1939 BTA LEXIS 1038 | B.T.A. | 1939
Lead Opinion
The sole question in issue is whether the nonmatur-ing debentures issued by the petitioner are essentially certificates of preferred stock or are evidences of indebtedness. If the former, the semiannual payments thereon made by the petitioner are to be treated as dividends; if the latter, they constitute interest and are deductible as such under the statute.
In deciding questions of this character, our consideration is premised on certain basic principles, but the decision in each case turns upon the facts of that case. Northern Fire Apparatus Co., 11 B. T. A. 355; Proctor Shop, Inc., 30 B. T. A. 721; aff'd., 82 Fed. (2d) 792. The name given to a security is not determinative, but it is not to be ignored nor is it lightly to be assumed that the parties have given an erroneous name to their transaction. I. Unterberg & Co., 2 B. T. A. 274; Kentucky River Coal Corporation, 3 B. T. A. 644; H. R. DeMilt Co., 7 B. T. A. 7. The intention of the parties must be accorded great weight. Commissioner v. National Grange.
The respondent contends first that the debenture is so similar in terms to the preferred stock certificate as to be practically equivalent thereto and that, taken as a whole, the debenture exhibits stock ownership characteristics which “transcended all other interests.”
We do not agree. When the petitioner purchased all its preferred stock from the stockholders it terminated the relationship of corporation and preferred stockholders. The issuance of the debentures created a new and different contractual relationship with the purchasers of the debentures, the former stockholders. Their rights as preferred stockholders differed in certain basic respects from those which accrued as debenture holders.
The preferred stock was expressly so called and provided for payment of dividends. The holders of preferred stock had certain voting powers in event of contemplated dissolution, or on the question of the issue of additional preferred stock with preference over present preferred stock, or other change in preferences of preferred stock.
By express words appearing on the face of the debentures the corporation “acknowledged its indebtedness” and “promises to pay interest at the rate of Seven (7%) per cent per annum.” The debenture holders had no voting rights in any event and had no voice in management. The rights at law of a preferred stockholder differ materially from those of a debenture holder.
The word “debenture” is variously defined, but all to the same tenor — that it evidences a debt. Thus, in Bouvier’s Law Dictionary, “any instrument (other than a covering or trust deed) which either creates or agrees to create a debt in favor of one person or corporation or several persons or corporations or acknowledges such debt”; and in Funk and Wagnall’s Standard Dictionary, “an instrument, in the nature of a bond, given as an acknowledgment of a debt and providing for repayment out of some specified fund or source of income.”
Thus, though the terminology employed is only evidentiary and not conclusive, if any presumption exists, it is that the creation of an obligation styled a “debenture” is in recognition of a debt. Moreover, it would seem clear, on the face of the record, that the petitioner intended to create the debentures as an evidence of indebtedness. All of its preliminary resolutions and acts, together with the terminology used, so show. The corporate records and the treatment of the debentures in reports to the State of New York are consistent only with the debtor-creditor relationship.
It has consistently been held that the provision that the obligation contains no fixed final due date or becomes payable at the option of the maker does not destroy its character as an indebtedness. In Helvering v. Richmond, Fredericksburg & Potomac Railroad Co., 90 Fed. (2d) 971, the court, in affirming the Board (33 B. T. A. 895) said:
The fact that the principal of the guaranteed stock is not demandable by the stockholder in the absence of default in the payment of the guaranteed dividends is not conclusive of a stock investment. In the light of the other attributes of the stock, this indicates rather a debt as to which there is a right of renewal so long as the interest is paid when due. There is nothing in the fact that the debt evidenced by the preferred stock is not payable at a fixed time which throws upon the holders thereof any of the risks with respect to the corporate enterprise which are characteristic of the position of the stockholder.
See also National Grange Mutual Liability Co., supra; Brush-Moore Newspapers, Inc., 37 B. T. A. 787.
To support bis contention tbat the provision requiring interest to be paid exclusively out of profits brands the debenture as stock, respondent relies on Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11, affirming 30 B. T. A. 337; and Jewel Tea Co. v. United States, 90 Fed. (2d) 451.
In the O. P. P. Holding Corporation case the court affirmed the decision of the Board that the debenture bondholders in question wore in fact creditors. Though the discussion of the law by the court gives us some pause, we find no support for respondent’s position in the decision in this case.
