Brief for Respondent — Paragon Jewel Coal Co. v. Commissioner

Supreme Court brief1965

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Tener rt oo | | - Office-Supreme Couct, U.S.

ersrerm- . a Gat abs rt %.," ‘ FI L E D :

FEB 17 1965

JOHN R DAVIS, Clean 4

' IN THE

Supreme Court of the Rnited States

OCTOBER TERM 1964

_ No. 237 hae

es OF INTERNAL REVENUE,

: Petitioner .

eo ‘Vv.

ROBERT LEE MERRITT, ET UX., ET AL.

On Writ of Certiorari To the United States _

Court of Appeals for the Fourth Circuit

BRIEF FOR RESPONDENTS

JOHN’ Y. MERRELL

PAUL P. SENIO ;

844 Shoreham Building

Washington, D. C. 20005

Attorneys for Respondents

WILSON - EPES PRINTING Co. - RE 7-6002 - WASHINGTON 1. D. C.’

se,

ae 4

INDEX

5 _ Page |

Prelimmary Statement

Question Presented

Statement of Facts

Summary of Argument : on

Argument...... / : ay : 10

I The Coal Mine Operators Made A Capital Invest-

_ ment In The Coal In Place and Could Look Only

To The Extraction and Sale of The Coal Deposit

For a Return of Their Capital

1. Nature and Extent of The Investment Made

By The Coal Mine Operators?...

2. The Operators’ Capital Investments Were

_ Made Pursuant To Agreements Which Gave .

. Them A Continuing Right To Mine Their

| Areas To Exhaustion 19

8. The Operators Could Look Only To The Ex-

traction and Sale of The Coal For a, Return

on fw

of Their Investments. — 24

II Analysis Of The Commissioner’s Brief.

eS RE one 28

2. Argument of the Commissioner . 30

III Analysis Of Brief For Paragon 35

IV - Comments Of Amicus Curiae Brief Of Jewel

FRR IES RE ER PENS ER, CE 46

CI eicheaetenc crt tatekaicisinietacicecetnanas omidies 47

Appendix NERA BSR SESE AL Ie, Se RE ahi 49

: _ CITATIONS

Cases:

Alstead Coal Co. v. Yoke, 200 F.2d 766 ie ‘Cir,

Oe LEI IE AER A (16

(1902)... : ag

INDEX (Continued)

Page

‘Burnet V. Petroleum Exploration, 61 F.2d 273 (4

Cir. 1932) aff’d 288 U.S. 467 17

Clear Fork Coal Co. Vv. Commissioner, 229 F. as 638

(6 Cir. 1956) 16

' Clifton, Norman E., Docket No. 64659 Aprit 21,

. 1958] 58065 P-H Memo T.C..: 47

Commissioner V. H. E. Harman Coal Corp., 200 F.:

2d 415 (4 Cir. 1952) ......: 16

Commissioner\v. Southwest Exploration Co., - 350

U.S. 308 - 36, 40

Cooper, Raymond E., et al, 39 T.C. 253 (1962) ...... _ AT

Cowan v. Radford Iron Co., 83 Va. 547 3 S.E. :

120 (1887)..: 48, 44

‘Helverng v. Bankline Oil Co., 303'U.S. 362 es 36, 37

Helvering v. Mountain Producers Corp., 303 U.S. _

376....... 37

Lindlay v. Raydire, 239 F. 928 (D.C. E.D.. Ky.

1917) aff’d 249 F.675. (6 Cir. 1918) 44

National Lead Co., 23 T.C. 988 (1955) rev’d on

other grounds 230 F.2d 161 (2 Cir: 1956), aff’d ©

C.A. 352 U.S. 313... 14,16

Palmer v. Bender, 287 U.S. 551 35, 36

, Parvo ® Smith, 359 U.S. 215 caasous 9, 10, 11, 15, 19, 24, 25,

27, 36, 39, 47

Phillips Petroleum Company: Vv. Piste 241 F.2d

178 (10 Cir. 1957) Cert.den. 355 U-S. 816.......... “- ae

Repplier Coal Co. v. Commissioner, 140 F.2d 554

‘ (8 Cir. 1944) .cert. denied 323 U.S. 736...............- 17

‘Stilwell v. United States, 250° F.2d 736 (4 Cir.

1957). 8, 42

‘United States Gunaen Co. v. U.S., 52 AFTR 1819.

(D.C.N.D..Ill. 1957) aff’d 253 F.2d 738 (7 Cir.

PERRIER RT See eee oe 17

United States v. Stallard, 273 F.2d 847 (4 Cir.

