*155 Decision will be entered for petitioner.
Petitioner, being in need of bank credit in the conduct of its business, negotiated for a line of credit in 1935 with a Cincinnati, Ohio, bank. As a prerequisite to the granting of such credit, petitioner wrote the bank a letter dated April 29, 1935, dealing with the payment of dividends, in which petitioner agreed: "We will not declare any dividend in the future while indebted to your bank, without first consulting you." The parties in their dealing with each other construed the contract as if it required petitioner to first consult the bank and secure its consent before petitioner could pay any dividends to its stockholders. Petitioner being still indebted to the bank, the bank refused its consent in both taxable years to the payment of any dividends, and petitioner claims a credit under section 26 (c) (1) in the computation of surtax on its undistributed profits. Held, the letter in question, coupled with its acceptance by the bank, constituted a written contract executed by petitioner prior to May 1, 1936, which expressly dealt with dividends and prohibited petitioner from the payment of any dividends in 1936 and 1937. Chess & Wymond, Inc. v. Glenn, 40 Fed. Supp. 666;*156 affd., 132 Fed. (2d) 621, followed.
*1188 The Commissioner determined deficiencies in petitioner's income tax of $ 100,751.67 for the year 1936 and $ 37,182.72 for the year 1937. The petitioner was assessed and has paid normal income tax of $ 85,365.58 for the year 1936 and $ 30,643.38 for the year 1937. The deficiencies in question are entirely due to the imposition by the Commissioner of a surtax on undistributed profits as provided by section 14 of the Revenue Act of 1936.
In its income tax returns for each of the taxable years petitioner claimed a credit under section 26 (c) (1) of the Revenue Act of 1936 against adjusted net income, to the full extent thereof, for contracts restricting dividend payments. The Commissioner in his deficiency notice denied this claim for credit as to both years. The petitioner by appropriate assignments of error contests the correctness of this action of the Commissioner. *157 This presents the only issue for our decision.
FINDINGS OF FACT.
The petitioner is a corporation organized and existing under the laws of the State of Missouri, with its principal office and place of business in Louisville, Kentucky, and is engaged in the business of distilling *1189 whisky. It filed its income tax returns for the years 1936 and 1937 with the collector's office of the district of Kentucky.
Petitioner was organized in November 1933, with an authorized capital of 200,000 shares of $ 1 par value common stock, of which only 125,000 shares were ever issued. These 125,000 shares were sold for a distillery site and $ 115,000 cash, which lacked about $ 25,000 of being enough to pay for petitioner's small 30-barrel-a-day distillery and one warehouse completed in the spring at a cost of approximately $ 145,000.
From the beginning petitioner required the use of bank credit in carrying on its business. As fast as petitioner improved its credit position and was able to borrow sufficient money from the banks its distillery capacity was successively increased from 30 barrels a day in May 1934 to 80 barrels a day in August 1934, to 150 barrels a day in November 1934, to *158 210 barrels a day in May 1936, at which rate it operated until November 1937.
As a result of large outlays for plant expansion, large increases in daily operating cost through increased production, its whisky aging program, and other business reasons, petitioner found itself in the spring of 1935 in need of a greater amount of bank credit than the Louisville banks could or would supply.
In April 1935 A. J. Harris, president of petitioner, requested Ben Kaplan, a director of petitioner, to go to Cincinnati and attempt to arrange a line of credit with some Cincinnati bank. Kaplan went to Cincinnati and discussed a line of credit with the Provident Savings Bank & Trust Co., sometimes referred to herein as Provident. Certain preliminary correspondence ensued.
Harris and Kaplan then went to Cincinnati on April 28, 1935, and conferred with Leo J. Van Lahr and William Hey, president and assistant treasurer, respectively, of Provident. In examining petitioner's statement, Van Lahr and Hey noticed that petitioner had paid a small dividend in December 1934. They felt that this had been a mistake and advised Harris and Kaplan that Provident would lend petitioner money only if it entered into*159 a written contract with Provident not to pay any dividends without Provident's permission while it owed Provident money. Harris and Kaplan returned to Louisville and talked to their associates in the Wathen Co., who consented that such an agreement be signed.
