*1098 Petitioner and a number of other corporations, banks, and individuals engaged in business in St. Louis, in December of 1931, signed an instrument of guaranty and deposited with one of the banks an aggregate of $2,000,000 to induce it to take over the assets and assume the liabilities of another bank, which was on the verge of being closed because of its inability to withstand a silent "run" and to meet withdrawals of $1,000,000 per day. The deposit was made to avert the probable loss of accounts receivable and other adverse effects upon petitioner's business, which it was felt would follow from the closing of the fourth largest bank in the community. The amounts were to be returned to the depositors in the event no loss was sustained by the absorbing bank, and they received interest thereon until 1936, when appraisals disclosed that the unliquidated assets would be insufficient by more than $2,000,000 to satisfy the liabilities of the absorbed bank. The deposits were then applied under the guaranty agreement. Held, that the expenditure was made by petitioner for the protection of its business and is deductible as an ordinary and necessary business expense under the provisions*1099 of section 23(a) of the Revenue Act of 1936.
*1119 The respondent determined a deficiency in petitioner's income tax for the year 1936 in the amount of $3,825.74. The sole issue is: May petitioner deduct from its gross income for 1936 the sum of $12,451.58 paid by it under the circumstances hereinafter set out? Most of the facts were stipulated.
FINDINGS OF FACT.
Petitioner is a Missouri corporation and throughout the period from 1931 through 1936 and at all times material herein was engaged in the business of manufacturing and selling shipping containers. Its principal office was located in the city of St. Louis, Missouri, and a *1120 large portion of its business was done with customers located in and near that city.
In 1931 the Franklin-American Trust Co. (hereinafter referred to as Franklin-American) was a bank and trust company created and existing under the laws of the State of Missouri. It was one of the four leading banks in St. Louis.
During December 1931 the banking situation in St. Louis was acute, many depositors*1100 were worried over the safety of their deposits, and runs on banks were frequent. During the latter part of December 1931 Franklin-American experienced a "silent run", withdrawals of approximately $1,000,000 a day in excess of deposits being made.
The Finance Commissioner of Missouri examined into the business and affairs of Franklin-American and, having found that it would probably be unable to pay its current liabilities, informed its officers and members of the St. Louis Clearing House Association that, unless it could forthwith be merged or consolidated with some other bank, or unless its liabilities were assumed by some solvent bank in the city of St. Louis, he must order it to be closed and appoint a receiver to liquidate it.
In order to avert the serious financial crisis which would result from the closing of Franklin-American and the appointment of a receiver, the First National Bank of St. Louis (hereinafter referred to as First National) was urged to take over the assets and assume the liabilities of Franklin-American. The First National was unwilling to do so unless it should receive guaranties against loss in an amount aggregating $2,000,000. It agreed, however, *1101 that, if it were furnished guaranties against loss in that amount, it would take over the assets and assume the liabilities.
At a meeting held on December 21, 1931, the member banks of the St. Louis Clearing House Association agreed to participate in such a guaranty fund to the extent of $1,250,000. This being $750,000 less than the amount required by the First National, on December 21, 1931, officers and representatives of other business in St. Louis, including the petitioner herein, were called together and informed of the whole situation and the terms and conditions under which First National would be willing to assume Franklin-American's liabilities. The vice president of First National and president of the St. Louis Clearing House Association informed the business men that the general banking situation was quite acute; that Franklin-American would be unable to open the following morning unless the guaranty could be had; that if it were allowed to fail it would seriously affect all business, industry, and banking in the city; and that the members of the Clearing House feared the failure of Franklin-American would result in a general run on the various banks in the *1121 *1102 city and possibly in the failure of some of them. He also stated that while First National was requiring, as a matter of protection, the guaranty of $2,000,000 before it would agree to take over the liabilities of Franklin-American, an examination of its assets and liabilities by the Clearing House examiner indicated that the loss which would be sustained would be covered by the capital and that there probably would be no occasion to require payment by those two subscribed to the "guaranty fund."
The following "Instrument of Guaranty" was prepared and ultimately signed by approximately sixty corporations and individuals:
THIS INSTRUMENT OF GUARANTY entered into this 21st day of December, 1931, WITNESSTH, That
WHEREAS the First National Bank in St. Louis proposes to take over the assets and assume the liabilities of the Franklin-American Trust Company, but is unwilling to do so except upon receipt by it of total guaranties against loss satisfactory to it in a sum equalling Two Million Dollars ($2,000,000.00); and
WHEREAS the members of the St. Louis Clearing House Association, including the First National Bank in St. Louis, have agreed to participate in this guaranty to the*1103 extent of One Million Two Hundred Fifth Thousand Dollars ($1,250,000.00); and
WHEREAS the undersigned are desirous of inducing the First National Bank in St. Louis to so take over said assets and assume said liabilities;
NOW, THEREFORE, in consideration of the premises, the undersigned do agree to participate in such guaranty to the amount set opposite their respective names.
