Opposition Brief — Missouri Pacific Railroad v. United States

INDEX

Page

SN I ee a ee ee ee i

DR RRP DE ee eee REAR yea 1

NON SONI ns oc co eng ene 2

Statute and regulations involved________-.------- 2

RC a ae oe a orc oc ines ee wens 2

STS htt oer Cea ae te asia 4 4

‘Conclusion _--__- i eh AA en cE page alps PS eRe 10

CITATIONS

Cases:

-lmerican Smelting & Refining Co. v. United

SN OO ee Uo eo ina cee 8,9

-lrkansas-Missourt Power Corp. v. Paschal,

Ree ee. oe Sic ea ok 8

Bethlehem Steel Corp. v. United States, 434 F.

oS 9s SER Is se ot nee eer ee TP 5

Commissioner v. Danielson, 378 F. 2d 771, cer-

SN ee A ee PG ke cnn onc pcck a's 5

Gt. WW. Power Co. v. Commissioner, 297 U.S.

ee ee ans ens we wea 6

Helvering v. Union Pacific Co., 293 U.S. 282__ +

Hundahi v. Commissioner, 118 F. 2d 349_____ 5

M.C. Parish & Co. v. Commission, 147 F. 2d

ee Si ir ak §

Missourt Pac. R. Co., In re, 93 F. Supp. 832_- 7

Missourt Pac. R.R. Co., Etc. v.. Thompson,

Be ee ee ca, aoe eotee ee. 7

Missouri Pacific Railroad Co. 544% S.S.B.C.

v. Thompson, 225 IF. 2d 761, certiorari

Geneee, G00 U.S. G00. on eee uc

“J

421-631—71

II

Cases—Continued

Missouri Pac. R. Co. Reorganization, 275 I.C.C.

Des dnc nda aekinneaeee ea aeaes ke

Missouri Pac. R. Co. Reorganization, 290 1.C.C.

DEG n eas h waas eo humane k Al eel ealeae ete

Moniana Power Co. v. United States, 159 F.

NE: sos ocr ace mean oeen eae

Nassau Lens Co. v. Commissioner, 308 F.

TS web kena es Ree

R.F.C. v. Denver & R.G.W.R. Co., 328 US.

MS ec ign oa ee hd ne eee eee

Sacramento Medico Dental Building Co. v.

Commissioner, 47 B.T.A. 315__..-.----_--

Southern Natural Gas Co. v. United States,

ee 2) ee So oss bs hae ake eas

Texas, State of v. Group of Institutional In-

vestors, 191 IF. 2d 265, certiorari denied,

BOR Ss ce We wn kee oe ake eee cae eee

Union Pacific Railread Co. v. United States

401 F. 2d 778, certiorari denied, 395 U.S.

Statile:

F ofperal Bankruptéy Act, 11 U.S.C. 205... _.-

Tax Reform Act of 1969, 413(b), P.L. 91-172,

ee WEA ica dak sawhorse eh nenaeaeue

Page

a |

Gu the Supreme Court of the United States

OctToBeR TERM, 1970

No. 1333

Missourt PactFic RatLRoap CoMPANY, PETITIONER

2.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF CLAIMS

BRIEF FOR THE UNITED STATES IN OPPOSITION

- OPINIONS BELOW

The Court of Claims filed two opinions in this

case. The first (Pet. App. 13-24) is reported at 427

¥, 2d 727; the second (Pet. App. 25-28) is reported

at 433 F. 2d 1324.

JURISDICTION

The original decision of the Court of Claims was

filed on June,12, 1970 (Pet. App. 13). Both parties

filed timely motions for reconsideration. On November

13, 1970, the court granted the government’s motion

and denied petitioner’s motion, and entered its second

opinion (Pet. App. 25). Petitioner’s motion for re-

hearing of the second decision was denied on Febru-

ary 5, 1971. The petition for a writ of certiorari was

(1)

2

filed on February 9, 1971. The jurisdiction of this

Court rests on 28 U.S.C. 1255(1).

