Opinion
No. J-370.
June 1, 1931.
Suit by the Christensen Machine Company against the United States.
Judgment for plaintiff.
This case having been heard by the Court of Claims, the court, upon the evidence adduced, makes the following special findings of fact:
1. The plaintiff at all times mentioned herein was a corporation organized under the laws of the state of Wisconsin, engaged in the manufacture and sale of stitcher-feeding machinery used in the bookbinding industry. The company was organized in the year 1912 with an authorized capitalization of $5,000, divided into 50 shares of capital stock of the par value of $100 each, of which 25 shares were issued to F.J. Greene, 24 shares to Martin Christensen, and one share to Mrs. Christensen.
2. For several years prior to the incorporation of the plaintiff, Christensen, who was an inventor, had been designing and perfecting an automatic gang stitching machine using a machine shop owned by Greene. A partnership was first formed between them through which Greene obtained a half interest in certain stitcher machine patents. Later the partnership was turned into a corporation, its assets consisting of patterns, some patents, jigs, and tools.
3. The earnings of the corporation for the years 1912 to 1925, based on the taxable net income, computed without the allowance of any deduction for exhaustion on the contract not to compete, referred to hereinafter, were as follows:
1912 ......................... $1,120.65 1913 ......................... 3,691.66 1914 ......................... 4,693.07 1915 ......................... 1,242.75 1916 ......................... 1,029.21 1917 .......... (Loss $368.07) 1918 ......................... 3,963.50 1919 ......................... 18,731.49 1920 ......................... 54,831.62 1921 ......................... 9,620.55 1922 ......................... 16,260.86 1923 ......................... 43,650.86 1924 ......................... 40,099.11 1925 ........................ 70,739.50
4. About 1915 or 1916 there appeared on the market a machine produced by the Dexter Folder Company of New Jersey which was superior to and seriously affected the sales of the plaintiff's machine. This competition continued as a factor in retarding the growth of the plaintiff's business until 1918, when Christensen perfected an improved model of his earlier machine.
5. During the whole period covered by Christensen's connection with the business, first as a partner and later as an associate with Greene in the plaintiff corporation, Christensen handled all matters relating to the sale and installation of the machines, had charge of the factory, conducted the applications and negotiations for patents, and was the active member in the concern in touch with the buying public. At the time of the contract he was giving all of his time to the enterprise. Greene gave only about one-third of his time to the business and that to the manufacturing end, drew no salary until the year 1919, made no sales, and had no contact with the trade.
6. Some time during the year 1917 the plaintiff's capital stock was increased from $5,000 to $25,000. Greene paid in $10,000 in cash, and Christensen $5,000 or $6,000 in cash, and gave a release of a credit due him for services performed and miscellaneous cash disbursements made for the corporation, for which each received an additional 100 shares of the capital stock of the corporation.
7. Disagreement between Christensen and Greene resulted in the execution of a contract as follows:
"This Memorandum of Agreement made the 21st day of February, A.D. 1920, by and between F.J. Greene, of Racine, Wisconsin, party of the first part, Martin Christensen, of Chicago, Ill., party of the second part, and Christensen Machine Company, a corporation organized under the laws of the State of Wisconsin, party of the third part,
"Witnesseth:
"Whereas Martin Christensen and F.J. Greene, above named, are now sole owners of the entire capital stock of the Christensen Machine Company, the above-named third party, each owning one-half of said capital stock; and
"Whereas the said Christensen Machine Company is, and for some years past has been, engaged in the manufacture and sale of multiple stitcher feeding machinery and machinery or improvements, devices, or attachments of various kinds adapted for use in connection with book stitcher feeding machines, all of which have been devised or invented by the said Martin Christensen and are covered by or described in sundry letters patent of the United States, or by applications for letters patent now pending in the United States Patent Office, excepting three inventions described and set forth in applications for letters patent heretofore prepared and now in the possession of Morsell Keeney, patent attorneys of Milwaukee, Wisconsin, the several numbers, dates, and descriptions of which are set forth in the schedule hereto attached, marked `Schedule A,' and made a part of this agreement; and