The president of petitioner, being duly authorized so to do, signed the document on behalf of petitioner and subscribed $15,000 to the fund. This sum was deposited with First National on January 5, 1932, and petitioner received a certificate of deposit for that amount. The required guaranty was oversubscribed and on January 12, 1932, a portion of the amounts paid in by the sixty corporations and individuals was returned to them. Petitioner surrendered its certificate of deposit for $15,000 and received $2,548.42 and a certificate of deposit in the amount of $12,451.58. The certificate provided that First National should pay "interest on said sum at the rate of five percent (5%) per annum payable semi-annually on July 1st and January 1st of each year so long as same is so held and until same has been*1104 either applied on said guaranty or repaid to said Robert Gaylord, Incorporated."
The president of petitioner signed the guaranty in its behalf because he believed such action to be for its best interest. He felt that the failure of Franklin-American would jeopardize petitioner's bank accounts and accounts receivable in and near St. Louis, would paralyze its current business, particularly the Christmas trade, which was then at its height, and in addition would cut down its prospective orders and future business.
*1122 Petitioner was not a stockholder or a depositor in Franklin-American. On the date the agreement was signed, however, petitioner and its stockholders had on deposit in other banks located in the city of St. Louis approximately $45,188.06. On that date petitioner also had accounts receivable of $182,088.75, a large part of which was owing from customers located in and near St. Louis, some of whom carried their accounts in Franklin-American.
Relying upon the guaranty agreement, First National on December 21, 1931, entered into an agreement with Franklin-American under which it took over its assets and assumed its liabilities.
First National regularly, *1105 at semiannual periods, from December 21, 1931, to December 21, 1936, in accordance with the terms of the certificate of deposit, paid or credited interest to petitioner on its deposit of $12,451.58, which amounts petitioner returned as income in the years received.
Petitioner was notified by letter from First National dated December 15, 1936, that appraisals of the remaining unliquidated assets taken over from Franklin-American, which had been made by the national bank examiner, by officers of Franklin-American and First National, and by representatives of the Clearing House Association, showed that as of October 15, 1936, such assets would be insufficient, by approximately $2,216,045.47, to satisfy the liabilities of Franklin-American. First National therefore stated that it, as of December 21, 1936, was "applying the total amount, deposited by you to secure your guaranty, on said indebtedness to the bank", and that interest on the certificate of deposit would cease at that time.
The letter referred to in the preceding paragraph pointed out that First National could, under the terms of the agreement, immediately sell the remaining unliquidated assets at public or private sale, *1106 but that such a sale probably would not realize the estimated values. To avoid this petitioner was requested to sign a form of consent to the extension of the period for liquidation of Franklin-American assets for three years and it was stated that if the liquidation of the assets should be continued under the contract as amended and extended there was "a possibility that more may be realized out of said assets, through continued orderly liquidation, than will be necessary to reimburse the Bank outside the amount of its guaranty, which excess, if any, would, of course, be distributed pro rata to the guarantors, including the Bank, up to the amount of their guaranties and interest."
Petitioner surrendered its certificate of deposit for cancellation and received interest on its deposit in accordance with the terms of the certificate to December 21, 1936, and on the same date First National applied the deposits, including petitioner's deposit of $12,451.58, as *1123 stated in its letter. Petitioner also signed the extension agreement, extending the contract of December 21, 1931, for a further period of three years.
During the period from January 1932 to December 1936 petitioner*1107 carried on its books an item entitled "Special Deposit" with First National Bank, $12,451.58. After the application of said amount to the satisfaction of petitioner's guaranty as set out above and within the calendar year 1936, petitioner charged said amount to its profit and loss account.
Petitioner keeps its books and files its income tax returns on the calendar year basis. In its income tax return for the calendar year 1936 it took as a deduction from gross income the amount of $12,451.58 on account of the application of its deposit of that amount to the satisfaction of its agreement of December 21, 1931. Petitioner had not for any year prior to 1936 taken any deduction on account of said agreement or on account of the deposit made by it to secure the agreement. The claimed deduction was disallowed by respondent. Petitioner was not, and has not been, compensated by insurance or otherwise for any loss sustained through the application of its deposit of $12,451.58 to the satisfaction of its obligation under the 1931 agreement.
OPINION.