On April 29, 1935, Harris wrote Provident a letter dealing with the subject of the payment of dividends. The letter, omitting formal parts, reads as follows:
Confirming conversation held with you with reference to the surplus of this company, wish to state that it is not the intention of the officers and directors of this company to pay any part of this surplus out to the stockholders. We *1190 furthermore, desire to state that we have no intention of declaring any dividend until such time as the borrowings of this company have been materially reduced.
We might also state that we will not declare any dividend in the future, while indebted to your bank, without first consulting you.
On April 29, 1935, Harris and Kaplan took this letter to Cincinnati and personally delivered it to Provident. Provident extended petitioner a $ 50,000 line of credit and loaned petitioner $ 25,000 at that time. Petitioner and Provident considered*160 this letter to be the required written contract whereby petitioner obligated itself not to pay any dividends while indebted to Provident without first securing the consent of Provident, and they so treated it throughout the years 1935, 1936, and 1937. This $ 50,000 line of credit was far from being sufficient to meet petitioner's needs.
In an effort to improve its banking relations, petitioner sought the services of E. G. Barker, the then officer of the Liberty Bank of Louisville, in charge of whisky financing. On July 15, 1935, Barker became treasurer of petitioner, and devoted himself to increasing and stabilizing petitioner's lines of credit. He advised the banks that the Wathen Co. needed lines of credit totaling $ 600,000, which would have to be maintained in force for a period of a good many years. Several banks turned him down, but he did succeed in arranging lines of credit of $ 100,000 with the Liberty Bank (Louisville), $ 125,000 with the Fifth-Third Trust (Cincinnati), $ 75,000 with the Lincoln Bank (Louisville), and $ 75,000 with the Provident Bank (Cincinnati). In 1936 the Liberty Bank's line was increased to $ 150,000, the Lincoln Bank's line to $ 125,000, and the*161 Fifth-Third Trust at times allowed petitioner to exceed its line.
When arranging these lines of credit, Barker advised all the other banks of the Provident dividend restricting letter and orally agreed with them that the Wathen Co. would not pay any dividend while indebted to them without their prior consent. The other banks verified the existence of the Provident dividend restricting letter, and they felt that the written agreement would be overlapping to them and did not insist upon additional written agreements. Barker further agreed that petitioner would not prefer any of the banks over the others in either borrowings or payments and that each should participate in proportion to its line in both borrowings and payments. These agreements made in the summer and fall of 1935 continued in force throughout 1935, 1936, and 1937.
During the two taxable years here in question petitioner's lines of credit were constantly being used and it never had any large amounts of cash on hand.
During 1936 the most cash that petitioner had on hand on any one day was $ 47,476.33; its lowest indebtedness to Provident was $ 66,797.93; and its lowest indebtedness to the other banks named above was *162 $ 287,928.12.
*1191 During 1937 the most cash that petitioner had on hand on any one day was $ 76,872.34. Its lowest indebtedness to Provident was $ 63,004.80 and its lowest indebtedness to the other banks was $ 341,075.04.
After April 29, 1935, when petitioner wrote Provident the letter in which it stated "we will not declare any dividend in the future, while indebted to your bank, without first consulting you," and Provident extended petitioner a line of credit of $ 50,000 and immediately loaned petitioner $ 25,000, petitioner continuously remained indebted to Provident throughout the remainder of the year 1935 and all of the years 1936 and 1937. Petitioner's indebtedness to Provident was not fully paid until 1940.
Petitioner gave Provident and the other banks participating in the lines of credit notes payable in three months, instead of long-term notes, as the banks wanted short-term notes so as to be able to rediscount them with the Federal Reserve Bank. But the credit lines were established with the understanding that petitioner would need the money for a long time and that these three-month notes would not be paid off at maturity but would be renewed from time to time.
*163 On December 16, 1936, petitioner wrote each of its banks substantially identical letters requesting permission to pay a dividend.
Its letter to Provident, omitting formal parts, was as follows:
* * * this company will earn for the 12 months period ending December 31, 1936, approximately $ 550,000.00 net, after depreciation, reserves for taxes, etc. Therefore, the management is favoring the payment of a dividend to stockholders.
In view of the fact that our Mr. A. J. Harris wrote you under date April 29, 1935, that we would not pay a dividend so long as this company was indebted to your institution, without first receiving your approval, we are, therefore, asking that you give careful consideration to this matter and advise us of your reaction.
