Docket No. 20196 20197.
05-15-1929
L. T. WALLER AND MRS. L. T. WALLER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. SHELBY J. BEENE AND MRS. SHELBY J. BEENE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Fred R. Angevine, Esq., for the petitioners. Phillip M. Clark, Esq., for the respondent.
Fred R. Angevine, Esq., for the petitioners.
Phillip M. Clark, Esq., for the respondent.
Petitioners seek a redetermination of deficiencies in income taxes proposed by the respondent for the calendar years 1920, 1921, and 1922 in total amounts as follows:
L. T. Waller _____________________________ $12,842.60 Mrs. L. T. Waller ________________________ 12,483.51 Shelby J. Beene __________________________ 12,962.53 Mrs. Shelby J. Beene _____________________ 13,374.67
An error alleged in the petitions as to the year 1920 was abandoned at the hearing. The only other error alleged is that respondent erred in disallowing deductions for depletion based on discovery revaluation, the deductions being claimed against bonuses received under instruments alleged to be subleases. The proceedings were consolidated for trial.
FINDINGS OF FACT.
L. T. Waller and Mrs. L. T. Waller are husband and wife, residing in the State of Louisiana.
Shelby J. Beene and Mrs. Shelby J. Beene are husband and wife, residing in the State of Louisiana.
Early in the year 1919 J. E. Smitherman and a group of others, including the petitioners, L. T. Waller and Shelby J. Beene, entered into an agreement with a number of land owners near Haynesville, La., the substance of which was that, if the owners would lease as much as 15,000 acres of land in a designated block to Smitherman and his associates, a test well would be drilled by the lessee within eight months. A partnership was formed by Smitherman and his associates, which was known as J. E. Smitherman, Special Account, in which L. T. Waller and Shelby J. Beene each had an interest of 2 3/8 per cent. Leases were obtained on some 26,000 acres, including the northwest ¼ of section 14, township 23 north, range 8 west, Louisiana meridian, in Claiborne Parish. These leases provided for the payment to the lessor of a bonus of 50 cents per acre and one-eighth royalty.
The partnership, either directly or through others, drilled several holes in the leased property in 1920, all of which proved to be dry. On March 30, 1921, a producing well, known as Anna Taylor No. 2, was brought in with an estimated daily production of 7,000 barrels. This well was located 580 feet north and 330 feet west of the center of the northwest ¼ of section 14, township 23 north, range 8 west. Until this well was brought in, the surrounding country was "wildcat" territory, the nearest producing well being about 12 miles distant. The cost of the well was slightly over $25,000.
On April 21, 1921, which was within 30 days after the discovery well Anna Taylor No. 2 was brought in, Smitherman and the Gilliland Oil Co. entered into an agreement relating to the 40 acres on which the discovery well was located which, omitting signatures and attestations, reads as follows: STATE OF LOUISIANA,| > PARISH OF CADDO, |
KNOW ALL MEN BY THESE PRESENTS, that personally came and appeared before me T. N. Milling, Notary Public in and for said Parish and State, duly commissioned and sworn, personally came and appeared James E. Smitherman, a married man, whose wife's maiden name was Ina Thompson, a resident of the City of Shreveport, said Parish and State, who declared, that for the consideration hereinafter set forth, he has and does by these presents sell, assign, set over, transfer and deliver, without warranty, but with full subrogation of all rights and actions in warranty, unto the Gilliland Oil Company, a Corporation organized under the laws of the State of Delaware authorized to do business in the State of Louisiana, with offices in the City of Shreveport, herein appearing through its Vice President, R. C. Gilliland, duly authorized hereto by Resolution of the Board of Directors, of said corporation, a certified copy of which is attached hereto, its successors and assigns.
An undivided one half interest in and to that certain mineral lease executed by Mrs. Annie Taylor, et al., on March 3rd, 1919, in favor of J. E. Smitherman, filed for record on the 8th day of March, 1919, and recorded on the 30th day of April, 1919, in Book 10, folio 35, Conveyance records of Claiborne Parish, Louisiana, is so far as same covers and effects the North West Quarter of North West Quarter (NW ¼ of NW ¼) of Section Fourteen (14) Township Twenty Three (23) North of Range Eight (8) West, containing forty acres more or less.