"Whereas it is mutually understood between said parties that all of said inventions, patents, and applications are the property of said Christensen Machine Company, and the majority of the same have been obtained at the expense of and have been heretofore assigned to said corporation, and any of the same that have not been so assigned are to be assigned to the corporation upon request whenever the proper time therefor arrives so as to vest in said corporation the entire right, title, and interest in said inventions and letters patent issued or to be issued therefor; and
"Whereas the said Martin Christensen has contracted to sell to the said F.J. Greene all of his stock in said corporation, being one-half of the entire capital stock issued and outstanding at a price agreed upon between them, the receipt of which is by the execution and delivery of this instrument confessed and acknowledged;
"Now therefore, in consideration of the premises, and of the purchase of said stock by the said F.J. Greene, and the payment of the stipulated price therefor, the said Martin Christensen hereby undertakes, covenants, promises, and agrees to and with the said parties of the first and third parts as follows:
"1st — That he will, without charge for his time or services, do and perform any and all acts, and execute and render all necessary assistance in the preparation of any papers or documents of whatever kind requisite to the prosecution of the said applications for letters patent now pending in the United States Patent Office, or in the hands of said patent attorneys, and to the procuring of letters patent for the inventions embodied or described therein, it being understood that all expense in connection with the prosecution of said applications and the issue of said patents shall be borne by the corporation and without expense to the said Martin Christensen.
"2nd — To execute and deliver to the said corporation, its successors or assigns, on demand, whenever the law permits the same, an assignment or assignments of the inventions described or intended to be described in said patents and applications for letters patent pending or in the hands of said patent attorneys which have not heretofore been assigned to said corporation so that the same corporation may be invested with the entire right, interest, and title in and to all of said inventions; the said Martin Christensen, however, reserving the right after two years from the date hereof to manufacture and sell, either individually or through his assigns, the single stitcher feeding machine which may hereafter be invented, devised, or perfected by him.
"3rd — That he will, in case any of the aforesaid inventions or machines or parts thereof, as now manufactured, shall hereafter be found to conflict with or infringe upon the prior inventions of other persons covered by letters patent of the United States now or hereafter to be issued, on pending applications, will diligently set about and devote his mechanical and inventive ability and render all possible assistance to the said Christensen Machine Company, its successors and assigns, without expense, however, to himself, to the devising or inventing of other machinery, or parts thereof, or mechanical operations which will avoid any conflict with or infringement upon such prior inventions or letters patent.
"4th — That for and during the full term and period of five years from the date hereof he will not, directly or indirectly, either individually or as manager, agent, or employee of another, or as an officer, director, or stockholder, agent or employee of a corporation, in any manner whatever, engage in the business of manufacturing or selling stitcher feeding machinery, or machinery or improvements, devices, or attachments of any kind adapted for use in connection with book stitcher feeding machines which will compete commercially with the machinery manufactured by said Christensen Machine Company, its successors or assigns, within and throughout the United States and the Dominion of Canada, excepting that after two years from the execution hereof he shall have the right and full license and authority is hereby reserved to him by himself, or his assigns, to manufacture, use, and sell the single stitcher feeding machine hereinbefore mentioned in the preceding paragraph second.
"5th — That for and during the said term of five years from and after the date hereof he will not grant to any person, firm, or corporation other than the said Christensen Machine Company, its successors or assigns, the right, either through assignment of or license under any patent granted to him or application made by him to manufacture, use, or sell within and throughout the United States and Dominion of Canada any new invention in multiple stitcher feeding machines which he may hereafter devise or invent and which shall compete or interfere with the business of the said Christensen Machine Company, its successors or assigns, and for and during the term of two years from and after the date hereof the same restriction shall apply to the manufacture, use, or sale within the territory aforesaid of any single stitcher feeding machine so invented by the party of the second part.