In the Jewel Tea Co. case the question related to the deduction of premiums paid on retirement of preferred stock, the facts there being very different from those before us.
In H. R. DeMilt Co., supra, we had for consideration a case where the debentures bore interest payable out of the net profits arising from the business of the company. There we said that such fact was not controlling. We think that is equally true in the case at bar.
Bearing resemblances both to preferred stock and to corporate indebtedness, as the debentures do, the case is not free from doubt. Our problem is to determine to which type the resemblance is greater. Considering the apparent intent of the corporation, the expressed terms of the debenture, the factual and legal incidences of the same,
Reviewed by the Board.
Decision will be entered under Bule 50.
Dissenting Opinion
dissenting: I must dissent. Although feeling that the relation of debtor and creditor is lacking in the instant proceeding because of the lack of a definite time of maturity (Jewel Tea Co. v. United States, 90 Fed. (2d) 451), I shall discuss principally the fact that payment of interest is limited by being payable only from profits. In Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11, the court laid down, I think, the sound distinction between a shareholder and a creditor as reflected in the difference between obligations being payable regardless of surplus, or payable limited to earnings. The court said:
* * * The final criterion between creditor and shareholder we believe to be the contingency of payment. The shareholder is entitled to nothing, prior to liquidation, except out of earnings. Even on liquidation, at least in New York, arrears of cumulative dividends are confined to earnings. Michael v. Cayey-Caguas Tobacco Co., 190 App. Div. 618, 180 N. Y. S. 532. These debenture bondholders were not so limited. The interest could be deferred, but it was not lost, though the company had no earnings; it could be collected, together with the principal, in 1954, from the corpus of the debtor’s property, regardless of whether there should be a surplus. See Warren v. King, 108 U. S. 389, 399, 2 S. Ct. 789, 27 L. Ed. 769. This distinction marks the vital difference between the shareholder and the creditor. The shareholder is an adventurer in the corporate business; he takes the risks, and profits from success. The creditor, in compensation for not sharing the profits, is to be paid independently of the risk of success, and gets a right to dip into the capital when the payment date arrives. The courts have very frequently been called upon to determine whether the rights of a claimant are those of shareholder or creditor. Each ease has turned on its special facts, and to cite them all would not be useful, if it were possible. We think all the decisions which we have examined may be harmonized by adopting the criterion above suggested. The decision of this court in Re Fechheimer Fishel Co., 212 P. 357, is entirely consistent with this view. There interest on the so-called bonds was to be paid only out of earnings, and upon liquidation or dissolution the whole residue of the corporate assets after payment of the debts was to go to the bondholders. * * *
In Warren v. King, 108 U. S. 389, though there were other circumstances, such as participation with common shares after payment of a certain percentage on both preferred and common stock, the Court emphasized, as reason for holding that there was no relation of debtor and creditor, the fact that the holder of the certificate could have no income unless there were net earnings; that interest was not to be paid
In Finance & Investment Corporation v. Burnet, 57 Fed. (2d) 444, the court stressed, among other reasons for holding that payments to preferred stockholders were dividends and not interest under section 234 (a) (2) of the Revenue Act of 1926 (the same as section 23 (b), Act of 1932, so far as here involved), the fact that the payments were out of net earnings, and that no express time is fixed for payment, without the exercise of an option at the election of the stockholder or the corporation. In the instant case there is, of course, no such right of election on the part of the certificate holder to receive payment of principal.
In Mercantile Trust Co. v. Baltimore & Ohio Railroad Co., 82 Fed. 360, there was involved a subscription by the State of Maryland to the Baltimore & Ohio Railroad Co. The Maryland statute provided that before any subscription to stock should be made, the stockholders of the company should bind the company to guaranty to the state payment “out of the profits of the organization” of 6 percent per annum until the profits enabled payment of a dividend of 6 percent, after which the state should be entitled to a perpetual dividend of 6 percent and no more (that is, no repayment of principal). The state had a right to six directors. The instrument was given, as required by the act. It was:
* * * Held that, the interest and dividends of the state being payable from “profits,” it did not become a creditor of the company, but a preferred stockholder, having no equitable lien on the property of the company which entitled the holders of the stock to dividends from the earnings of the road in the hands of receivers in preference to the payment of interest on mortgage indebtedness subsequently contracted.
