*643 1. Held, petitioner was prohibited from paying dividends by a written contract and is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936.
2. A corporate resolution by the debtor transmitted to the creditor with a covering letter and acknowledged by a return letter of the creditor, held to constitute a contract in writing executed by the corporation within the meaning of section 26(c)(1) of the Revenue Act of 1936.
*795 Respondent determined a deficiency in income tax of $37,263.70 against petitioner for the year 1936. Petitioner concedes that the deficiency is correct to the extent of $4,321.82 but contests its correctness as to $32,941.88. The sole issue is whether petitioner was entitled to a credit under section 26(c)(1) of the Revenue Act of 1936, relating to contracts restricting the payment of dividends.
FINDINGS OF FACT.
We adopt as a part of our findings of fact the stipulation of the parties. In so far as they are material to our decision they are substantially as follows:
*644 Petitioner is a New Jersey corporation, with its principal office at Fifth and Butler Streets, Cincinnati, Ohio. Its Federal income tax return for the taxable year 1936 was filed with the collector for the first Ohio district at Cincinnati, Ohio.
On June 25, 1934, the petitioner was indebted to five banks for loans aggregating $644,000, as follows:
| Manufacturers Trust Co., New York | $176,000 |
| Chase National Bank, New York | 176,000 |
| Fifth-Third Union Trust Co., Cincinnati | 142,000 |
| First National Bank & Trust Co., Covington, Ky | 50,000 |
| Butler County National Bank, Butler, Pa | 100,000 |
| Total | 644,000 |
On August 13, 1935, the balances of the loans remaining unpaid were as follows:
| Chase National Bank, New York | $149,600 |
| Manufacturers Trust Co., New York | 149,600 |
| Fifth-Third Union Trust Co., Cincinnati | 120,700 |
| First National Bank & Trust Co., Covington, Ky | 42,500 |
| Butler County National Bank, Butler, Pa | 65,000 |
| Total | 527,400 |
*796 Sometime prior to August 13, 1935, the petitioner entered into negotiations with the Bank of the Manhattan Co. of New York for a loan of $300,000, to be used to liquidate in full the amounts owing to the*645 Chase National Bank and the Manufacturers Trust Co. On about the same date petitioner entered into negotiations with the Fifth-Third Union Trust Co. for an additional loan of $65,000, to be used to liquidate in full the amount owing to the Butler County National Bank.
On August 13, 1935, the board of directors of the petitioner adopted the following resolution relating to the loans from the Bank of the Manhattan Co. and the Fifth-Third Union Trust Co.:
RESOLVED, that the ratio of the bank debt, viz. $300,000 at the Bank of the Manhattan Company and $185,700 at the Fifth Third Union Trust Company be approximately maintained except for thirty or sixty day borrowings at either bank, to be paid at maturity.
RESOLVED FURTHER, that both banks be kept informed prior to any additional borrowings either direct or indirect at either bank.
RESOLVED FURTHER, that a monthly balance sheet and operating statement be sent to both banks.
RESOLVED FURTHER, that no dividends shall be declared or paid by the company on any of its capital stock without approval from both banks, while borrowing from said banks.
On August 14, 1935, petitioner wrote the following letter to the Bank of the*646 Manhattan Co. enclosing a copy of the above resolution:
We enclose herewith extract from minutes of meeting of the Board of Directors held on the 13th day of August 1935, setting forth your stipulated requirements while this company is borrowing money from your bank.
We wish to assure you that the various conditions laid upon us by the enclosed resolution will be strictly adhered to.
Very truly yours,
VALVOLINE OIL COMPANY,
(signed) C. C. GOULD
Secretary.
On August 15, 1935, the Bank of the Manhattan Co. wrote the following letter to the petitioner acknowledging receipt of the above letter of August 14, 1935:
Thank you for your letter of August 14, enclosing certified copy of a resolution of your Board of Directors, relative to the ratio of bank debt and the payment of dividends.
Very truly yours,
(signed) WILLIAM PFAFFLE,
Vice President.
On August 14, 1935, petitioner wrote the following letter to the Fifth-Third Union Trust Co. enclosing therewith a copy of the above-mentioned resolution adopted by its board of directors:
We enclose herewith extract from the minutes of meeting of the Board of Directors held on the 13th day of August 1935, setting*647 forth your stipulated requirements while this company is borrowing money from your bank.
*797 We wish to assure you that the various conditions laid upon us by the enclosed resolution will be strictly adhered to.