"And in consideration of the premises and the retirement of said party of the second part from said corporation, the party of the third part hereby undertakes, covenants, promises, and agrees:
"First. That it will not use upon stitcher-feeding machines hereafter manufactured and sold by it, or in connection with the sale of said machines, the individual name of said party of the second part disassociated from its said corporate name.
"Second. That it will hold and keep the party of the second part absolutely free and harmless of and from all expense, liability, damages, and costs arising or growing out of any and all patent litigation arising out of or involving the inventions, patents, and applications for patent on inventions of said party of the second part now owned, or hereafter acquired by said party of the third part; the party of the second part hereby agreeing to render such assistance as he may be called upon for in defending said actions, without charges for his time, said third party agreeing to pay and defray the actual, reasonable financial expense of said second party in that behalf.
"In witness whereof the said parties of the first and second parts have hereunto set their hands and seals, and the party of the third part has caused this contract to be duly executed by its president and sealed with its corporate seal the day and year first above written.
"F.J. Greene, [Seal.] "Party of the first part. "Martin Christensen, [Seal.] "Party of the second part. "Christensen Machine Company, "By F.J. Greene, President. "Signed, sealed, and delivered in presence of — "John B. Simmons. "Wm. D. Thompson."
8. The consideration agreed to be paid to Christensen for the execution of the contract was $60,000. At the time the contract was entered into, the corporation neither had that amount of money available nor did it have a sufficiently ample line of credit at its bank upon which it could borrow such an amount. In order to raise the necessary amount, Greene arranged for a personal loan in the amount of $20,000, advanced $6,000 of his own funds, and arranged for a bank loan for the corporation in the amount of $34,000. The $60,000 was placed on deposit in the First National Bank of Racine to the credit of the plaintiff company, and a check in that amount was on February 21, 1920, drawn by the plaintiff payable to Christensen, and, after being certified by the bank, was delivered to him.
Interest on both notes was paid by the corporation and the $26,000 note completely paid off within a period of about 3 years. Interest on the $20,000 personal loan was paid directly by Greene from the interest payments received from the corporation.
9. Originally, the whole amount paid for the Christensen interests was charged to Greene's personal account and credited to cash in bank. All of the 125 shares of capital stock thus acquired from Christensen were thereupon issued to Greene, except one qualifying share, which was at his direction issued to James E. Easson, the newly elected secretary and treasurer of the corporation.
Subsequently, on December 14, 1920, on the advice of an accountant employed to close the company's books for the year 1920, these entries were reversed. Greene and Easson thereupon surrendered the 125 shares of stock issued to them at the time Christensen's interest was acquired, for which Greene's personal account was credited with $60,000, and the surplus and treasury stock account debited with $47,500 and $12,500, respectively. The credit to surplus was captioned "Premium on stock reacquired."
At the time of the sale of Christensen's interest, nothing was said or considered as to whether Greene was purchasing the stock for his personal account or for the corporation.
An important feature of the contract was the agreement on the part of Christensen not to directly or indirectly engage in business which would compete commercially with that of the plaintiff corporation, and without this agreement the contract would not have been executed by Greene.
At the time of the execution of the contract above set forth, the total value of the stock of the corporation was $60,000, and the agreements made by Christensen and contained in the contract were reasonably worth $30,000.
10. Plaintiff duly filed its income and excess profits tax returns for the years 1920, 1921, 1923, and 1924, all of which were supplemented by amended returns filed for the years 1920 and 1921 on August 13, 1922, and for the years 1923 and 1924 on March 13, 1926. Statutory waivers for the years 1920 and 1921 were filed with the amended returns for those years.
11. On March 15, 1926, plaintiff filed claims for refund of taxes for the years of 1920, 1921, 1923, and 1924, asserting a claim for allowance and deduction of depreciation on a then estimated value of the cost to the corporation of the Christensen agreement not to compete for a 5-year period provided for in the contract of February 21, 1920, prorated over the 5-year period from 1920 to 1924, inclusive.
12. On November 5, 1925, the corporation entered into a contract with Christensen by which Christensen agreed not to compete with the corporation for a further period of 15 years in consideration of the sum of $11,000. At that time Christensen had lost his contact with the trade; the market for the machines had been canvassed and was not as great as it was in 1920; and the plaintiff had established its own sales force and agencies.
