*1030 Where it is shown that certain stock became worthless prior to the taxable year, claimed loss deduction is disallowed.
*237 The respondent determined an income tax deficiency of $14,478.88, for the year 1934, as the result of his disallowance of a deduction of *238 $78,700 claimed as a loss sustained on certain bank stock alleged to have become worthless in that year. Petitioner assigns error in such determination.
This opinion is in lieu of, and in substitution for, a memorandum opinion entered herein on April 29, 1940.
FINDINGS OF FACT.
In 1934 the petitioner, an individual residing in Ludlow, Pennsylvania, owned 848 shares of capital stock of the Warren Savings Bank & Trust Co. (hereinafter referred to as the old bank), which shares he had acquired from 1912 to 1931 at a total cost of $78,700.
The old bank was chartered in 1870, under the laws of the State of Pennsylvania, and was engaged in the business of general and commercial savings banking. On and after January 1, 1933, its capitalization*1031 was 15,979 outstanding nonassessable shares, par value $50 per share, or a total of $798,950, owned by approximately 400 stockholders.
In 1929 the old bank's deposits totaled approximately $11,000,000, which were reduced, through gradual withdrawals, to approximately $5,500,000 by December 31, 1932. During that period the necessary liquidation of assets to meet those withdrawals resulted in a concentration in the hands of the old bank of a relatively large volume of slow assets, which sustained a very considerable shrinkage in value. During 1932 an impairment of the old bank's capital to the extent of approximately $85,000 was restored through advances by its directors of approximately $140,000, including an advance by petitioner of $80,000. Also, the old bank obtained from the Reconstruction Finance Corporation two loans of $400,000 and $300,000 during 1932 and a loan of $75,000 in 1933.
After the national bank holiday in March 1933, the old bank reopened on a restricted basis under the provisions of a Pennsylvania statute, Sordoni Act of March 8, 1933, for several successive 90-day periods. The restrictions prohibited the withdrawal of old deposits and confined the old*1032 bank's operations solely to the liquidation of its old assets and to the receipt of new deposits which were required to be segregated from the old deposits and against which new deposits a 100 percent reserve had to be maintained either in cash or Government bonds. During the 90-day periods and until some time shortly prior to December 15, 1933, efforts were made to rehabilitate the old bank under its charter so as to remove the restrictions. In connection with such efforts an appraisal of the value of the old bank's assets was made as of April 15, 1933, by one of its active vice presidents, together with a proposed readjustment of the bank's liabilities and capital structure with a view to its rehabilitation under its *239 charter. That vice president was also a director and member of the executive or discount committee of the old bank, which supervised all the operations of the bank, and he was familiar with all its financial affairs and with the credit standing of its debtors.
The appraisal showed an excess of assets over liabilities (the liabilities not including capital stock, surplus, or undivided profits) of $1,232,539.53, but embraced in these assets were: (a) *1033 The amount of a decline in the value of stocks and bonds to the extent of $539,211.97 representing the difference between the book and market values of the stocks and bonds; (b) loss of $685,996.68 on loans and discounted notes representing the difference between their face values and the total of those which were good, slow, and doubtful; (c) loss of $147,947.99 on loans embraced in mortgages and judgments, the loss representing the difference between the face values of such loans and the total of those which were good, slow, and doubtful; and (d) the book value of the bank building at $539,452.28 when its actual market value at that time was only $110,000, a reduction from its book value of $429,452.28.
The proposed readjustments of the old bank's liabilities and capital structure made in conjunction with the appraisal and with a view to its rehabilitation under its charter called for a minimum investment of new capital in the amount of $768,704. The appraisal and proposed rehabilitation were communicated to all of the old bank's directors, including petitioner. Shortly prior to December 15, 1933, efforts to rehabilitate the old bank under its charter were abandoned and consideration*1034 given to the plan hereinafter mentioned as being formulated on December 15, 1933.
The liabilities of the old bank on April 15, 1933 (not including its capital stock, surplus or undivided profits), exceeded its assets by more than $570,000 and it was then insolvent to that extent. There was no material change in that financial condition from April 15, 1933, through 1934, except that some of its assets had been liquidated.
On brief the petitioner concedes that the bank was insolvent on April 15, 1933, to the extent of approximately $570,000 and continued in that condition throughout 1934, and bases his contention that the stock was worthless in 1934 on this primary fact.