On December 19, 1936, Provident replied:
After giving this matter careful consideration, we cannot permit the payment of a dividend at this time which would be in violation of an agreement entered into by the officers of your company under date of April 29, 1935. They agreed they would not pay a dividend as long as your company was indebted to our bank. The payment of a dividend at this time would decrease your working capital and work a *164 hardship on the operation of your business.
The other banks to which petitioner was indebted replied in a similar vein to petitioner's letter of December 16, 1936, and refused petitioner's request for permission to pay a dividend to its stockholders at the end of 1936.
In December 1937 petitioner again requested the banks to which it was indebted for permission to declare and pay a dividend to its stockholders at the close of 1937. This time the request was oral. Each of the banks again refused to give its consent to the payment of any dividends.
*1192 Petitioner paid no dividends in either 1936 or 1937 because it considered it was bound by a written contract with Provident, verbally extended to the other banks, not to pay any dividends without the banks' consent, and in each year the banks had refused their consent.
Petitioner's letter to Provident dated April 29, 1935, coupled with Provident's acceptance of its terms, followed by the making of loans to petitioner, constituted a written contract executed by petitioner prior to May 1, 1936, which expressly dealt with dividends and prohibited petitioner from the payment of any dividends in 1936 or 1937 without first securing *165 the consent of Provident.
OPINION.
The law and regulations applicable to this proceeding are printed in the margin. 1
*166 We do not understand that there is any substantial dispute as to the facts in this proceeding. The real controversy is whether the letter which petitioner wrote Provident on April 29, 1935, as a basis for procuring a line of credit with that bank, followed by the acceptance by the bank of the terms of the letter and the making of a loan to *1193 petitioner, was a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operated within the taxable years as a legal restriction upon petitioner in the payment of dividends.
Respondent, in his brief, after citing a number of cases holding that the provisions of section 26 (c) (1) must be strictly complied with by the taxpayer corporation to secure the credit therein provided, says:
* * * From the strict test enunciated in these cases, it would seem that, for the purpose of said section 26 (c) (1), the contract restricting the payment of dividends should be in writing, that the various restrictions should be expressly stated therein, that it should be executed by the proper officer of the claimant, attested by the secretary and sealed with the corporate seal. * * *
*167 We agree with all the foregoing requisites except that which says that the written contract must be "attested by the secretary and sealed with the corporate seal." There is no such formal requirement to be found in the statute or in the Treasury regulations.
In the instant case it was clearly the intention of the parties that the letter of April 29, 1935, should operate as a contract between the bank and petitioner. It was signed by "John A. Wathen Distillery Company By A. J. Harris President." It was personally delivered to Provident by Harris. The bank received the letter, placed it in its files, and immediately acted upon it by granting a line of credit of $ 50,000 and making a loan that day to petitioner of $ 25,000. This was enough, we think, to make the letter a binding contract between the parties, even though it did not contain the formalities of being attested by the secretary of petitioner and bearing the seal of the corporation. See on this point Atlantic Co., 45 B. T. A. 657; affd., 129 Fed. (2d) 87. Valvoline Oil Co., 47 B. T. A. 795. Therefore, we hold that the letter in question*168 was a written contract executed by petitioner prior to May 1, 1936, which expressly deals with the payment of dividends. Whether it operated as a legal restriction upon petitioner as to the amounts which it could distribute within the taxable year as dividends, we shall now discuss and decide.
It is petitioner's contention that it could not legally distribute any dividends within the taxable year without first consulting Provident and securing its consent to the declaration and payment of dividends, and that, in each year, it did consult Provident and endeavored to secure such consent and failed. Petitioner also points out that it had oral agreements with its other bank creditors, based on its written agreement with Provident, that it would not declare any dividends without consulting them and securing their consent. It is clear, however, that, in determining credits to be allowed under section 26 (c) (1), oral agreements which a taxpayer may have entered into with *1194 creditors restricting the payment of dividends are of no effect. Such oral agreements may be binding between the taxpayer and its creditors, but they are not recognized by section 26 (c) (1). Cf. Sandura Co., 45 B. T. A. 491.*169
Thus it seems clear that a determination as to whether petitioner is entitled to the credit which it claims under section 26 (c) (1) depends upon a proper construction of the written agreement which it had with Provident on April 29, 1935. That agreement was evidenced by a letter (see the findings of fact) written by petitioner to Provident which contains the following language: "We might also state that we will not declare any dividend in the future, while indebted to your bank, without first consulting you." It is petitioner's contention that the foregoing language should be construed as if it read: "We might also state that we will not declare any dividend in the future while indebted to your bank without first consulting you and securing your approval." (Emphasis supplied.)