MELLOTT: The amended petition alleges that the claimed deduction of $12,451.58 should be allowed as a loss not compensated for by insurance*1108 or otherwise under section 23(f) (all references being to the Revenue Act of 1936); under section 23(a) as an ordinary and necessary expense paid or incurred during the taxable year in carrying on a trade or business; under 23(q) as a contribution; or under 23(k) as a debt ascertained to be worthless and charged off.
The respondent denies that the deduction is allowable under any of the sections relied upon. He contends that petitioner merely made a voluntary contribution; that it participated in the "rescue party" purely as a "matter of civic pride"; that the amount was not paid as an ordinary or necessary expense of carrying on its trade or business; and that since petitioner signed an agreement extending the 1931 contract to December 31, 1939, no deduction can be taken until after that date.
Petitioner's argument in connection with its claim that the amount is deductible as a loss, a contribution, or a debt ascertained to be worthless, is not without substantial merit. We are of the opinion, however, that the issue may be determined by ascertaining whether or not the expenditure constituted "an ordinary and necessary" business *1124 expense within the purview of section*1109 23(a), 1 shown in the margin.
That petitioner places substantial reliance upon this section is indicated by the testimony of its president. When asked why he signed the agreement, he stated: "We were trying to save the situation. It was a tough picture in town. There were rumors going around * * *. Rumors always circulate * * *. We had quite an equity in this picture here. We had accounts receivable that were centered around this area. We had our balances, bank balances, I do not know the exact figure, but I imagine we had around a quarter of a million dollars." When asked whether or not he felt that the involuntary closing of the Franklin-American would adversely affect his business he replied: "Most decidedly. It would probably paralyze the Christmas trade right in the center of it. That would mean that our orders would*1110 eventually be cut off."
It has been stipulated, and we have found as a fact, that petitioner's president signed the agreement because he believed it to be for the best interest of petitioner. This stipulated fact may, if necessary, be supplemented by matters as to which we would take judicial notice, although there is ample testimony in the record to prove all of the necessary facts. Thus, it is a matter of common knowledge that in the fall of 1931 the banking situation throughout the country was in a precarious condition. Large and important banks, many of which had been in existence for decades, were closing, never to reopen. Bank failures during the year 1931 were twice as numerous as during the preceding year, almost four times as numerous as during the year 1929, and almost six times as numerous as during the average of predepression years. The then president of the St. Louis Clearing House Association stated that the whole situation was "very serious. Very acute; runs on banks were frequent and many, and the public was very nervous over the general situation financially." He stated it was his opinion, when the meeting of business men was held in December of 1931, and*1111 he so advised them, that the failure of Franklin-American "would probably bring the failure of other banks and a general run on the various banks." This, then, was the general picture when they were asked to sign the agreement and to deposit with the absorbing bank the amounts of their subscriptions.
Respondent argues that the agreement constituted a contract of indemnity without consideration inuring to petitioner; that petitioner *1125 was not engaged in the indemnity or guaranty business; and that the payment was made purely as a "matter of civic pride." Upon brief he says: "How can it be said that participation by petitioner in a 'rescue party' for a bank with which it had no direct financial relations, no deposits, nor stock, was an ordinary or necessary expense of this business concern?"
It is true that petitioner was not engaged in the indemnity or guaranty business. Petitioner does not contend that the amount is deductible as an expenditure made in carrying on such business. It contends that the payment was made for its own behefit; to preserve, protect, and promote its own business of manufacturing and selling containers. As pointed out by this Board in *1112 Edward J. Miller,37 B.T.A. 830">37 B.T.A. 830, 833, "Many expenditures made without legal compulsion are deductible, such as insurance premiums on business property, bonuses to a taxpayer's employees, donations resulting in business benefits, and numerous others." Of course, if the payment is made for the acquisition of a capital asset it is not deductible.
What constitutes an ordinary and necessary expense has been passed upon in many cases. Many of them are cited in First National Bank of Skowhegan, Maine,35 B.T.A. 876">35 B.T.A. 876, some of the more important being Kornhauser v. United States,276 U.S. 145">276 U.S. 145; Helvering v. Community Bond & Mortgage Co., 74 Fed.(2d) 727; Welch v. Helvering,290 U.S. 111">290 U.S. 111; and Deputy v. du Pont,308 U.S. 488">308 U.S. 488.
That the expenditure in question was deemed by the taxpayer to be necessary for the protection of its own business can not be doubted. The fact that it had no direct financial stake in the Franklin-American Bank is not determinative. The effect of the failure of this bank upon petitioner's business might well have been considerable. As pointed out by*1113 its president, it stood to lose upwards of a quarter of a million dollars through the collapse of the financial institutions of the community, which at that time was imminent. If the guaranty had not been raised and the apprehended collapse had occurred, it is entirely possible that petitioner's business would have been wiped out. This must have been in the minds of the officers and directors of petitioner when they authorized the agreement to be signed and the amount to be deposited. We think it must be held, therefore, that the expenditure was a "necessary" one.