Together with a like interest in the oil well thereon known as Taylor Number Two (2), with all the machinery appurtenances and attachments thereto belonging; Eight steel storage tanks having a total capacity of Seven Thousand barrels together with the oil therein, and the oil in earthern storage heretofore produced by the well known as Taylor No. 2, whether situated on the above described property or not.
Also a like interest in and to the drilling well known as Taylor Number Four (4), subject however to the obligation of assignee to pay and discharge one half of the cost and expenses of drilling said well, all situated in Claiborne Parish, Louisiana.
To have and to hold unto the said purchasers, its successors and assigns, subject to the terms and conditions of said mineral leases.
The consideration for which this sale and assignment is made, is the sum and price of Six Hundred Thousand ($600,000.00) Dollars, cash in hand paid, receipt of which is hereby acknowledged and full discharge and acquittance granted for same.
The said parties declared that it is understood between the parties to this agreement that all conditions between the parties hereto extend to their heirs, executors, administrators and assigns.
Thus done and passed in my office, in said Parish of Caddo, in the presence of Sam W. Mason and E. G. Palmer, competent witnesses, on this the 21st day of April, A. D. Nineteen hundred and Twenty one.
The recited consideration of $600,000 was paid by the Gilliland Oil Co. There was at that time $14,250 worth of oil in storage on the property, payment for which was included in the $600,000.
On April 18, 1921, Smitherman, as party of the first part, and the Gilliland Oil Co., as party of the second part, had entered into what they term a working agreement covering certain acreage, including the 40 acres on which the well Anna Taylor No. 2 was located. This agreement, as far as material here, reads:
That for and in consideration of the sum and price of Seven Hundred and Fifty Thousand Dollars ($750,000), to be paid in cash and property as hereinafter set forth, party of the first part binds and obligates himself to sell assign and set over unto the party of the second part, and party of the second part agrees to buy, without warranty, but with full subrogation of all rights and actions of warranty, unto said party of the second part, its successors and assigns, and for the particular consideration set forth, the following described property, to-wit:
First. An undivided one-half interest in and to the mineral leases covering, Northwest Quarter (NW ¼) of Northwest Quarter (NW ¼) of Section Fourteen (14), Township 23 North, Range 8 West, and the South Half (S ½) of Southwest Quarter (SW ¼) of Southwest Quarter (SW ¼) of Section Eleven (11), Township 23 North, Range 8 West, Claiborne Parish, Louisiana.
Together with the oil well thereon known as Taylor #2, and all drilling wells and equipment, tankage, derricks, etc., situated upon said lease, together with all the oil produced from said well known as Taylor #2, whether situated upon said property or not, for the consideration of the sum and price of Six Hundred Thousand Dollars, ($600,000.00).
It is agreed and understood that party of the first part shall pay one-half (½) of all of the expenses necessary and incident to exploiting, developing and producing oil and gas from said above described leases and for the marketing thereof as crude oil, at the loading rack or pipe line connection at the Tank Farm at Minden, Louisiana, together with the necessary expense and up-keep, of operating the said pipe line, tank farm and other marketing facilities, together with a like proportion of all rentals, renewals and other expenses made necessary and incidental to keeping the said above described leases in full force and effect on or before the 15th day of the month succeeding that on which said expenses are incurred.
It is further agreed and understood that if party of the second part should desire to manufacture casing head gasoline, that all manufacturing plants made necessary for the purpose of manufacturing said casing head gasoline and all facilities for marketing same at Haynesville, Louisiana, shall be borne equally by the parties hereto and the profits derived therefrom shall likewise be shared equally by the parties hereto.
On April 21, 1921, Smitherman and the Gilliland Oil Co. entered into an agreement respecting other leases which the partnership owned and which are not involved in this proceeding.