As of December 15, 1933, there was completed the formulation of a new plan which contemplated: A Reconstruction Finance Corporation loan of $1,500,000 to the old bank upon a pledge of practically all of its unacceptable assets; the organization of a new bank to take over the old bank's acceptable assets, including the proceeds of the Reconstruction Finance Corporation loan, in consideration of the assumption by the new bank of an equivalent amount of the old bank's deposit liabilities; the liquidation of the*1035 old bank's unacceptable *240 assets by the new bank as trustee; and the issuance of liquidating trust certificates to the old bank's stockholders and all its creditors, except the Reconstruction Finance Corporation.
The liquidating trust certificates to be issued were, in the order of their priority of payment, as follows: Class A to depositors for 38 percent of their deposits in the old bank; class B to the directors of the old bank for advances made by them in 1932; and class C to the stockholders of the old bank in exchange for their shares of stock in the old bank. The plan did not provide for the acquisition of any stock of the new bank by the stockholders of the old bank and the only recovery on their investment in the stock of the latter bank was to be through distributions, if any, made to them as holders of liquidating trust certificates C from proceeds of the proposed liquidation of the old bank's unacceptable assets, after such proceeds had been applied first to the payment of the Reconstruction Finance Corporation loan and thereafter to the holders of liquidating trust certificates A and B in the order of their priority. To consummate the plan it was necessary*1036 that it be approved by 75 percent of the old bank's depositors, shareholders, and the directors who had made advances in 1932.
The plan of December 15, 1933 (hereinafter referred to as the plan), was mailed to the various parties in interest on December 22, 1933, but approval thereof by the required percentage of interested parties was not given until January 9, 1934. Only approximately 50 percent approvals had been received at December 31, 1933. Also, on January 9, 1934, the stockholders of the old bank duly met and by resolution adopted the plan and authorized the old bank's directors and officers to borrow $1,500,000 from the Reconstruction Finance Corporation and to execute and deliver all instruments necessary to put the plan into effect.
Pursuant to the plan, the Warren Bank & Trust Co. (hereinafter referred to as the new bank) was chartered on January 19, 1934. On February 15, 1934, the directors of the old bank met and resolved that it sell certain assets, approved by the State Department of Banking, aggregating $3,365,623, and accept in payment therefor the new bank's assumption of a like amount of the old bank's deposit liability, and further authorized and directed*1037 the proper officers to take all necessary action to carry out the plan and that resolution.
On February 9, 1934, the old bank and the new bank executed a series of written agreements, conveyances, etc., whereby the plan was consummated and carried out. The new bank purchased all of the old bank's assets which were approved as acceptable and took over 62 percent of the latter's deposit liability. The old bank's *241 depositors agreed to accept liquidating trust certificates, class A, for the remaining 38 percent of their deposits in the old bank. They also agreed that of their deposits in the old bank 52 percent should become deposits in the new bank available for withdrawal and 10 percent should be contributed to the capital of the new bank.
Included in the acceptable assets transferred to the new bank was the cash derived from the Reconstruction Finance Corporation loan, which, after certain adjustments, was made available in February 1934, in the amount of $1,421,316.58. As collateral for that loan there was pledged to the Reconstruction Finance Corporation between 90 and 91 percent of the old bank's remaining assets which were classed as unacceptable by the State*1038 Department of Banking. All of the unacceptable assets were transferred to the new bank as trustee for liquidation for (1) repayment of the Reconstruction Finance Corporation loan and (2) distribution to the holders of the liquidating trust certificates issued in the order of priority as classes A, B, and C. Class A represented 38 percent of the deposits in the old bank and class B represented the advances made by the old bank's directors in 1932. Class C was issued by the trustee to the stockholders in exchange for their shares of stock in the old bank, which subsequently forfeited its charter for nonuse. The shareholders of the old bank did not acquire any stock interest in the new bank. Class C certificates were worthless when issued on the consummation of the plan and would have been worthless had they been issued on the date of the formulation of the plan.