QUESTION PRESENTED

Whether the court below correctly held that peti-

tioner did not incur amortizable bond discount when,

in a reorganization under Section 77 of the Federal

Bankruptcy Act, it issued new bonds in exchange for

old bonds of equivalent maturity value, and new bonds

in exchange for stock which was of equivalent value

in the view of the Interstate Commerce Commission

and the federal courts reviewing the reorganization.

STATUTE AND REGULATIONS INVOLVED

The pertinent statutory and regulatory provisions

are set forth in Appendix A to the petition (p. 12).

STATEMENT

Effective March 1, 1956, petitioner and its subsidi-

aries were reorganized and merged under Section 77

of the Federal Bankruptcy Act, 11 U.S.C. 205, pur-

suant to a plan of reorganization approved by the

Interstate Commerce Commission and reviewing fed-

eral courts. In accordance with the plan, so far as per-

tinent, petitioner issued new interest-bearing debt se-

curities (collateral trust notes, mortgage bonds and

debentures, collectively hereinafter ‘‘new bonds’’)

largely in exchange for its own old bonds and bonds

of its subsidiaries. In many cases, new bonds were

issued for old bonds of equal face value, with the in-

terest accrued on the old bonds being paid in cash. In

the remaining bonds-for-bonds exchanges, the new

bonds were equal in face amount to the face amount

3

of the old bonds plus accrued interest thereon.’ All

unamortized discount on the old bonds was carried

forward and amortized during the life of the new se-

curities. (Pet. App. B 14-15, 21.)

Petitioner also exchanged its new bonds for pub-

licly-held stock of a 94 percent owned subsidiary, the

New Orleans, Texas and Mexico Railway Company

(hereinafter ‘‘New Orleans’’) (Pet. App. B 20-21).

In petitioner’s reorganization proceedings, the Inter-

state Commerce Commission and the reviewing fed-

eral courts determined, after thorough consideration,

that the New Orleans stock was worth $250 per share,

and that $216 in maturity value of new bonds should

be allocated to each share of stock as its ‘‘equitable

equivalent’’ (Pet. App. B 27).

Petitioner asserted below (Pet. App. B 15-16),

as here, that it incurred hond discount in the amount

of the excess of the face value of the new bonds over

the New York Stock Exchange price quotations for

the old securities at the time of the exchange. The

court below rejected this contention. Limiting its con-

clusions to exchanges within a corporate family, the

court ruled first that the only relevant value to peti-

tioner of the old bonds was their face amount and,

hence, that the issuance of new bonds for equivalent

indebtedness was an exchange of equal values in which

no discount was incurred (Pet. App. B 18, 21). As for

+The court below has remanded to the trial commissioner

the essentially mechanical question as to whether there was

an equivalence of face values in the exchange of petitioner's

new bonds for the old bonds of one subsidiary, the Little Rock

& Hot Springs Western Railroad Company.

+

the exchange .f new bonds for New Orleans stock, the

court held on rehearing that no discount was ineurred

because there was an exchange of equivalent values

as determined by the Interstate Commerce Commission

and confirmed by the reviewing courts (Pet. App.

Ee anhe

ARGUMENT

The decision below is correct in result. There is no

direct conflict or other warrant for furthexz_review.

1. Bond discount has been characterize@ as a form

of deferred interest—an amount to be paid im futuro

for the use or forbearance of money. Helvering v.

Union Pacific Co., 293 U.S. 282, 286; United States v.

Midland-Ross Corp., 381 U.S. 54, 66. The fact and

amount of a discount is clear where bonds are issued

for a cash amount which is less than the face amount

of the bonds. Such a discount is amortizable by the

issuer, so that the cost of the future interest may be

deducted ratably over the life of the bods. It seems

clear that a similar result should follow where bonds

are issued for property under a contract which places

an agreed price on the property and thereby reflects

a discount bargained for at arm’s length.

“The court held in its first opinion that petitioner would

have incurred discount if the face amount of the new bonds

exceeded the amount originally paid in for the New Orleans

stock, and remanded the issue for further proceedings (Pet.

App. B 22-24). On rehearing, the court withdrew the remand

and modified its views to hold that there could be discount only

to the extent that the face amount of the new bonds exceeded the

greater of (1) the amount originally paid in for the stock or

(2) the value of the stock at the time of the exchange, taking

into account not only the current market quotations but other

factors bearing on the value of the stock fo petitioner.