Whether the expenditure was or was not an "ordinary" one presents more difficulty. The Supreme Court pointed out in Welch v. Helvering, supra, that ordinary "does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often." Referring to the expenditure of heavy counsel fees in connection with a lawsuit affecting the safety of a business, *1126 the Court characterized such a payment as an ordinary expense because of the fact that it is "the common and accepted means of defense against attack."
*1114 In the recent case of Deputy v. du Pont, supra, the Court quoted with approval its language in Welch v. Helvering: "What is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance." It refused to permit the deduction from the taxpayer's gross income of amounts paid by him to a corporation for the loan of certain shares of stock, borrowed by him for the purpose of selling it to some executives of a company in which he had substantial interests, pointing out that there was "no evidence that stockholders or investors, in furtherance of enhancing and conversing their estates, ordinarily or frequently lend such assistance to employee stock purchase plans of their corporations." It said: "In the absence of such evidence there is no basis for an assumption, in experience or common knowledge, that these payments are to be placed in the same category as typically ordinary expenses of such activities, e.g., rental of safe deposit boxes * * *." The Court was careful not to overrule *1115 Welch v. Helvering, supra, however, and reiterated that: "It is the kind of transaction out of which the obligation arose and its normalcy in the particular business which are crucial and controlling."
Was the transaction out of which the obligation in question arose, normal? In other words, was it, in the language of Welch v. Helvering, supra, the "common and accepted means of defense" adopted by corporate businesses generally when faced with a situation such as that which confronted the business men of St. Louis in 1931? We think that both questions should be answered in the affirmative. It will be recalled that the states had found it to be impracticable, or at least unworkable, to insure bank deposits. Nor had any plan been devised under which they, either alone or in conjunction with existing financial institutions, could take over the affairs of a bank, except through receivership, which was well known to be an expensive proceeding not conductive to continued faith in such institutions. The Federal Government had not, as yet, undertaken to insure bank deposits or to render aid to distressed banks and financial institutions either*1116 directly or through governmental agencies, nor had any provision been made whereby a bank might avail itself of the modicum of protection now given to corporations under sections 77(a) and 77(b) of the Bankruptcy Act. In other words, banks and financial institutions were dependent first upon their own assets and secondarily upon such assistance as they might receive, in times of stress, from their officers, directors, and stockholders, from other banks, and from corporations *1127 and individuals who came to their rescue either as a gesture of friendship or more frequently, as in the instant proceeding, as a matter of self-defense. The plan, devised and followed by the banks and business men of St. Louis, or some modification or variation of it, was being carried out in many sections of the country. Cf. O'Connor v. Bankers Trust Co.,289 N.Y.S. 252">289 N.Y.S. 252; First National Bank of Skowhegan, Maine, supra.We think therefore it can not be gainsaid that in December of 1931 the transaction entered into by this petitioner was both "normal" and constituted a then "common and accepted means of defense" to protect it and its business from an imminent*1117 loss.
In First National Bank of Skowhegan, Maine, supra, the facts were somewhat analogous to those in the instant proceeding. A national bank paid the sum of $10,000 to another bank in consideration of its taking over the assets and assuming the liabilities of a local bank, thus obviating the failure of the local bank. It was held, as succinctly stated in our headnote: "Since the expenditure was made to protect petitioner's business, its depositors, and its stockholders, it is an ordinary and necessary expense within the meaning of section 23(a) * * *." The Commissioner acquiesced in our decision and apparently does not now contend that it is wrong. He attempts to distinguish it from the instant proceeding on the ground that the participation in the "rescue party" in that case was by a bank, whereas the "petitioner here was a manufacturing and selling corporation with no direct interest in the distressed bank and the effect of its being closed upon petitioner's business was remote." The distinction, we think, is without substance. The closing of Franklin-American, even assuming that it did not result in the closing of other banks, would have had a direct effect*1118 upon a substantial portion of petitioner's accounts receivable. To that extent at least, its closing would have affected petitioner's business adversely; but, as we have pointed out above, the general condition of the country was such that the closing of this bank would probably, as prophesied by the president of the Clearing House Association, have resulted in runs upon, and the closing of, other banks in the city, and this would have been disastrous to petitioner's business.
We are of the opinion and hold that the amount in question is deductible as an ordinary and necessary expense of carrying on petitioner's trade or business.
Reviewed by the Board.
Decision will be entered for the petitioner.
ARUNDELL, STERNHAGEN, MURDOCK, ARNOLD, and OPPER concur only in the result.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) EXPENSES. - All the ordinary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * * ↩