The new bank commenced its banking business on February 9, 1934, and, on the same day, as trustee, started liquidation of the old bank's unacceptable assets transferred to it as such trustee. At that time the trustee's balance sheet, based solely on the old bank's book value, was as follows:
| Resources: | |
| Unacceptable assets pledged to R.F.C. | $4,163,588.35 |
| Unacceptable assets held free of pledge because of R.F.C. refusal to accept them as collateral | 450,844.38 |
| 4,614,432.73 | |
| Liabilities: | |
| Debts payable to R.F.C. | $1,421,316.58 |
| Liquidating trust certificates, class A | 1,872,992.11 |
| Liquidating trust certificates, class B | 140,381.49 |
| Liquidating trust certificates, class C | 940,849.65 |
| Reserves for depreciation, interest and losses | 238,892.90 |
| 4,614,432.73 |
*1039 *242 The purpose of the trusteeship was to allow a longer period of time than would have been possible under a receivership to liquidate those unacceptable assets, the actual value of which was substantially less than the book value thereof, due to the very considerable shrinkage in value during 1932 and 1933. From February 9, 1934, up to the time of the hearing on this proceeding the trustee has materially reduced the principal amount of the Reconstruction Finance Corporation loan, but has not made any distribution to any of the holders of the liquidating trust certificates A, B, and C.
From 1924 until February 1934 the petitioner was a director and vice president of the old bank and kept himself informed as to the bank's financial affairs. He had also held various positions with the J. G. Curtis Leather Co., which was a four or five million dollar concern, since its organization in 1901 and has been president of that company since 1935. When the new bank commenced its business and began to liquidate the old bank he, for the first time, lost all hope of recovering anything on his old stock and charged it off as worthless. In his 1934 income tax return he claimed a*1040 loss deduction of $78,700 on account thereof. Petitioner has never realized anything on his stock in the old bank since 1933 and has never been allowed a loss thereon in any year.
The respondent's disallowance of the deduction in his deficiency notice dated August 5, 1937, was based upon the assigned reasons that the stock of the old bank could not "be considered worthless as long as the assets held by the trustee are in process of liquidation and no identifiable event has occurred to show that the trust certificates received by the stockholders * * * are worthless," and that, therefore, any loss sustained in the final settlement between the liquidators and the stockholders "is not an allowable deduction in the year 1934." Respondent's counsel in his opening statement at the hearing said: "We have a very simple issue. The question of whether or not the stock in this bank became worthless in 1934. * * * The burden is on the petitioner to prove that the worthlessness of this stock did occur in 1934." On brief, the respondent contends that the facts of record establish that petitioner's old bank stock investment became worthless in 1933. The petitioner contends that, while the*1041 old bank was insolvent during 1933 to the extent of approximately $570,000 the stock therein did not become worthless during that year because of continued efforts (during that year) to relieve the old bank of its financial difficulties and that the identifiable event establishing worthlessness of the stock occurred in 1934 upon the consummation of the plan for organizing the new bank and for liquidating the remaining assets of the old bank.
Petitioner's stock in the old bank became worthless during 1933.
*243 OPINION.
TYSON: The issue presents a question of fact as to whether the old bank stock actually became worthless in the taxable year 1934, which presupposes that it had value during 1933, or, whether such stock became worthless during 1933.
A loss by reason of the worthlessness of stock must be deducted in the year in which the stock becomes worthless and the loss is thereby actually sustained. In , the Board, after citing numerous cases, reviewed many types of "identifiable events" under varying factual circumstances which have been considered as establishing the worthlessness of stock. Applying*1042 the principles there announced to the facts in the instant case, we conclude, and have so found, that the petitioner's stock in the old bank actually became worthless during 1933 and thus prior to the taxable year here involved.
Here it is shown that the old bank was insolvent to the extent of approximately $570,000 in April 1933, and remained in that condition throughout the balance of that year and through 1934. Thus, it is also necessarily shown that during 1933 petitioner's old bank stock lost any liquidating value. To avoid a determination that the stock became worthless at that time, there must be a showing that despite the loss of any liquidating value there still remained throughout 1933 a real potential value through the continued existence of a reasonable expectation that the stock would become valuable. ; affd., ; ; and . Cf. ; *1043
The record shows that, while the old bank was permitted to reopen after the national bank holiday in March 1933, and was permitted to remain open during the remainder of 1933 and up to February 1934, the restrictions imposed caused the old bank to really cease doing its regular banking business and commence the liquidation of its assets, with the sole exception of merely acting as a depository for new deposits, which were required to be segregated. From April to December 1933, efforts were made to rehabilitate the old bank under its charter pursuant to a proposed plan to readjust its capital structure by a required minimum of $768,304 new capital. However, such plan was abandoned shortly prior to December 15, 1933, and a plan for a new bank and the liquidation of the old bank was inaugurated. That event definitely extinguished any potential value the old bank stock may have had from April to December 1933.