1959) ; &

INDEX (Continued) Fiennes ii

Statutes: . = es, 2 oe

* Internal Revenue Code of 1954, as.Amended:

§ 614(a)..... 38

SSeS a aes 7 ae

§ 631 (c) : 88

". Treasury Regulations and Rulings: | ;

G.C.M. 22730 1941-1 C.B, 214.................. 10, 17, 18, st

Regulations § 1.611-1(b) (1) ; 35.

7 «Regulations § 1.611-1(c) (1) and (2)................ 38

Mise. : ie ewe ‘ | ee ee

Donley, The Law of Coat Oil and Gas In W. Va. &

Va. (1951). § 57 ‘ 21

Summers, Oil & Gas, Vol. 2, 2 Ed. SF i iiiceckcxedemetons 21, 44

itm |

| Salpreme Court of the Wuited States

‘ OCTOBER TERM 1964

No. 237 : ei Ri

Comms OF iNTERNAL REVENUE,

2 Petitioner

. ve .

_ RoBerT L&E MERRITT, ET UX., ET_AL.

On Writ of Certiorari To the United States

Court of Appeals for the Fourth Cicuit

BRIEF FOR RESPONDENTS

aa Preliminary Statement .

This case is consolidated with No. 134 and this brief is~

in reply to the brief for the Commissioner (respondent in

No. 134 and ‘petitioner in this case, No. 237) and the

brief for the petitioner filed by Paragon Jewel Coal Com-

pany, Inc., ( petitioner ‘in No. 184). Any relevant mat-

ters contained in the Amicus Curiae brief filed by Jewell .

. Ridge Coal Corporation ‘in support of pettioner in No.

134. will be discussed herein.”

'1The ‘following abbreviations will be used hicmabinat this brief:

“Comm'r r. Br.” refers | to the Brief for the Commissioner. “Paragon

“~~

Pos

“he has always controll

& ©

QUESTION PRESENTED

The issue in this consolidated case is whether the coal

mine operators operating in ‘various partnerships dur-

ing the years 1954, 1955 and 1956 are entitled to, an al-

locable portion of the percentage depletion allowance hased

~. 9n amounts received for mining coal under agreements

with the sub-lessee of the mineral rights or whether the

sub-lessee is entitled to deduct percentage depletion on its

gross income from the property, undiminished by amounts

paid to the coal mine operators for ‘coal mined and de-

. . livered to the sub-lessee. The Tax Court decided that the

sub-lessée was entitled to the entire percentage depletion

deduction. The Court of: Appeals for the Fourth Circuit

erators.

: Statement of Facts. i eG

. C. A. Clyborne acquired by lease and purchase certain

coal bearing lands located in Buchanan County, Virginia.

In 1951 Clyborne created Paragon Jewel Coal Company,

~Syeversed, and determined that the sub-lessee is required.

to share the depletion deduction with the coal mine op- | ~

Inc, (hereinafter “Paragon”), the.eorporate stock of which .

is held almost exelusively by-Clyborne and his wife and

is corporation. After Paragon

was formed, Clyborne“assigned leases heldsin his name to

his corporation for an overriding tonnage royalty. This

royalty w. deducted: by Paragon as an operating expense

and reported: by Clyborne as long-term capital gain? (R.

191,196), . ee oor”

Br.” refers to the Brief for the Petitioner in No. 134. “Jewell Ridge

Br.” refers. to the.Amicus Curiae brief filed by Jewell Ridge Coal

Corporation in support of petitioner in No. 134.

‘The returns of Clyborne for the years 1955, 1956 and 1957 show

that he received coal royalties from Paragon in the aggregate

amount of $471,425.93, which were deducted by that corporation as ©

operating expenses and reported by Clyborne as long-term capital

gain. (Ex. 1-A, 2-B, 3-C) ; ;

° °°

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Under the assignments from Clyborne, Paragon as- FE :

sumed the obligations to pay minimum royalties,’ tonnage we

royalties and land taxes, all 4 which:-were deductible by”

that’ corporation as business expenses or taxes. Paragon

_ made substantial investments for processing, shipping and

marketing coal all, of which were deducted as a business

expense, depreciation or amortization. In fact, all expendi-

~~ of Paragon with reference to its eval operations were

ucted for tax purposes. (R. 84, 211)

g’ 1951 Paragon had ‘acquired sifbstantial acreage of .

coal bearing lands from Clyborne. It had erected an.

expensive processing plant and was committed to the pay- -

ment. of certain minimum royalties. Production of the

coal was essential but most of Clyborne’s experience had

been as a sales agent, wholesaler or processer and Para-

gon was intended’ to be a processing rather than a ‘produe-

ing coal company. Also; Paragon did not have any excess

funds to invest in the coal producing business—it was

in debt approximately $300,000, was six months behind

in the payment. of its bills and its financial /outlook was

dark. Since coal mining is very hazardous,/ Clyborne did -

s”