Allen H. Gardner, of Washington, D.C. (George M. Morris and KixMiller, Baar Morris, all of Washington, D.C., on the briefs), for plaintiff.
James A. Cosgrove, of Washington, D.C., and Charles B. Rugg, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, WHALEY, WILLIAMS, and LITTLETON, Judges.
Plaintiff brings this suit to recover certain sums specified in the petition paid at different times on its taxes for 1920, 1921, 1923, and 1924, alleged to have been collected by the defendant in excess of the amount legally due. The issue in the case is whether the plaintiff is entitled to deductions from gross income for the years in controversy on account of payments made for a certain contract with one Christensen, to which reference will hereinafter be made more particularly.
There is no material conflict in the testimony, but the parties dispute as to the inferences and ultimate conclusions that may be drawn therefrom. The evidence shows that the plaintiff is a corporation, and during the time involved in the case was engaged in manufacturing and selling book stitcher-feeding machinery. Its capital stock when organized was divided into 50 shares, of which 25 shares were issued to F.J. Greene, 24 shares to Martin Christensen, and one share to Mrs. Christensen. Some time during the year 1917, the plaintiff's capital stock was increased from $5,000 to $25,000. Greene paid in $10,000 in cash, and Christensen $5,000 or $6,000 in cash, and released a credit due him from the corporation. Each received an additional 100 shares of the capital stock. From the first Christensen was the active figure in the corporation. He originated and perfected the inventions owned by it, directed the manufacture, and made the sales. Greene looked after the company's finances, but was not known to the customers. In 1920 Christensen and Greene disagreed with reference to the business, and decided to sever relations. On February 21, 1920, a written contract was executed by and between Greene, Christensen, and the corporation under which Christensen sold all of his stock in the plaintiff corporation to Greene, made certain special covenants with reference to the inventions used by the company, and agreed for the period of 5 years not in any way, directly or indirectly, to compete with the business carried on by the corporation. The consideration for his agreement therein was $60,000, which was paid by the corporation.
In making up its returns for the years involved the plaintiff claimed to be entitled to a deduction from gross income for exhaustion of the agreement of Christensen not to compete, allocated pro rata over the years involved. The Commissioner refused to make any deduction on account of the $60,000 paid under the first contract, but did make such an allowance for the amount paid on the second contract not to compete. The case turns upon the question of whether this ruling of the Commissioner was correct.
The defendant practically concedes that such a deduction would be proper if the evidence definitely showed the value of the agreement not to compete contained in the first contract. Specifically it is contended on behalf of the defendant:
First. That, in addition to the contract not to compete, there were other promises, covenants, and agreements made by Christensen to the corporation which had a value which must be ascertained before the cost of the contract not to compete can be determine and that, as there is no evidence of such value, the court cannot find or determine the cost of the contract not to compete.
Second. That, if it be conceded that the other agreements were merely incidental or had at most merely a nominal value, the cost of the agreement not to compete would be the difference between the total amount paid under the contract and the value of Christensen's stock and financial interests, and there is no satisfactory evidence of such value.
Considering the first contention made on behalf of defendant, it must be conceded there were other promises and agreements made by Christensen in the first contract besides the one not to compete; but we think, as said by the Board of Tax Appeals in determining the same question between the same parties, that (Christensen Machine Company v. Commissioner, 18 B.T.A. 256): "The other engagements of Christensen were only incidental and precautionary so far as Greene and the petitioner were concerned." The first agreement provided that during the term thereof Christensen should not "directly or indirectly," or "in any manner whatever, engage in the business of manufacturing or selling stitcher-feeding machinery, or machinery or improvements, devices, or attachments of any kind adapted for use in connection with book stitcher-feeding machines which will compete commercially." The agreement not to grant any other person the patent or application on any new invention that would compete with the business of the corporation merely made the agreement before recited more specific, and defined in part the meaning of the words "directly or indirectly." The other agreements appear to be merely precautionary devices, as by them Christensen agreed to do certain things contingent upon the happening of certain events, but there is no evidence that any of these events happened or were likely to happen. Such agreements could have only a nominal value at most. Even if it be conceded that the other agreements had some value, and that there is no evidence from which that value can be found, there is still sufficient evidence for the court to find and determine that their total value was not large enough to make any substantial difference in the way of reducing the income of the corporation when spread over a period of years. De minimis non curat lex. Courts are not powerless to act and prevented from rendering a judgment because the amount thereof can not be determined with precise mathematical accuracy.