Very truly yours,
VALVOLINE OIL COMPANY,
(signed) C. C. Gould, Secretary.
On October 10, 1935, the Fifth-Third Union Trust Co. wrote the following letter to petitioner acknowledging receipt of the above letter of August 14, 1935:
I wish to acknowledge your letter of August 14th, in which you enclose extracts from minutes of the meeting of the Board of Directors, held on the 13th of August, setting forth your (sic ) stipulated requirements while your Company is borrowing from the Bank of the Manhattan Company and ourselves.
Yours very truly,
(signed) G. CARLTON HILL,
Assistant to the President.
On August 13, 1935, John J. Rowe, president of the Fifth-Third Union Trust Co., wrote the following letter to Sterling B. Cramer, vice president of that company:
I enclose herewith carbon copies of letters I have written to the Chase and Manufacturers at New York in connection with Valvoline Oil Company's borrowings. The Company has had a*648 $300,000 credit line given by the Bank of Manhattan, New York and no stand-still agreement is asked for. The Company's June 30th balance sheet shows reasonable increase in working capital practically to the extent of the depreciation account and with the expenditures for tanks on the Edgewater property on the Hudson River behind the Company, its working capital position should increase more rapidly from now on as the revenues from the leasing of these tanks are important.
At a Directors Meeting of the Valvoline Oil Company today an appropriate resolution was passed binding the Company to continuation of the various clauses under the present agreement as affecting the Company and I am asking Mr. Gould to send you a copy of this resolution. You will note that should an agreement be deemed wise by either of the two banks that the Company is authorized to execute it.
The Company obtains a lower rate of interest here and we must debate the rate at home. Mr. Leroux is under the impression that I agreed to a four per cent rate which is the rate the Manhattan Company has granted. My own mind was occupied with my agreement to increase the loan by $65,000 which I did, but I do not*649 remember considering the rate. I told this to Greer over the telephone, he will talk to you about this. We might make it 4 1/2% on September 23rd.
I feel that the loans can stand on their own merits, with no agreement between the banks, as obviously does the Manhattan Company or they would not have offered the line.
I am in town for the day only and am going back to Wainscott this afternoon.
After the above adjustments had been made, the loan balances were as follows:
| Bank of the Manhattan Co., New York | $300,000 |
| Fifth-Third Union Trust Co., Cincinnati | 185,700 |
| First National Bank & Trust Co., Covington, Ky. | 41,500 |
| Total | $527,200 |
*798 On December 2, 1936, the board of directors of the petitioner adopted a resolution instructing the officers of the company to request permission of the banks to pay a dividend on the preferred stock before December 31, 1936. The resolution as adopted is contained in the following letter which was sent to both the Fifth-Third Union Trust Co. and the Bank of Manhattan:
At a meeting of our Directors held August 13, 1935 in the office of the Valvoline Oil Company, Chrysler Building, New York City, the following*650 resolutions were passed unanimously:
RESOLVED, that the ratio of the bank debt, viz. $300,000, at the Bank of the Manhattan Company and $185,700 at the Fifth-Third Union Trust Company be approximately maintained except for thirty or sixty day borrowings at either bank, to be paid at maturity.
RESOLVED FURTHER, that both banks be kept informed prior to any additional borrowings either direct or indirect at either bank.
RESOLVED FURTHER, that a monthly balance sheet and operating statement be sent to both banks.
RESOLVED FURTHER, that no dividends shall be declared or paid by the company on any of its capital stock without approval from both banks, while borrowing from said banks.
At a meeting of the Board of Directors held on the 2nd day of December, 1936, the following resolution was unanimously passed:
RESOLVED, that the officers of this company be and hereby are instructed to request the banks from whom we are now borrowing money under the terms of the above resolutions to allow us to pay dividends upon our Preferred Stock before December 31, 1936.
In view of the fact that a new tax bill has been passed since August 13, 1935, putting an extra tax on earned surplus, *651 we would ask your permission to pay dividends this year on the preferred stock which is in arrears.
Our total loans at the banks are now $235,000.
Awaiting your reply, we are * * *.
On December 8, 1936, the Bank of the Manhattan Co. wrote the following letter to petitioner:
We are in receipt of your letter of December 3rd, in which you quote the resolutions of your Company at the meetings held on August 13, 1935, and December 2, 1936.
The resolution of August 13th, not to pay dividends on the Capital Stock while the Company was in debt to its banks, was created because it was one of the conditions under which the Bank of the Manhattan Company made the loan, and until we have been paid in full, we will not agree to the payment of dividends. We feel that the current position of the Company is such that it will retard the payment of our loan if any distribution of cash is made.