If it is permissible to adopt petitioner's construction and construe the written contract for the purpose of applying the statute as if it contained the words underscored above, then we think the contract is one which falls within the ambit of section 26 (c) (1). See Valvoline Oil Co., supra;Cotton States Fertilizer Co., 47 B. T. A. 748. We think*170 the contract should be so construed. It is clear that this is the construction which the parties themselves placed upon the letter contract and acted upon, and we are not prepared to say that their construction was wrong.
The petitioner, in contending that the letter of April 29, 1935, coupled with the acceptance of its terms by the bank and the immediate granting of a line of credit to petitioner, constituted a written contract prohibiting the payment of dividends within the meaning of section 26 (c) (1) of the Revenue Act of 1936, relies chiefly upon the case of Chess & Wymond, Inc. v. Glenn, 40 Fed. Supp. 666; affirmed per curiam (C. C. A., 6th Cir.), 132 Fed. (2d) 621. We think this case is in point and supports petitioner's contention. We think the facts in the instant case are much stronger for the taxpayer than they were in Chess & Wymond.
In Chess & Wymondthe First National Bank of Louisville, Kentucky, wrote Chess & Wymond a letter in which among other things it was said:
We understand that you feel obligated to declare and pay preferred dividends on your new issue requiring $ 28,000 per year. While*171 we feel that it is wrong in principle for stockholders to withdraw money from this company in view of its present need, the amount is relatively small in relation to the contemplated earnings. We would definitely oppose the payment of such dividends, however, should the earnings fall under $ 30,000 per quarter.
*1195 Chess & Wymond replied to the bank as follows: "Thanks very much for your letter of December 18 which will be very helpful and is greatly appreciated." Following receipt of this letter the bank made Chess & Wymond a loan, which loan was still outstanding during the year which was involved. The court held that, notwithstanding that they made no mention of any specific prohibition against the borrower paying out dividends on its common stock during the pendency of the loan, these letters, taken together with the surrounding circumstances, constituted a written contract entered into prior to May 1, 1936, which prohibited Chess & Wymond from paying in excess of $ 28,000 dividends on its preferred stock and altogether prohibited the payment of any dividends on its common stock while the loan was outstanding.
In arriving at its decision the court, among other things, *172 said:
* * * The Court should give great weight to the fundamental rule used in construing any written instrument, namely, that it should be construed according to the intention of the contracting parties as gathered from the words of the entire instrument and from the circumstances surrounding the parties at the time when the written agreement was made. * * *
The court then went on to hold that the taxpayer in that case was entitled to a credit under section 26 (c) (1) of the Revenue Act of 1936 because it could not distribute dividends in the taxable years, except a limited amount under certain circumstances to its preferred stockholders, without violating a provision of a written contract executed prior to May 1, 1936, which provision expressly dealt with the payment of dividends. The decision of the lower court was affirmed per curiam by the Sixth Circuit in Glenn v. Chess & Wymond, Inc., supra.
In the instant case the petitioner had only one class of stock outstanding, namely, common stock. When two of its officers went to Cincinnati on April 28, 1935, to arrange a line of credit with Provident, the officials of that bank informed them that the bank would grant them*173 a line of credit and make them an immediate loan provided petitioner would enter into a written contract that it would not pay any dividends without Provident's permission while it owed Provident money. These two officers of petitioner went back to Louisville and the letter shown in our findings of fact was immediately written by the John A. Wathen Distillery Co. and it was personally delivered to Provident and placed in its files and acted upon, as stated in our findings.
We think that, under authority of Chess & Wymond Inc. v. Glenn, supra, and our decision in Valvoline Oil Co., supra, this letter, coupled with the circumstances of its delivery to the bank and acceptance by the bank in making its loan, constituted a written contract entered *1196 into by petitioner prior to May 1, 1936, which expressly dealt with the payment of dividends and operated as a legal restriction upon petitioner as to the amounts which it could distribute within the two taxable years before us as dividends. We so hold. This decides the only issue in the case in favor of petitioner.
Decision will be entered for petitioner.
