one of his notes to petitioner. As pointed out, we have been furnished no evidence as to the value of these shares. Whatever may have been lost by the Pacific Co. in 1922 by reason of the contract with the Olympic Products Co. was, so far as we are informed, recoverable on the surety bond at least to the extent of $31,250. Patterson did not leave the State of Washington until some time in 1923. The mere fact of his leaving the State is not of itself evidence of the worthlessness of his notes. It is not hinted that his departure was surreptitious, and it is not shown what his earning capacity was or might have been in the future.
15 B.T.A. 774">*787 The respondent's action with respect to the deduction of these notes is affirmed.
When we come to the end of the year 1923 a different picture is presented. 1929 BTA LEXIS 2797">*2827 The Pacific Co. had then ceased to do business, except to wind up its affairs. Its swipes had proved unmarketable. The Olympic Products Co., which manufactured the swipes and which existed only by reason of the financial assistance afforded by the Pacific Co., had become a bankrupt. As early as February 15, 1923, the Pacific Co. had refused the offer of the Surety Co. to the effect that the Pacific Co. might, without prejudice to its rights under the surety bond, advance the Olympic Products Co. the sum of $7,000. Except its claim against the Surety Co., the assets that remained to the Pacific Co. were swipes which had only junk value, and accounts receivable, both of which items had a then value of approximately $4,000. Its liabilities were over $35,000, of which there was due petitioner about $30,000. Of this amount petitioner charged off in 1923 only $15,000, leaving due him approximately the same amount, of which, as above shown, he attempted to deduct as of 1922 the total amount of $7,283.59. We are now concerned only with the amount charged off in 1923 and sought to be deducted from the gross income for that year. It is at once evident that, unless something could be1929 BTA LEXIS 2797">*2828 recovered from the Surety Co., petitioner's debt was worthless in 1923 in an amount largely in excess of the sum sought to be deducted in that year. Nor do we think it material that petitioner seeks to deduct the whole amount of each note, rather than a part thereof. His total debt was represented by all the notes and under the provisions of section 214 of the Revenue Act of 1921 he had the right to deduct so much of his total debt as he had ascertained to be worthless. This amount he placed at the sum of $15,000, and it is therefore of no importance that this amount precisely represents the principal of certain notes. It may be stated here that endorsements of interest on the notes were made by a clerk without the knowledge of petitioner. He testified that if he had known of this matter he would have had the money received (which in fact arose from the sale of junk swipes) applied as payments on other notes which he had neither charged off nor sought to have deducted either in the year 1922 or the year 1923. We are of opinion on the facts presented by the record that petitioner's debt against the Pacific Co. was worthless and was ascertained to be worthless in 1923 to the extent1929 BTA LEXIS 2797">*2829 of $15,000, unless petitioner then believed and had reasonable ground to believe that the Pacific Co. could recover on the surety bond.
The surety bond provided that the Surety Co. should not be "subject to any suit, action or other proceeding thereon that is instituted 15 B.T.A. 774">*788 later than the 9th day of August A.D. 1923." Such a provision is legal and enforceable unless waived by the insurer. Cooley's Briefs on Insurance Law, vol. IV, pp. 3964 and 3989. Not only was no suit brought on the surety bond prior to August 10, 1923, but no suit has ever been brought on the bond. The suit that was filed was based upon an entirely different contract. This fact is disclosed by the excerpt we have made in our findings of fact from the complaint and by the opinion of the Circuit Court of Appeals in .
After setting forth the allegations of the complaint, to which we have just referred, the court said:
The contract thus pleaded was denied by answer, and at the close of the testimony the court below directed a verdict for the defendant. The judgment on the verdict is now1929 BTA LEXIS 2797">*2830 before us for review. It was conceded on the trial, and is conceded now, that the present action was not on the bond. Indeed, this is manifest because the bond is in no wise referred to in the complaint. The theory of the case, as advanced by counsel for the plaintiff in error in his brief, is this:
"The theory of the action and foundation of legal liability was that a contract and bound had been executed and given together as one entire transaction constituting a joint and several primary obligation shown by the documents themselves and accompanied with the surrounding facts, circumstances, acts, and transactions of the parties between themselves with subsequent correspondence evidenced and established the liability of defendant in error jointly with its principal to the plaintiff in error to answer for and pay the pecuniary loss sustained by the plaintiff in error; and that this was the whole governing intention of the transaction and the gist of the action."