We regret that we can not cooperate with you in this matter.
On December 10, 1936, the Fifth-Third Union Trust Co. wrote the following letter to petitioner:
We wish to acknowledge receipt of your letter of the 3rd, quoting the following resolution passed by your Board of Directors at the*652 meeting on December 2nd -
RESOLVED, that the officers of this company be and hereby are instructed to request the banks from whom we are now borrowing money under the *799 terms of the above resolutions, to allow us to pay dividends upon our preferred stock before December 31, 1936.
In August 1935, when we agreed to increase our loan to the Company, it was on the expressed condition and agreement that your Company would pay no dividends until the debt to us was discharged. You were then faced with an approaching maturity date on your debentures, and while we appreciate that the Company has made progress this year, we feel that we must stand on our decision then, and insist that the agreement be not broken.
On December 31, 1936, the unpaid balances of the bank loans totaled $175,000, divided as follows:
| Bank of the Manhattan Co., New York | $75,000 |
| Fifth-Third Union Trust Co., Cincinnati | 75,000 |
| First National Bank & Trust Co., Covington, Ky | 25,000 |
| Total | 175,000 |
In addition to the foregoing stipulated facts, we find that on June 25, 1934, a written memorandum of agreement was entered into between petitioner and the Fifth-Third Union Trust Co., Manufacturers*653 Trust Co., and Chase National Bank, wherein it was stated that these banks would extend their respective loans to petitioner for a period of 90 days from June 25, 1934. This agreement also provided as follows:
1. Valvoline Oil Company shall make no further borrowings from any source without the written consent of the three banks.
2. During the 90 day extension period and until the said bank loans are paid, all three banks shall continue banks of deposit of the Valvoline Oil company and the Valvoline Oil Company shall see that the proportion of the deposit balances of any one of the three banks to the total three deposit balances shall not be substantially in excess of or below the proportion of that bank's present loan to the total of the present loans of the three banks to Valvoline Oil Company.
3. All payments on account of the Valvoline Oil Company's loans held by the three banks shall be pro-rata to their present loans to Valvoline Oil Company.
4. During the 90 days extension period and thereafter until said bank loans are paid, information as to the condition of the Valvoline Oil Company and its current operations, including monthly balance sheets and operating*654 statements and such other information of a financial and general character as any of the banks may require, shall be furnished to the three banks by the Valvoline Oil Company's management. These figures shall be supplemented by a detailed audit as of December 31st made by a firm of certified public accountants acceptable to the banks.
5. So long as said bank loans are unpaid, no dividend shall be declared or paid by the Valvoline Oil Company as to any of its capital stock.
This memorandum of agreement was extended from time to time by written agreement signed by all the parties for 90-day periods upon the same and all of the terms set forth in the memorandum of agreement dated June 25, 1934. Each extension was made by a written memorandum of agreement, the last one having been made on June 24, 1935, extending the loans to September 23, 1935.
In the early part of August 1935 petitioner, through its president, E. W. Edwards, entered into an oral agreement with the Bank of the*800 Manhattan Co. of New York whereby this bank was to loan petitioner $300,000 at the rate of 4 percent provided, among other conditions, that during the life of the loan no dividends would*655 be paid by petitioner on its capital stock, which oral agreement resulted in the resolution of August 13, 1935, and the exchange of letters above set out.
OPINION.
VAN FOSSAN: The question presented for our decision is whether petitioner was entitled to a credit on its undistributed profits tax under section 26(c)(1) of the Revenue Act of 1936 1 by reason of a contract prohibiting it from paying dividends. Petitioner relies first on a contract respecting the loan from Fifth-Third Union Trust Co. The loan was originally for $142,000 and was made pursuant to a signed agreement dated as of June 25, 1934, which provided in part that so long as the loan was unpaid no dividend could be declared or paid by petitioner. Ninety-day extensions of this loan under the same terms and conditions were made from time to time until September 24, 1935. Respondent argues that the failure to extend the loan on September 24, 1935, caused the loan agreement to expire. With this we can not agree. Although the agreement was not renewed on September 24, 1935, the loan was still outstanding. The agreement itself indicated that it governed the loan, although no formal extension was made because*656 it provided that certain bank balances were to be maintained "during the 90-day extension period and until the said bank loans are paid." It further provided that no dividends were to be paid on capital stock of petitioner "so long as said bank loans are unpaid." Thus it is clear that the parties themselves intended to be bound by the terms of the agreement as long as the loans were outstanding.