*244 The formulation of the plan to organize a new bank and liquidate the old bank, dated December 15, 1933, did not provide a basis for a continued reasonable expectation that the old bank stock would become valuable through*1044 the consummation of that plan. The plan contemplated the organization of a new bank to take over all of the old bank's acceptable assets in consideration for its assumption of an equal amount of the old bank's deposit liability; the liquidation of the old bank's remaining unacceptable assets by a trustee to pay off, as far as possible, its remaining liabilities, which greatly exceeded the value of such remaining assets; and the issuance of liquidating trust certificates C to the stockholders of the old bank in exchange for their stock in that bank. Upon the formulation of that plan on December 15, 1933, it was as evident as it was on February 9, 1934, when the plan was consummated, that the class C liquidating certificates would be worthless when issued because of the great excess of liabilities, amounting to approximately $570,000, over the value of the assets, resulting in the insolvency of the old bank. Cf. ; ; certiorari denied, ; and *1045 ; affd., . Thus, from the time efforts to rehabilitate the old bank were abandoned and the plan for the new bank was formulated in December 1933, and up to the consummation of the plan in February 1934, the total lack of any prospect of the petitioner ever recovering anything on his old bank stock remained the same.
The petitioner's position is that the old bank stock became worthless in February 1934, upon the consummation of the plan for the new bank, but the facts show that it was equally worthless in December 1933. Accordingly, the consummation of the plan in February 1934 had no effect, as an identifiable event, in establishing worthlessness of the old bank stock, as contended by petitioner, for such stock had definitely become worthless in December 1933.
The fact that petitioner in February 1934 for the first time lost all hope of recovering anything on his stock in the old bank "does not form a basis" for holding that the stock became worthless at that time. *1046
The petitioner's old bank stock having become worthless prior to the taxable year 1934, we hold that respondent did not err in disallowing the claimed loss deduction of $78,700.
Reviewed by the Board.
Decision will be entered for the respondent.
*245 MURDOCK, dissenting: The Commissioner disallowed the deduction for 1934 on the ground that the stock was not worthless even at the end of that year. The statement which his counsel made at the hearing was entirely consistent with the determination and did not put the petitioner upon notice that the Commissioner was changing his ground in any respect. An examination of the notice of deficiency and of the pleadings would naturally lead one to believe that the only difference between the parties was whether the stock had lost all of its value by the end of 1934 or whether it still retained some value at that time. The petitioner introduced evidence showing that the stock was worthless at the end of 1934 and the respondent no longer contends that the stock had any value at that time. The petitioner has thus established that the basis upon which the Commissioner*1047 made his determination was incorrect. Counsel for the Commissioner now argues that the stock was worthless prior to 1934. Not only is this argument entirely inconsistent with the ground upon which the deficiency was determined, but it is made for the first time in the Commissioner's brief.
Furthermore, the facts do not support the argument of the Commissioner that the stock became absolutely worthless in 1933. An appraisal of the assets of the bank indicated that it was insolvent in April 1933. A similar appraisal at that time of the assets of many other corporations might have shown that they too were insolvent, yet many of those institutions recovered from that period of depression and went on to new success. The bank was still in possession of its properties and was still in operation, although to a limited extent. This situation continued up to February 1934. The prevailing opinion holds that a plan to rehabilitate the bank "was abandoned shortly prior to December 15, 1933, and a plan for a new bank and the liquidation of the old bank was inaugurated. That event definitely extinguished any potential value the old bank stock may have had from April to December 1933." *1048 It is true that one plan was abandoned about that time and a new plan was suggested, but no plan was adopted until February 9, 1934. Thus any potential value the old bank stock may have had from April to December 1933, was not definitely extinguished until a plan was actually adopted. The plan finally adopted was one under which the old stockholders could hope to benefit only from the liquidation of the assets rather than from the continuation of a bank which had once been successful and might again be successful.
ARUNDELL, SMITH, VAN FOSSAN, BLACK, and MELLOTT agree with this dissent.