5

The situation is entirely different where bonds are

simply issued in exchange for property (including

securities) without negotiation of an agreed purchase

price which reflects a discount. In such circumstances

it is the government’s general position that discount

may not be imputed by reference to fair market value

or any other factor—that the parties have in sub-

.tanee contracted to make an even exchange, with the

property acquired taking as its cost basis the face

amount of the bonds issued. Any other result attrib-

utes to the parties a contract they did not make, im-

puting interest for which they did not provide. This

is contrary to recognized tax principles (Bethlehem

Steel Corp. v. United States, 434 F.2d 1357 (Ct. Cl.) ;

Commissioner Vv. Danielson, 378 F. 2d 771 (C.A. 3), cer-

tiorari denied, 389 U.S. 858; M. C. Parrish & Co. v. Com-

missioner, 147 F. 2d 284 (C.A. 5); Hundahl v.

Commissioner, 118 F. 2d 349 (C.A. 5)) and to deci-

sions squarely involving exchanges of bonds for prop-

erty (Southern Natural Gas Co. v. United States, 412

F. 2d 1222 (Ct. Cl.); Montana Power Co. v. United

States, 159 F. Supp. 593 (Ct. Cl.) ; Sacramento Medico

Dental Building Co. v. Commissioner, 47 B.T.A.

315). In the instant case no agreed price or discount

was negotiated by the parties.

In rejecting petitioner’s claim that it incurred bond

discount upon issuance of the new bonds, the court

below’ did not squarely pass upon the validity of the

government’s general position, as outlined above.

Rather, it found that under no theory could a discount

be established in the particular circumstances herein.

This finding is clearly correct.

6

Petitioner issued the new bonds in exchange for

equivalent face amounts of its old bonds and bonds

of its wholly-owned subsidiaries which were merged

into it. It eontends that the exchanges should be

treated as if it had bought the old bonds for cash and

issued the new bonds in a separate transaction. But

this Court rejected a similar contention under similar

circumstances (except that subsidiaries were not in-

volved) in Gt. W. Power Co. v. Commissioner, 297

U.S. 543. The Court there held (297 U.S. at 546)

that there was a substitution of obligations which re-

quired the taxpayer to carry over unamortized dis-

count on the old bonds and to amortize it (together

with other expenses attributable to the issuance of the

new bonds) over the life of the new securities. This

ruling applies to the bonds of petitioner’s subsidiaries,

as well as to petitioner’s own bonds, since petitioner

absorbed its subsidiaries and assumed their liaLilities

as its own in the reorganization.

The rationale of the ruling is cogently stated by the

court below (Pet. App. B 17-18). The court reeog-

nized that when a debtor issues new bonds in substitu-

tion for old bonds of equivalent maturity value, bond

diseount cannot be determined by reference to the

market value of the old bonds which are to be ean-

celled. This value is 1: caningless to the debtor because

the old bonds will no longer be subject to market con-

ditions, and the debtor will be in the same position

after the exchange as it was previously, the amount

of its indebtedness not having been reduced. To

recognize bond discount in these circumstances (in

excess of the unamortized discount on the old bonds

me

7

which may be carried over) would permit a

debtor to generate income tax deductions merely

by reshuffling its financial structure, but without any

real change in that structure. It would, as the court

below concluded (Pet. App. B 18), “‘give credence to

an illusional or fictional interest charge which does not

actually exist. * * * [Petitioner] would be unjustly

increasing the amount of its deductions without corre-

spondingly increasing its obligations.”’

It is likewise clear in the special circumstances

of this case that petitioner did not incur bond dis-

count in issuing new bonds for the New Orleans

stock. The fair market value of the New Orleans

stock was extensively litigated over several years in

the reorganization proceedings before the Interstate

Commerce Commission (Missouri Pac. R. Co. Re-

organization, 275 1.C.C_59, 113, 125-127), and before

the District Court for the Eastern District of Mis-

souri (In re Missouri Pac. R. Co., 93 F. Supp. 832,

848-849; 129 F. Supp. 392, 399). The issue was ap-

pealed on three different occasions by the New Or-

leans stockholders, who claimed that the stock had a

value of $390 per share, and this Court twice denied

applications for certiorari. State of Texas v. Group of

Institutional Investors, 191 F. 2d 265, 273-274 (C.A.