In the body of the opinion, it is stated:
* * * If it had been the intention of the legislature that the position of the state should be that of creditor, or analogous to that of creditor, there would be no reason for resricting its rights to a payment out of profits. A creditor might be restricted to payment out of revenue, or out of net revenue, or out of revenue from which enough has been taken to pay operating expenses, repairs, and fixed charges; but a creditor who is never to be paid the principal of his debt, and is to have only an annual sum, and is restricted, as to that annual sum, to a payment out of profits, is but a preferred stockholder. * * *
Emphasis is placed upon the fact that payment is to be made out of profits, and to the fact that, if there were no profits, there would be no payment.
I believe that the position of the debenture holder here was that of having a lien or security upon a fund, the profits, for payment of interest, with no positive obligation to pay such interest and no obligation whatever to pay principal, and therefore no debt. The debenture twice refers to the principal money as “hereby secured.” A holder of security is not thereby a creditor, in the sense of being able
In bankruptcy, that which is received by the distributee is commonly referred to as a dividend, which not only is the same term applied to distributions to shareholders, but serves to emphasize the fact that it is received as the result of a division of the assets of the bankrupt. Even sharper emphasis is accentuated in the instant matter, for the debenture provides that, after debts to banks and bankers, debenture holders shall receive “dividends or other payments.” A distribution of principal, possible only through dissolution, liquidation, or bankruptcy (in the absence of voluntary redemption) is thus plainly seen as not payment, but as sharing in a division of the assets of the corporation, by operation of law, necessarily on a plane of equality with all similarly situated. This is the nature of the right of a shareholder, or stockholder.
Moreover, the agreement that in the event of bankruptcy, liquidation, or dissolution the debenture holder would be in a position inferior to that of banks and bankers demonstrates that the debenture holder has a position inferior to that of a creditor — for the simple reason that no bank or banker (unless holding security, which is not the provision stated in the debenture) could arrogate to himself a position over that of common creditors. To do so would be to claim preference forbidden by law. Therefore every common creditor,
Moreover, as a matter of fact, there is nothing to indicate that the debts of the corporation were not entirely held by banks or bankers. By assignment of any other debts to banks or bankers they could become holders of all of the corporate debts. Such, banks and bankers, however, not being required to be secured creditors, it is obvious that petitioner has not shown that the debenture holders did not occupy a position inferior to and junior to that of the only creditors, and they common creditors — the position of a participant with common stockholders in the corporate assets after application thereof to satisfaction of rights of common creditors. This is the status, at best, of a preferred stockholder.
Another fact demonstrates analogy to stockholding: For two years no dividends were payable to common stockholders, surplus being accumulated during that time to pay the debenture interest — which was cumulative. The taxable years in question come within those two years, and we are constrained therefore to consider only the situation within that period. Vermont-Hydro Electric Corporation, 29 B. T. A. 1006; Pantlind Hotel Co., 23 B. T. A. 1207. Plainly, then, the debenture holders in the taxable years had a preference over common stockholders. If they were creditors, they were preferred creditors, for ordinary creditors have no right to have dividends (within the earnings) withheld from common stockholders. Yet they were not preferred creditors, for banks and bankers had priority over them, even though having unsecured claims. Patently this discloses a participation, for two years and including the taxable years, in a fund which would otherwise have belonged to and would have been distributable to, the stockholders. An ordinary creditor, in order to participate therein, would, in the absence of voluntary payment, have been obliged to levy upon such fund in order to preclude its distribution as dividends to common stockholders. The debenture holders, however, had a covenant or agreement beforehand protecting them in payment from the two-year surplus. This covenant I believe to be of the essential nature of sharing with the stockholders. It protected against the weakness in the ordinary creditor’s position, and is inconsistent therewith. I note that in In re Fechheimer Fishel Co., 212 Fed. 357, referred to above in Commissioner v. O. P. P. Holding Corporation, the court considered as characteristic of stock, and not characteristic of bonds, the same situation here involved in the taxable years, i. e., the fact that the debenture bond should be entitled to