On April 23, 1921, which was within 30 days after the discovery well Anna Taylor No. 2 was brought in, Smitherman entered into an agreement with the Ohio Oil Co. relating to the remaining 120 acres of the quarter section in which the discovery well was located, which, omitting signatures and attestations, reads as follows: STATE OF LOUISIANA, | > PARISH OF CADDO, |
KNOW ALL MEN BY THESE PRESENTS, that before me SAM W. MASON, a Notary Public duly commissioned and sworn in and for said Parish and State, personally came and appeared James E. Smitherman, a married man, whose wife's maiden name was Ina Thompson, a resident of Shreveport, said Parish and State, who declared that for and in consideration of the sum and price hereinafter set forth, he has and does by these presents sell, assign, set over, transfer and deliver, without warranty or recourse, but with full subrogation of all rights and actions of warranty, unto the OHIO OIL COMPANY, a corporation organized under the laws of the State of Ohio, domiciled in the City of Findlay, County of Hancock, State of Ohio, herein appearing for the purpose of accepting this assignment through its agent and attorney in fact, O. D. Donnell, Vice-President, duly authorized and empowered hereto by a resolution of the Board of Directors of said Company, a certified copy of which is attached hereto, and by reference made part hereof, the following described property situated in the Parish of Claiborne, State of Louisiana, and particularly described as follows, to-wit:
That certain oil, gas and mineral lease acquired by James E. Smitherman, from Mrs. Annie Taylor, et al., dated March 3rd, 1919, and recorded April 30th, 1919, in Conveyance Book 10, page 35, of Records of Claiborne Parish, Louisiana, in so far as same covers and effects.
East Half (E ½) of Northwest quarter (NW ¼) and Southwest quarter (SW ¼) of Northwest quarter (NW ¼) of Section 14, Township 23 North, Range 8 West, containing one hundred twenty acres more or less.
TO HAVE AND TO HOLD unto the said THE OHIO OIL COMPANY, its successors and assigns forever, subject to the performance of the terms and covenants in said mineral lease, and payment of rentals and royalties as stipulated in said mineral lease, in so far as same covers and effects that portion herein assigned.
TO HAVE AND TO HOLD unto the said THE OHIO OIL COMPANY, its successors and assigns, for and in consideration of the sum and price of Three Million dollars ($3,000,000.00) cash in hand paid, the receipt of which is hereby acknowledged, and full discharge and acquittance granted therefor, and the obligation of said THE OHIO OIL COMPANY to pay over and deliver unto the Assignor, its successors and assigns, the sum of One Million dollars ($1,000,000.00) out of one-half of the first oil produced and saved from the said above described premises, and subject to the further obligation of the said Assignee, its successors and Assigns to pay over and deliver unto said Assignor, his heirs, executors and Assigns, the equal one-eighth ( 1/8 ) of all oil produced and saved from the above described premises as an excess royalty, whether produced under the present lease contract or under any extension renewal, or other contractual obligations entered into by and between the said Assignee, its successors or assigns with the Lessor, his heirs or assigns.
It is agreed and understood that if the said THE OHIO OIL COMPANY, its successors or assigns, should elect to manufacture casing head gasoline from the premises herein assigned, that the said Smitherman, his heirs and assigns, shall share in the profits derived from the manufacture of said product to the extent of an undivided one-eighth ( 1/8 ) thereof, provided he contributes a like proportion of the costs and expenses of building the plants and equipping same for the purpose of manufacturing said casing head gasoline, and a like proportion of the expenses of manufacturing same.
The appearers further declared that it is agreed and understood by and between them that the deferred payments to be made out of the oil, as well as settlements for the one-eighth ( 1/8 ) excess royalty herein above stipulated, shall be made on or before the 15th day of the month succeeding that during which the oil is removed from the premises.
The recited consideration of $3,000,000 cash was paid by the Ohio Oil Co. and the partnership also received the additional $1,000,000 provided for in the agreement.
On the same date, April 23, 1921, the Ohio Oil Co. addressed to Smitherman a letter as follows, which embodied a part of the agreement between the parties: THE OHIO OIL CO. Shreveport, La., April 23, 1921. Mr. J. E. SMITHERMAN, Shreveport, Louisiana.
DEAR SIR: With reference to the act of assignment executed this day by you unto The Ohio Oil Company transferring and conveying unto said company one hundred twenty-eight oil, gas and mineral leases covering and effecting lands situated in Claiborne Parish, Louisiana, in Twp. 22 North, Ranges 7 and 8 West, and in Twp. 23 North, Ranges 6, 7 and 8 West, this writing is addressed to you for the purpose of expressing the agreement of this company that if at any time hereafter we shall elect to release, surrender or cancel all or any part of any one or all of said leases then before effecting such release or cancellation such lease or leases or part or parts thereof will be first offered to you, and if you shall request it, same will be reassigned or reconveyed to you by this company instead of being released or surrendered direct to the lessors. Yours very truly, (Signed) THE OHIO OIL COMPANY, By J. K. KERR, JKK:C Vice-President.
