1930 BTA LEXIS 2064">*2064 1. An amount paid by a corporation in settlement of a suit brought against its officers on account of their alleged wrongdoing, held not to constitute an ordinary and necessary expense of the corporation.
2. An amount paid by a corporation, which was the lessee of certain oil-producing property, in settlement of a suit brought against it and others, in which the plaintiffs sought to have title to the property quieted and to be declared the fee owners of the property as well as to have damages awarded on account of mesne profits and waste committed, held not deductible as an ordinary and necessary expense of the corporation.
20 B.T.A. 661">*662 This proceeding involves deficiencies in income tax as determined by the Commissioner for the calendar years 1923 and 1924 in the respective amounts of $32,502.09 and $8,188.99. Of the foregoing amounts, petitioner admits liability for 1923 to the extent of $27,135.01 and for 1924 to the extent of $931.37, leaving the respective differences in controversy. The error assigned1930 BTA LEXIS 2064">*2065 for 1923 is the disallowance by the Commissioner of a deduction with respect to an amount paid by the petitioner on account of the settlement of a suit brought against certain directors and an attorney of petitioner, and the issue for 1924 is whether an amount paid by the petitioner in that year in settlement of a suit brought against petitioner on account of certain property then held by it under a lease constituted an ordinary and necessary expense, as contended by the petitioner, or whether it is to be considered a capital expenditure, as contended by the Commissioner.
FINDINGS OF FACT.
The petitioner is a corporation with its principal office in Cushing, Okla., and is engaged in the production and sale of oil and gas.
In 1923 an option agreement was entered into between certain stockholders of the petitioner and S. A. Guiberson under the terms of which Guiberson was given the option to purchase all of the stock held by these stockholders at a certain price, within a specified time, and under certain terms and conditions. At the time the agreement was entered into the petitioner had approximately 382 stockholders, of whom approximately 86 were parties to the agreement. 1930 BTA LEXIS 2064">*2066 One provision of the agreement was that, in case the purchase as outlined should be carried out, the stockholders involved would pay to J. E. Carr and J. M. McLeod a commission of 5 per cent based on the total price paid by the purchaser for the stock bought.
When the proposed sale was not carried out, Carr and McLeod brought suit for $112,500, the commission which they alleged they would have been entitled to have received had the transaction been carried out. A petition was filed in the United States District Court for the Western District of Oklahoma and named as defendants ten individuals who, the petition alleges, were directors of, and large stockholders in, the Blackwell Oil & Gas Co. except as to two individuals. Of these two individuals, it was alleged that one was a brother-in-law of the president of the Blackwell Oil & Gas Co. and did himself desire to secure control of the said Blackwell Oil & Gas Co. The other individual was an attorney for the Blackwell Oil & Gas Co. The said petition, after alleging the terms of the option agreements and the compliance, or readiness to comply, therewith on the part of Carr and McLeod and/or the parties whom they represented in1930 BTA LEXIS 2064">*2067 the acquisition, alleged that the defendants entered into a conspiracy and combination with malicious intent which prevented 20 B.T.A. 661">*663 the carrying out of the transaction. Various acts of fraud and misrepresentation on the part of these individuals were set out in the petition. Before the suit came to be heard a compromise was entered into between the parties, under which it was agreed that the plaintiffs therein would be paid $42,936.66, and the suit was dismissed on this basis. Prior to the dismissal of the suit, but after the suit had been begun, the board of directors of the petitioner adopted a resolution, which, after making certain statements with respect to the filing of the suit, read in part as follows:
AND WHEREAS said defendants are either directors or stockholders of The Blackwell Oil and Gas Company, except H. S. Gurley who was the attorney for The Blackwell Oil & Gas Company at the time complained of in said petition and is now the attorney for the company.
AND WHEREAS all of the parties named as defendants in said suit were acting for the benefit and in the interests of the Blackwell Oil & Gas Company and its stockholders and were acting in line and within1930 BTA LEXIS 2064">*2068 the scope of their several duties in the several matters complained of in said petition.
AND WHEREAS the Blackwell Oil & Gas Company recognizes that it is its duty to pay all costs and expenses of said litigation which said defendants may incur therein and to hold them severally harmless from any judgment which may be finally rendered in said action against them or either of them or in any other action which may be prosecuted against them or either of them by reason of the things complained of in said petition.
The resolution then set out that petitioner would pay all costs and expenses and any judgment that might be rendered on account of such suit. After the suit was settled, the petitioner paid $42,936.66 in 1923 in full settlement of the suit, which amount is now claimed as a deduction by the petitioner as an ordinary and necessary expense, and this deduction has been disallowed by the Commissioner.
During the years 1923 and 1924 petitioner did not employ a geologist or have a geological department, but the work usually performed by such an individual, or individuals, was performed by the president and directors of the petitioner. Petitioner was engaged in extensive1930 BTA LEXIS 2064">*2069 development work during 1923. Its development costs from 1920 to 1923, inclusive, were as follows:
| 1920 | $159,364.38 |
| 1921 | 137,149.34 |
| 1922 | 150,960.85 |
| 1923 | 569,183.42 |
The net profits and losses as shown by petitioner's books from 1920 to 1922, inclusive, and as determined by the Commissioner for 1923 and 1924, were as follows:
| 1920, profit | $23,057.77 |
| 1921, loss | 95,164.36 |
| 1922, loss | 149,291.66 |
| 1923, profit | 279,208.25 |
| 1924, profit | 569,298.75 |
20 B.T.A. 661">*664 In 1923 Michael Corrigan and others brought suit against the petitioner and various other corporations and individuals, in which it was alleged that the plaintiffs were owners in fee simple of certain real estate and that the defendants (except one individual) were claiming estates or interests in the property adverse to the plaintiffs and were unlawfully keeping the plaintiffs out of the possession thereof. It was further alleged that such estates or interests of the defendants were without right or foundation and that such defendants were committing waste with respect to such property and were engaged in taking oil and gas therefrom in large quantities and converting the same to their1930 BTA LEXIS 2064">*2070 own use. The plaintiffs asked for judgment in the amount of $5,000 on account of mesne profits and in the amount of $500,000 on account of waste committed, and further asked that the plaintiffs be declared owners in fee simple to the property and that title be quieted with respect thereto.