But the record utterly fails to show that the defendant in error executed any contract in writing or otherwise, such as is set forth in the complaint, or any contract of any kind, other than the indemnity bond to1929 BTA LEXIS 2797">*2831 which we have referred, and the contention that a surety on such a bond becomes a party to the original contract between the principal and the obligee in the bond and assumes all obligations of that contract, regardless of the conditions, provisions and limitations contained in the bond or indemnity contract, finds no support in reason or authority. The contract of the defendant in error was one of indemnity only, and the obligation it assumed must be measured by the terms of the indemnity contract to which it was a party, not by the terms of some other contract to which it was not a party. Of course, the question of liability on the bond is not before us; but it would seem entirely plain that the surety incurred no obligation in any event beyond the penalty of the bond, and that a breach of the conditions and provisions of the bond would release it unless waived. This, it would seem, shows the absurdity of the contention that the surety was bound absolutely and unconditionally by the terms of the contract between the manufacturer and the purchaser without limitation even as to the amount. Had the bond been for $1, instead of for $31,250, the same contention might1929 BTA LEXIS 2797">*2832 be made.
For these reasons, the court below correctly ruled that there was a failure of proof, and its judgment is affirmed. (Italics supplied.)
What impresses us with reference to this suit wasits utter futility. The Pacific Co. and petitioner, who sponsored and paid the expense 15 B.T.A. 774">*789 of this suit, evidently recognized that no suit could be successfully maintained against the Surety Company on its bond and therefore they brought their suit on a contract which had no existence except in their imaginations. We feel at liberty to make this statement in view of the unusually vigorous language used by the Circuit Court of Appeals in discussing the contentions of the plaintiff.
With the right to sue on the bond apparently barred after August 1923, petitioner must have been an "incorrigible optimist" to have had any reasonable expectation of recovering anything against the surety company. cf. .
In , the reverse of the instant question was presented. There a corporation of similar name owed the Chicago, Rock Island & Pacific Railway Co. about $5,900,000. 1929 BTA LEXIS 2797">*2833 This debt was charged off by the railway company in 1915 and a deduction was taken therefor in its income-tax return for that year. At the time of the charge-off, the debtor corporation was insolvent and the debt in so far as it was concerned was worthless. Before the debt was charged off several stockholders of the railway company sued its directors for the whole amount of the loss. After long and fruitless litigation the claim of the stockholders in behalf of the railway company was by agreement settled in the year 1917 for less than one-eleventh of the amount of the principal of the claim. The railway company, in its proceeding before the Board, attempted to transfer the loss of its debt from the year 1915 to the year 1917 on the ground that its debt was not worthless in the former year, when it was charged off and deducted. This contention was denied for the reason that the railway company was well within its rights in taking the deduction in 1915, since its debtor was then insolvent, and its debt was worthless as against its debtor, and for the further reason that the suit against the directors had no real merit. The same rule should apply to this case. We should determine1929 BTA LEXIS 2797">*2834 income-tax liability on the basis of reality and not of extravagant hopes. . Petitioner in 1923 determined that the debt against the Pacific Co. was worthless to the extent of $15,000 and charged off that amount. There was ample justification for the action he took and his judgment has been verified by subsequent events. His right of deduction should not be denied him for the sole reason that he financed a suit against the surety company brought on a mythical contract. He was, to use the vernacular, throwing good money after bad.
We are of opinion that petitioner should be allowed to deduct from his gross income for 1923 his debt against the Pacific Co. to the extent of $15,000, the amount charged off in that year and claimed in his petition.
Judgment will be entered under Rule 50.