On July 12, 1921, Smitherman and the Ohio Oil Co. entered into what they term a working agreement concerning certain lands, including the 120 acres which were the subject of the agreement of April 23, 1921. This instrument, as far as material here, reads:
WHEREAS: By the terms of certain assignments from James E. Smitherman to The Ohio Oil Company conveying to said Company certain interests in oil and gas leases in Claiborne Parish, State of Louisiana, and in the County of Columbia, State of Arkansas, said instruments of assignment being recorded in Book 45, Page 392, records of Columbia County, Arkansas, and in Book 28, Pages 15 to 25, inc., of the Conveyance Records of Claiborne Parish, Louisiana, The Ohio Oil Company agreed to pay over and deliver to the said Smitherman the equal one-eighth ( 1/8 ) part of all oil produced and saved from the premises so assigned.
Now, THEREFORE, This agreement to provide for gathering, storing and disposing of such one-eighth interest.
In consideration of the sum of One Dollar each to the other paid, receipt of which is hereby acknowledged, and in consideration of the mutual covenants herein contained, it is agreed as follows;
FIRST: The Ohio shall have control of said Smitherman one-eighth interest, with the right to place in storage commingled with the Ohio's oil or any other oil that may be stored in such tanks from the Smitherman leases, for as long as it shall think wise, all or any part of said interest, and the right at any time to sell with the Ohio's portion of the oil, any part or all of such interest at the price the Ohio shall at the time be receiving for its oil run from the tank farm in the Haynesville, Louisiana, field, settlements for oil sold to be made on or before the 15th day of the month succeeding that in which the oil is so sold, such settlements to be made subject to any deductions that may be made by the Pipe Line Company at the time the oil is run.
On April 23, 1921, Smitherman and the Ohio Oil Co. entered into an agreement respecting other leases running to the partnership, covering approximately 17,000 acres of land, which are not involved in this proceeding.
By reason of the discovery well being to the north and west of the center of the northwest quarter of section 14 (T. 23 N., R. 8 W.), the boundary lines of the 160 acres embraced in the discovery area as recognized by the respondent do not coincide with the boundaries of the Government survey of the quarter section. The boundary lines of the discovery 160 acres laid out under the method recognized by the respondent's regulations include all of the northwest quarter of the northwest quarter of section 14, and only 74 acres of the remaining 120 acres. That is, these boundaries include all of the 40 acres on which the Anna Taylor No. 2 well was located and with respect to which the transaction with the Gilliland Oil Co. was entered into; they include 74 acres of the remaining 120 acres with respect to which the transaction with the Ohio Oil Co. was entered into; and they exclude 46 acres covered by the Oil Company transaction.
For the calendar year 1921 the partnership filed an income-tax return (Form 1065), showing royalties received in the amount of $536,638.34, and depletion in the amount of $1,066,505.99, of which the amount of $536,638.34, equal to the income from royalties, was claimed as a deduction. Other income of the partnership as shown in the return was divided into shares according to a schedule attached to the return, the share of L. T. Waller and Shelby J. Beene each being $9,320.04. These amounts were reported as gross income by Waller and Beene in their individual income-tax returns (Form 1040) for the year 1921. For the year 1921 and likewise for the year 1922 Waller and Beene returned as taxable only one-half the net income of each, the other half being returned by their respective wives.
OPINION.
ARUNDELL:
The major difference between the parties is whether the contracts between Smitherman on the one hand, and the Gilliland and Ohio oil companies, on the other, are sales or subleases. The petitioners contend that the instruments are subleases and that as sublessors they are entitled to depletion based on discovery value under the provisions of Treasury Decision 3938. The respondent concedes that if the instruments are subleases, then the petitioners are entitled to depletion, but he contends that the instruments are contracts of sale or assignments.
An assignment is an act whereby the alienor transfers the whole or a part of his interest for the whole term. Where only a part is so transferred an assignment pro tanto is effected. In order for a transfer to operate as a sublease, as distinguished from an assignment, it is necessary that the transfer leave a reversionary interest in the transferor.