Before the foregoing suit was heard, settlement was effected between the parties in 1924 through the payment to the plaintiffs of approximately $70,000, of which amount petitioner was required to pay $58,061.01. The foregoing amount of $58,061.01 was paid by the petitioner in 1924.
During 1923 petitioner was operating properties involved in the foregoing suit under a lease and during that year the production from such properties was 364,764.1 barrels of oil. The oil thus produced was selling for approximately $1.75 per barrel.
The petitioner claimed the aforementioned amount of $58,061.01 as a deduction in determining net income, which deduction has been disallowed by the Commissioner.
The petitioner's policy was to settle suits brought against it, in so far as possible, without recourse to court procedure, so that its officers and directors might have more time to devote to its1930 BTA LEXIS 2064">*2071 development work and business operations.
OPINION.
SEAWELL: The first issue is whether an amount paid by the petitioner in 1923 in settlement of a suit brought against its directors and attorney on account of certain alleged acts of wrongdoing on their part constitute a deduction as an ordinary and necessary expense of carrying on the petitioner's business. In whatever manner we view the question, we fail to see how the deductibility of the item can be sustained. The petitioner was not a party to the suit, and the acts complained of were acts of certain individuals therein named and not acts of the petitioner. That a corporation is separate and distinct from its stockholders is too well established to require a citation of authority in support thereof. But even if it could be said that the acts alleged to have been done were 20 B.T.A. 661">*665 acts of the corporation through its directors, payments on account of such malicious act of wrongdoing could hardly be said to be ordinary and necessary expenses of producing and selling oil and gas. The fact that the directors of the corporation adopted a resolution to the effect that the acts in question were done in the interest of the1930 BTA LEXIS 2064">*2072 petitioner and by its officers in their corporate capacity, and that the petitioner accordingly recognized its obligation to make payment on account thereof, means little when we consider that the individuals against whom the suit was brought were likewise the petitioner's directors. One of the arguments of the petitioner in support of the deduction is that this payment enabled it to continue with its development program without having its officers harassed by a lawsuit, but if looked at in this manner as somewhat in the nature of additional compensation for services performed by the individuals against whom suit was brought, there is no evidence that these individuals were not otherwise reasonably compensated for the services rendered, and this is all the statute allows as a deduction. In view of the foregoing, we are of the opinion that the action of the Commissioner in disallowing the deduction claimed should be sustained.
Under the second issue the petitioner contends that it should be allowed a deduction for 1924 in the amount of $58,061.01 paid in that year in the settlement of a suit brought against it and others with respect to the title to certain property then being1930 BTA LEXIS 2064">*2073 operated under a lease by the petitioner and for an accounting for the prior oil production. We have little evidence as to the respective interests of the defendants in the properties involved in the suit other than what may be shown in the petition which formed the basis of the plaintiffs' suit, though it would appear that whatever right the petitioner herein had to remove oil from the ground was derived from its lessor, and the plaintiffs were claiming the fee simple to the property and questioning all right of the defendants with respect thereto. Whether, therefore, the petitioner could continue its operations under its lease was involved in the settlement of the controversy. What the plaintiffs asked was that title to the property be quieted, that they be decreed to be the fee owners to the property, and that they be awarded damages of $5,000 on account of mesne profits and $500,000 on account of waste committed. The suit was compromised through the payment of $70,000, of which the petitioner paid $58,061.01, and we know nothing as to the basis upon which the amount paid was arrived at. In view of the foregoing, and when we consider the record as presented, we fail to1930 BTA LEXIS 2064">*2074 see why this does not come squarely within the decision of , wherein the Board said:
20 B.T.A. 661">*666 To the extent that the expenses and payment were incurred and made in defense of the claim against the oil properties, they were capital expenditures. We have repeatedly held that the cost of defending title, whether in the form of legal fees or compromise payments, is a capital expenditure representing additional cost of the property. ; ; ; Frederick McLean Bugher, supra; ; . The decisions in Kornhauser v.United States, supra, and the , which are relied upon by the petitioner, are not in conflict with these cases. In the Superheater case the contemplated litigation grew out of an action of the board of directors, acting as such. The claim settled did not involve title. In the Kornhauser case the legal1930 BTA LEXIS 2064">*2075 expenses were incurred to contest a claim against income received, differing fundamentally from the ordinary attack on title, even though the income in question consisted of shares of stock.
In view of such conclusion we must reject petitioner's contention that the total deductions claimed should be allowed. We can not allow the total and it would be idle for us to further consider whether any part of such total (i.e., that portion allocable to the defense and settlement of the claim for accounting) is allowable as the record furnishes no basis for the apportionment of the whole among the several claims defended or settled.
In any event, it would seem that a reasonable view of the payment would be that the benefits derived therefrom - at least for a part of the payment - extended beyond the year of payment and enabled the petitioner to continue the use and enjoyment of its rights in the property. A successful defense of the suit was vital to the continued operations under the lease not only for 1924, but also for other years as well. We are accordingly of the opinion that the action of the Commissioner in disallowing the deduction should be sustained.
Judgment will be1930 BTA LEXIS 2064">*2076 entered for the respondent.