*657 Our view is supported by , and . In the latter case we held that a taxpayer was entitled to a credit under section 26(c)(1) although the original loan contract made prior to May 1, 1936, prohibiting the payment of dividends on all of its capital was extended and amended on September 2, 1936, to permit *801 the payment of dividends on preferred stock. We stated therein as follows:
The letter or contract of September 2, 1936, refers in express terms to the renewal of the company's note for $30,000, balance due on the original obligation, and expresses the desire to extend the agreement made February 25, 1936. As the terms and conditions of that instrument were binding on petitioner until all the obligations to the bank were discharged, no extension or renewal was necessary. The obligation to the bank was not discharged until 1938. While the letter or contract of September 2, 1936, modified the agreement of February 25, 1936, by the removal of the prohibition or restriction against the payment of preferred dividends, in all other respects it was a confirmation*658 of that agreement and did not otherwise abrogate or supplant its terms and conditions. The giving of the note of September 2, 1936, can not be considered as the discharge of the existing obligation and the creation of a new obligation, in the absence of evidence that it was so intended.
As the foregoing quotation indicates, the modification of the loan agreement between petitioner and the bank in the present proceeding did not result in a new contract. By express agreement the old restriction against the payment of dividends by petitioner remained effective even after the modification of the original agreement. Moreover, that the modified agreement was considered by the bank to be merely an extension of the old agreement is indicated in a letter in which the president of the bank informed a vice president that at a directors' meeting of petitioner "an appropriate resolution was passed binding the company to continuation of the various clauses under the present agreement."
We are of the opinion and hold that the petitioner was bound by the terms of a written contract, signed by the corporation, to pay no dividends and accordingly is entitled to the credit asked under favor of*659 section 26(c)(1).
Petitioner, however, has two strings to its bow. It contends that the documents and letters set forth in the findings of fact respecting the loan from the Bank of the Manhattan Co. constitute a contract prohibiting it from paying dividends within the meaning of the statute as interpreted by the Supreme Court in , and that accordingly it is entitled to the credit sought. The respondent contends that the statute "contemplated as between the taxpayer and its creditor a single written formally executed and delivered contract containing therein an explicit prohibition against the payment of dividends."
We are unable to agree with respondent's premise or to accept the construction asked. It is justified neither by the statute nor by anything said by the Court in An exchange of letters may constitute a written contract under the cited statute. See ; affd., *660 . Moreover, the Supreme Court expressly observed *802 in the above cited case: "True, obligations not set out at length in a written contract may be incorporated by specific reference, or even by implication."
We are of the opinion that under the holding of the Supreme Court in , and the reasoning of the Board in , and , the petitioner is entitled to prevail. In 1935 petitioner was under an express prohibition against paying dividends by virtue of the resolution of August 13, 1935, and the exchange of letters between petitioner and the Bank of the Manhattan Co. and petitioner and Fifth-Third Union Trust Co. The limiting language was explicit and absolute. The documents and letters clearly constitute written contracts executed by the corporation prior to May 1, 1936. This restriction was never removed or relaxed. It remained in full force and effect throughout 1936. That the parties so construed their rights, intentions, and restrictions is well evidenced by the exchange of*661 letters of December 2, 1936, December 8, 1936, and December 10, 1936, wherein petitioner requested permission to pay a dividend on December 31, 1936, and the banks preemptorily refused. At the time the Bank of the Manhattan Co. wrote:
The resolution of August 13th, not to pay dividends on the Capital Stock while the Company was in debt to its banks, was created because it was one of the conditions under which the Bank of the Manhattan Company made the loan, and until we have been paid in full, we will not agree to the payment of dividends.
The Fifth-Third Union Trust Co. at the same time wrote:
In August 1935, when we agreed to increase our loan to the Company, it was on the expressed condition and agreement that your Company would pay no dividends until the debt to us was discharged. You were then faced with an approaching maturity date on your debentures, and while we appreciate that the Company has made progress this year, we feel that we must stand on our decision then, and insist that the agreement be not broken.
We see no occasion for extending the discussion. By this agreement also petitioner was prohibited from the payment of dividends by the provision of a contract*662 in writing executed by the corporation before May 1, 1936, and is entitled to the credit provided by section 26(c)(1) of the Revenue Act of 1936.
Reviewed by the Board.
Decision will be entered under Rule 50.
DISNEY concurs only in the result.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -
* * *
(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -
(1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. ↩