Where stock has no established market value and no recent sales or offers to purchase or offers to sell have been made, it is always difficult to determine its value accurately. But, where the nature of the business is shown, its operations described, its profits for several prior years fixed, the amount of its tangible assets known, and the testimony shows the surrounding circumstances which bear on the question of what its profits are likely to be in the future, the court cannot say that there is no evidence of value, but must proceed to determine the value as accurately as it can from the evidence which is before it.
Taking up now the evidence as to the value of the capital stock, we find that the Commissioner of Internal Revenue determined in another proceeding that the fair average value of plaintiff's capital stock for the period of June 30, 1919, to June 30, 1920, was $42,017.67, but we have no knowledge of how the Commissioner arrived at that sum. The average earnings for the years December 31, 1912, to December 31, 1919, inclusive, were only $4,263.03, and, if the value of the stock was computed on that basis, the amount fixed by the Commissioner was, in our opinion, large enough. But from 1915 up to the last of 1918 the corporation was exposed to competition from the Dexter Folding Company, which had a superior machine, and in 1917 the corporation actually had a small deficit. Then Christensen invented a machine which was much superior to the Dexter machine, and in 1918 the profits rose to nearly $4,000, and were $18,731.49 in 1919. But the value of the stock cannot be properly computed on the earnings for 1919. As the Board of Tax Appeals states in its opinion (Christensen Machine Co. v. Commissioner, supra):
"* * * Christensen was leaving. He had been the most important person in the business. He had invented the machines, he had manufactured them and had sold them. Greene knew but little about conducting the business, but before he agreed to the purchase of this stock, which was to make him sole owner of the corporation, he made an extensive investigation to learn just what he would have, how much he could reasonably expect to make out of it and how much the stock was worth."
After making this investigation, Greene concluded that Christensen's stock and his agreement not to compete for 5 years, which he considered "the life of the contract," or, in other words, an essential element of the contract, were worth together $60,000. The Board of Tax Appeals, in its opinion, allocated one-half of the $60,000 to each of the two principal things purchased, or, in other words, concluded that Christensen's stock was worth $30,000 and the agreement not to compete the same amount. As Christensen had half of the stock, the total value thereof would be $60,000. We think this is substantially correct. Counsel for plaintiff have presented an elaborate computation based on the average earnings for all of the years above referred to and capitalizing the return on tangibles at 10 per cent. and on intangibles at 20 per cent. By this computation the value of Christensen's 125 shares is found to be $25,182.12. Deducting this from $60,000 would make the cost of the agreement not to compete $34,817.88. But this calculation, in our opinion, does not make sufficient allowance for the change in the condition of the business of the company brought about by the invention of a superior machine as above stated. Making due allowance for the fact that Christensen was going out of the business on the one hand, and on the other for the fact that a superior machine had been acquired by the corporation, we concur in the finding of the Board of Tax Appeals.
As the contract cost $30,000 and ran for 5 years, at the end of which it would be exhausted, the average deduction for each year would be $6,000.
The amount of taxes due from plaintiff for the years in controversy, when a deduction from gross income is made in accordance with the foregoing opinion, is merely a matter of computation, but no computation has been submitted on the basis of the values which we have fixed therein. The plaintiff is entitled to judgment, but the entry thereof will be withheld until a computation is presented to the court in accordance with the opinion. If the parties agree with reference to the result of the computation, judgment will be entered for the amount so fixed; otherwise the court will have the computation made and judgment entered.