The test is whether the grant leaves a reversionary interest in the original lessee or operates to transfer his entire term. The essential nature of the conveyance is not affected by the particular words employed, and though the instrument purport to be a lease or demise, it may still be an assignment. Broadly speaking, the distinction between an assignment and sub-lease is that by the former the lessor conveys his whole interest in the unexpired term, leaving no reversion in himself, while the latter transfers a part only of the leased premises for a period less than the original term. * * * An under-lease for the whole term is an assignment. Technical terms or special words are not necessary to an assignment. Any language which shows the intention of the parties to transfer the property from one to the other is sufficient, the form of the instrument being immaterial. If it has the legal effect to pass to another the lessee's interest in the whole or in any part of the demised premises for his entire term, or the remainder of his term, it is an assignment. (Thompson on Real Property § 1372, 1373, supported by copious citations.)
See also Craig v. Summers (Minn.), 49 N. W. 742; Stewart v. Long Island R. Co., 102 N. Y. 601; 8 N. E. 200; Davidson v. Minnesota Loan & Trust Co. (Minn.), 197 N. W. 833; In re Bayley, 177 Fed. 522; 35 C. J., Landlord and Tenant, §§ 80-83; 16 R. C. L., Landlord and Tenant, § 319 et seq.
The above rules are those of the common law. While the views of the common law and the civil law differ somewhat as to the nature of leases (Viterbo v. Friedlander, 120 U. S. 707), the courts of Louisiana seem to draw the same distinction between assignments and subleases as do the courts of the common law States. The case of Walker v. Dohan, 39 La. Ann. 743; 2 So. 381, quotes from Bartels v. Creditors, 11 La. Ann. 433, as follows:
There are two ways of selling the unexpired term of a lease—one by selling it for a premium, subject to the payment of the rent to the landlord; the other by selling or assigning the right of occupation without the assumption of rent. The latter is the more frequent way of selling or assigning it, since it rarely happens that the unexpired term of a lease is worth a premium. The case of a sublease is a familiar illustration of one form of this latter mode of assignment.
The recent case of Smith v. Sun Oil Co., 165 La. 907; 116 So. 379, notes the same distinction between assignments and subleases as is set out above, quoting the definition of "under-lease" from Bouvier's Law Dictionary as follows:
An alienation by a tenant of a part of his lease, reserving to himself a reversion; it differs from an assignment, which is a transfer of all the tenant's interest in the lease. W. Bla. 766. And even a conveyance of the whole estate by the lessee, reserving to himself the rent, with a power of re-entry for non-payment, was held to be not an assignment but an underlease.
The court further quotes from Taylor on Landlord and Tenant, in part as follows:
An assignment differs from a lease in that, by the latter, the lessor grants an interest less than his own, reserving to himself a reversion; but by an assignment he parts with the whole of his interest in the estate. * * * But it is held that if by the terms of the conveyance, be it in the form of a lease or an assignment, new conditions with a right of entry, or new causes of forfeiture, are created, then the tenant holds by a different tenure, and a new leasehold arises, which cannot be treated as an assignment or a continuation to him of the original term.
That the distinction is fully recognized in Louisiana, not only by the courts but also by statute is shown by the following excerpt from the Smith v. Sun Oil Co. case:
The Civil Code, in article 2725, recognizes the distinction between a sublease and an assignment of a lease, for it provides that a lessee has the right of sublease, or even to cede his lease, to another person, unless the right is expressly prohibited * * *.