8), certiorari denied, 343 U.S. 929; Missouri Pacific

Railroad Co. 5%4% S.S.B.C. v. Thompson, 225 F.

2d 761, 765 (C.A. 8), certiorari denied, 350 U.S.

959; Missouri Pacific Railroad Co., Etc. v. Thomp-

son, 229 F. 2d 898, 900 (C.A. 8).

The upshot was that the New Orleans stock was

valued at $250 per share. Only $216 in maturity value

8

of bonds were allocated to each share on the ground

that the bonds were ‘‘of higher grade” and there-

fore “the equitable equivalent” of the stock. Missouri

Pac. R. Co. Reorganization, 290 I.C.C. 674, 678-679.

It was eminently reasonable for the Court of Ciaims

to adopt the determination of the expert administra-

tive body and the bankruptcy and appellate courts

to which Congress has delegated the functions of

determining security values and insuring the fair-

ness of a railroad insolvency reorganization. See

R.F.C. v. Denver & R.G.W.R. Co., 328 U.S. 495, 508;

Arkansas-Missouri Power Corp. v. Paschal, 243 F.

2d 584, 588 (C.A. 8).

In sum, it was authoritatively determined that pe-

titioner did not give up any greater value than it

acquired in exchanging bonds for New Orleans stock,

and this determination was reflected in the contract

of the parties—the reorganization plan as finally

approved. .

2. Contrary to petitioner’s assertion (Pet. 4), the

decision here is not in “direct conflict’? with Nassau

Lens Co. v. Commissioner, 308 F. 2d 39 (C.A. 2), and

American Smelting & Refining Co. v. United States,

130 F. 2d 883 (C.A. 3). There is not even an arguable

conflict with Nassau Lens. In that case the taxpayer

purchased inventory at an agreed price of $100,000,

issuing therefor one hundred $1,000 debenture notes.

Each note provided for yearly increases in the re-

demption price. These increases obviously represent-

ed the cost of borrowing rather than payment of the

agreed purchase price, and the court properly held

that the increases were amortizable discount. Con-

9

cededly, in American Smelting & Refiniixg Co., the

court employed a different method of valuing stock

for which new bonds were issued than the method

employed by the Court of Claims here—but in a sig-

nificantiy different context. In American Smelting,

the court valued the stock by reference to market

quotations. It did not, however, have the authoritative

administrative and judicial determination of value

which the Court of Claims had here; if it had, there

is no reason to believe that the Third Circuit would

not have accepted such a determination.’

3. As petitioner notes (Pet. 6), there is some con-

fusion among the courts concerning the circumstances

under which bond discount may be ineurred in ex-

changes of bonds for property. The matter continues

to be of administrative importance notwithstanding

the provisions added to the Internal Revenue Code

by the Tax Reform Act of 1969 as to bonds issued

after May 27, 1969 (Section 1232(b) of the Code, as

amended by Section 413(b) of P.L. 91-172, 83 Stat.

611). ‘This is not an appropriate case for certiorari,

however, because it is clear that petitioner did not

issne new bonds with a value greater than the value to

it of the old securities. Hence, under any theory, no

bond discount was incurred here.

* Amicus incorrectly alleges conflict between the decision below

and the decision of the same court in Union Pacific Railroad Co. v.

United States, 401 F. 2d 778, certiorari denied, 395 U.S. 944. There

is no conflict. In both cases, the Court of Claims refused to impute

discount in an exchange of bonds for stock, rejecting the conten-

tion that. market quotations at the time of exchange required

recognition of discount. Moreover, any inconsistency in the de-

cisions of the Court of Claims would afford no basis for review

by this Court.

10

CONCLUSION

The petition for a writ of certiorari should be

deniad.

Respectfully submitted.

a ErRwIN N. GRiswoOLp,

Solicitor General.

JOHNNIE M. WALTERS,

Assistant Attorney General.

Puitie R. MILLER,

Grant W. WiprRvp,

Attorneys.

Aprit 1971.

SS COVERNMENT PRINTING OFFICE: t971