taxpayer’s payments in satisfaction of bankrupt subsidiaries’ debts deductible as business expenses because made to protect taxpayer’s reputation in business community
How later courts described this case
- taxpayer’s payments in satisfaction of bankrupt subsidiaries’ debts deductible as business expenses because made to protect taxpayer’s reputation in business community
- payments by jeweler to creditors of bankruptcy subsidiary in order to improve credit-rating
- payments by jeweler to creditors of bankrupt subsidiary in order to improve credit-rating
- payment of debts of a subsidiary reorganized under section 77B of the Bankruptcy Act
Written by the judges who cited it.
The opinion
Hill, J., dissenting: A merchant’s credit is built on his record as to honesty, his ability to pay, and the payment of his obligations. I do not find in the record here any direct evidence that petitioner was deficient in any of the particulars named. So far as the record here discloses, it was petitioner’s subsidiary and not. petitioner that was in financial difficulties.
If in the instant proceeding petitioner’s credit was impaired by reason of the deficiencies of its wholly owned subsidiary, we must look for the basis for ascribing such deficiencies to petitioner. If petitioner in discharging its responsibilities of control over the subsidiary diverted the latter from the line of rectitude or sound business practices in its trade relations and thus impaired the subsidiary’s ability to pay its debts, it is conceivable that an impairment of petitioner’s credit standing might also result therefrom. If such impairment of petitioner’s credit so resulted, it occurred from its voluntary conduct in controlling the operation of another corporation’s business.
The question then is, Can the cost of remedying any such impairment of petitioner’s credit be classed as an ordinary and necessary business expense of petitioner? The remedy as applied, according to petitioner’s contention, consisted of paying the debts of the subsidiary in order that the latter might be rehabilitated under a 77B reorganization. It is claimed by petitioner that such rehabilitation of the subsidiary was necessary to, and did, restore its own credit standing. In other words, petitioner seeks to deduct as an ordinary and necessary expense of its own business the cost of eliminating an impairment of its credit due to its own control of the business of another corporation. The foregoing, in my opinion, reflects the logical development of the theory upon which petitioner claims the deduction. I submit that such theory forecloses the right to such deduction.
However, the record discloses facts which call for the application of another legal principle which, I think, definitely denies the right of deduction claimed by petitioner.
The subsidiary was reorganized under section 77B of the Bankruptcy Act. A proposed plan of reorganization was accepted by its creditors and ordered adopted by the court. On the surface, the main points of that plan were: (a) That the unsecured creditors should be paid 45 per cent of their claims out of the assets of the subsidiary; and (b) that petitioner should subordinate its claims against the subsidiary to those of other unsecured creditors to the extent of such 45 per cent. But, on the side, petitioner’s president orally agreed on behalf of petitioner with such other unsecured creditors that petitioner would pay the remaining 55 per cent of their claims against the subsidiary.
Obviously, this oral agreement was made for the purpose, and had the effect, of inducing such unsecured creditors to accept the proposed plan of reorganization. It accomplished its intended purpose.
The question, if any, of whether such agreement, because it was oral, was enforceable, is eliminated for the reason that to the extent here involved it was performed.
The promise to pay and the payment by petitioner of the remaining 55 per cent of certain claims against its subsidiary was based on a consideration which petitioner must have deemed valuable and adequate. That consideration was the acceptance by the other creditors of the plan of reorganization of the subsidiary. I assume the purpose of the reorganization was to enable the subsidiary to continue in business. I can conceive of no other reason for the reorganization. No doubt it was deemed financially advantageous to petitioner that the subsidiary be so reorganized as to conserve its status as the operator of a going business rather than have it run through the wringer of an outright bankruptcy proceeding.
The arrangement whereby petitioner promised to pay and paid the moneys herein involved was not to protect the business of its own operations, but the business and assets of the subsidiary. Moreover, the promise and payments in question were made pursuant to a side agreement in connection with the reorganization proceedings. It is true that the record shows representations were made to petitioner that it would be helpful to its credit if it paid the moneys which it had promised to pay. However, the fact that such payments may have had the effect of strengthening the credit standing of petitioner was merely incidental to the performance of its agreement entered into for a valuable and adequate consideration. Petitioner got what it paid for, namely, the acceptance of its plan for the reorganization of its subsidiary. It realized neither gain nor loss, nor incurred business expense, from such transaction any more than if it had bought and paid for a house, a horse, or an automobile.
Therefore, it appears to me that petitioner neither sustained a deductible loss nor made the payments in question as an ordinary and necessary expense of its business. Certainly, there is no basis for a contention that petitioner is entitled to a deduction as a bad debt for the payments made.