Examining the contracts in the light of the above discussion, it is difficult to see in them anything on which to rest the claim that they are subleases. There is no hint in them of any reservation of a reversion in favor of the grantor, but, on the contrary, the interests conveyed by them are conveyed for the whole of the grantor's term. The parties to the Ohio Oil Co. contract were apparently aware that no reversionary interest was retained by Smitherman and his associates, for in a letter dated the same day as the contracts, the Ohio Oil Co., referring to the "act of assignment," expressed its agreement to offer to Smitherman, and at his request to reassign or reconvey to him such of the leases as it might desire to surrender. The instruments here do not even reserve to the grantor any power of reentry for breach of covenant, which is held in a minority of cases to constitute an instrument a sublease (See Davis v. Vidal, 105 Tex. 444; 151 S. W. 290); they do not impose any obligations under penalty of forfeiture or reversion as appears to have been the case in Smith v. Sun Oil Co., supra . That the contracts in the latter case and those before us are materially different is apparent from the following excerpt from the court's opinion:
The conditions of and in the contracts between the Sun Company the lessee and Elliott the sub-lessee which made it a sublease, and not merely an assignment were that the Sun Company did not dispose of all its rights and obligations under the original lease on the 20 acres of land, but granted to Elliott an interest less than its own, and imposed upon him obligations under penalty of reversion to the Sun Company, in addition to the obligations which Elliott assumed in favor of the original lessor. * * * It was stipulated that Elliott should pay an additional one-eighth royalty to the Sun Company, besides paying the one-eighth royalty due to the original lessor; and it was stipulated that all of Elliott's rights as lessee should revert to and revest in the Sun Company whenever Elliott should cease operations, and that all of the drilling material turned over to him should also revert to the Sun Company.
It is upon this case that petitioners principally rely in making their claim that they were sublessors and not assignors. From a comparison of the contract as above described with those under which petitioners make their claim, about the only point in common that we see is the overriding one-eighth royalty. The conditions present in that case are not present here, and the court explicitly holds that it was those "conditions * * * which made it a sublease." Because of this difference in the facts the conclusion in the Sun Oil case can not be taken as controlling in the present cases.
In the course of the opinion in the Sun Oil case the court quotes from a commentator the following rule of construction:
In case of doubt, the expression employed should always be consulted; thus the word "assignment" of lease, if it is not interpreted by another clause, indicates that there was actually an assignment.
Now let us look at the contracts to see what expressions the parties used, with italics supplied. In the Gilliland contract the grantor says that he "does * * * sell, assign, set over, transfer and deliver * * * an undivided half interest" in the discovery 40 acres and a "like interest" in the Anna Taylor Well No. 2, the machinery tanks, etc., "to have and to hold unto the said purchasers * * * subject to the terms and conditions" of the original leases, and "the consideration for which this sale and assignment is made is the sum and price of Six Hundred Thousand ($600,000) Dollars." In the working agreement which had been entered into prior to the formal contract, Smitherman agreed to "sell, assign, and set over" and the Gilliland Company agreed "to buy * * * an undivided half interest * * *."
In the Ohio contract, Smitherman as grantor "does * * * sell, assign, set over, transfer and deliver * * * that certain gas and mineral lease * * * to have and to hold unto the said Ohio Oil Company * * * in consideration of the sum and price of Three Million ($3,000,000) Dollars * * * and the obligation of said Ohio Oil Company to pay over and deliver to the assignor * * * the sum of One Million ($1,000,000) Dollars * * * and subject to the further obligation of the assignee * * * to pay over and deliver unto said assignor * * * the equal one-eighth of all oil produced."
If there could be any doubt as to what the parties intended their repeated use of the words italicized certainly dispels it. Where words used "have a plain and obvious meaning, all construction, in hostility with such meaning, is excluded." Green v. Biddle, 8 Wheat. 1, 88. See also Calderon v. Atlas Steamship Co., 170 U. S. 272, 280.
Petitioners cite several Louisiana cases from which it appears that the Supreme Court of that State is inclined to view mineral contracts as leases rather than as sales. See Spence v. Lucas, 138 La. 763; 70 So. 796, and Logan v. State Gravel Co., 158 La. 105; 103 So. 526. Those decisions had to do with cases in which the "owner of the soil" (as the court expresses it) was a party to the contract, and in so holding they are in harmony with the Federal courts. See Rosenberger v. McCaughn, 20 Fed. (2d) 139; affd. 25 Fed. (2d) 699. Those cases did not deal with contracts whereby a lessee transferred his rights to a third party, and, consequently, they can not be said to be any authority for the question we have to decide.
Our conclusion is that the contracts between Smitherman and the Gilliland Oil Co. and the Ohio Oil Co. were not subleases, but they were assignments. Accordingly, petitioners are not entitled to depletion based on discovery value as deductions from the consideration received for such assignments.
In view of the conclusion reached, it is unnecessary to attempt to determine the fair market value of the discovery property.
Judgment will be entered under Rule 50.