*174 Disney, J., dissenting: I am unable to concur in the majority view. In allowing a substitute for actual payment of dividends, by section 26(c) (1) of the Revenue Act of 1936, Congress pointedly and definitely intended to be strict, for the prerequisite to allowance of credit was a provision, written, express, dealing with payment of dividends, which would be violated by payment. Language could hardly be more explicit. So definite is it, that it does not refer to the contract in general, but to the particular provision. Perhaps other portions of the contract could be garnered from implications; but not the one described in section 26 (c) (1). That provision must be written, and not only so, but express on the point of dividends. Nothing is to be left to uncertainty, conjecture, or implication. This, I think, is the clear meaning of that language from Helvering v. Northwest Steel Rolling Mills, 311 U.S. 46">311 U.S. 46, which says:
* * * True, obligations not set out at length in a written contract may be incorporated by specific reference, or even by implication. But Congress indicated that any exempted prohibition against dividend payments*175 must be expressly written in the executed contract. It did this by adding a precautionary clause that the granted credit can only result from a provision which "expressly deals with the payment of dividends."
To me this means that though ordinarily a written contract may, by reference or even implication, include other matter, in this case Congress intended that the provision in question "must be expressly written in the executed contract" (italics supplied), and not left to be supplied. Not only so, but this is only to accentuate the principle of strict interpretation of a provision relied upon for an exemption. I do not think that the requisite provision is found here. The written agreement here was merely not to declare dividends without first consulting. In Hewey v. Metropolitan Life Ins. Co., 62 Atl. 600, "consult" is defined as: "To apply to or for direction or information; ask the advice of, -- as to consult a lawyer." An agreement to consult is, obviously, not in and of itself an agreement to obey the advice of the consultee. The petitioner did not agree not to declare dividends; it agreed only that it would first consult. *176 Only by implication *1197 and equity doctrine, if indeed at all, can we import into, or add to the language involved here, any element of agreement to be governed by the consultation. In the last analysis the agreement relied on by the majority is seen to lie, not in the written provision, but in the fact that the bank relied thereon. No written acceptance appears. In substance and effect, the conclusion of the majority has its basis in equitable estoppel, because of reliance by the bank upon the statement made by the petitioner. Congress, in my view, particularly intended to permit the credit upon no application of equitable doctrine, but only upon an express written provision. It was just the sort of loose and equivocal arrangement here found, having to rest upon something outside of written and express language, which the legislators, I think, did not intend to be base for the credit.
In Hobbs-Western Co. v. Commissioner, 133 Fed. (2d) 165, the court was urged to approve credit under section 26 (c) by consideration of the purpose of the agreement, the practical construction given the parties, and the fact that the payment could have*177 been made from no source other than surplus profit or earnings. The reaction of the court was: "To concede arguendo that such a construction of the contract is reasonable does not aid the petitioner. So to construe the contract one must supply by implication a provision not expressly stated. One must by implication insert in section 10 a provision requiring the notes to be paid out of current earnings and profits. There is no such express provision in section 10." Not finding such express provision, the court denied the credit, citing Helvering v. Northwest Steel Rolling Mills, 311 U.S. 46">311 U.S. 46, and Helvering v. Ohio Leather Co., 317 U.S. 102">317 U.S. 102. In Helvering v. Nelson Co., 133 Fed. (2d) 846, considering the language of section 26 (c) (2), it is said:
* * * The requirement that the contract must deal "expressly" with the disposition of "earnings and profits of the taxable year" cannot be satisfied by "implication" nor inference. The provision must be specific. Nothing less satisfies the requirements of the statute.
The word "consult" does not mean "agree," or to obey advice. The*178 meaning of the word is almost a negation of that meeting of minds which is required for contract. The distinction between consultation and agreement is clear even in common parlance. In my opinion, no written provision within the purview of the statute can be found. I respectfully dissent.
Footnotes
1. SEC. 26. [Revenue Act of 1936.] 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.
Art. 26-2. [Regulations 94.] Credit in connection with contracts restricting payment of dividends. -- * * *
* * * *
(b) Prohibition on payment of dividends. -- The credit provided in section 26 (c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend --
(1) in one form (as, for example, in stock or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, or
(2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable year) without violating such provision --
then the amount is one which, under section 26 (c) (1), can be distributed within the taxable year as a dividend without violating such provisions.* * * *↩