- not want .to expose his personal funds to’ the dangers in-.

herent in the coal producing business. (R./84-36, 45, 253) _

; The éoal was to be produced by the drift mining meth- -

od, which is prevalent in the Appalachia area of Vir- ¢

ginia, West Virginia and Kentucky. Drift mining is an -

underground mining: operation, in which a horizontal .coal -

‘seam is reached by clearing away a part of the mountain-

side with a bulldozer. Two openings are. made into the

coal seam. One is an entry and the other is an air course

which is ‘used to ventilate the mihe. Coal is removed

the seam of coal. Generally, the coal seam ranges from

8 Paragon prepaid some minimum royalties, which were ‘all re-

couped as a result of the coal production of the mine operators.

(R. 84)

’. thirty inches down ‘to two inches, and in: some places it

pinchés out entirely. The height of the mine is approxi-

Mmately thirty inches. Such shallow seams are kuown as

‘ “low coal”, and are not capable of being mined by auto-

«matic or highly mechanized equipment. The roof of. the

_mine is supported by leaving a certain amount of coal

in place known as pillars, and also erecting wooden sup-

ports every eighteen inches known as timbers. When tlie

‘ mine is driven to its full extent, which maybe more than

a mile as in some instances in this. case, the pillars of

coal are removed as-the miners retreat. The coal is ob- .

tained from the seam either by cutting it on the bottom —

with a machine which yields.a lump coal, or by a “solid- -

shot” (explosion ) method. which yields a finé powder.

Drift mining is recognized: in the industry as.a most diffi-

cult and economically marginal operation.‘ (R. 43-45, 67,

101, 102, 106, 109, 116, 117, 132, 136, 150, 253).

Rather than mine the coal, Paragon elected to rely or

‘others exclusively for production and entered into verbal

agreements with coal mine operators who mined the coah

In many instances in Buchanan County, Virginia, leases

‘to people who mine coal are oral—not’ in writing at all.

It is: a* common’ practicé-in that area to transfer coal

mining interests and rights by~verbal agreement—such

rights’ are transferred on the mountainside—not: in law

_ Offices and: the agreement is concluded by-a_handshake—

rather than 4 signature and seal. (R. 37-89, 46):

In addition to equipment necessary for processing and

shipping coal, Paragon installed a road, running around © .

the mountain close te the outtrop line of the am of coal |

_ . over which the coal could be hauled from the mines to

* Most of the coal in ‘the Appalachia area is produced by large

companies with expensive automatic and highly mechanized equip- .

- ment. Drift mining is about the only means by which a small opera-

tof of ‘moderate means can develope a mining eae and en-

_ gage in head “a mining business in.that area.

5: ae

ae i ip

Paragon’s processing plant.. At the-plant Paragon cleaned,

sized and sold the coal. Beginning in 1951 Paragon en-

tered into oral leases or agreements with a number of mine

operators, including respondents in No. 237,.all of which

were similar in terms. Under the. agreement an operator

would be allocated a specific surface area under which it

could mine the coal.. The operator assunied Paragon’s ob-

ligation to open; develop and preserve the mineral prop-

erty and agreed to mine all mineable and marketable |

coal within, that area and deliver it to Paragon at the

- operator’s expense. Paragon agreed to handle and. pay

- for all marketable coal produced by the operators. Para-

gon agreed to pay a fixed price per ton of marketable

coal at the tipple, but it was. understood that the price

per ton would, and in fact it did, vary with the market

price of coal.. (R: 49, 54-56, 64, 90; 106, 114, 119, 136,

147, 180, 186, 253, 254) |

All expenses of opening, developing and operating the

mines were to be borne by the several operators. Such ex-

penditures including building 4 road from Paragon’ s road

to the mine entry, clearing the area, at the mine site, mak-

ing the installations and preparations at the. mine site

Durer as, building a tipple, laying track to the mine, ob- .

ing machinery and equipment, installing an electric

| power plant and fans and ‘the construction of several

es buildings. :The operators were responsible for the safety

_and proper development of the mine and were required to

.“ obtain mining permits and develop and operate their

mines in accordance with state and federal mining laws

and regulations. Also, they were to pay the taxes on their

equipment, obtain liability insurance, maintain proper

ventilation and roof support and overcome any adverse -

mining conditions sueh'as water, faulty roof and rolls,

cur when the seam of coal squeezes out. The sev-

eral operators agreed to use and pay for the services of a

mining engineer designated by Paragon. (R. 103, 104, 111- !

118, 123, 162, 167, 183, 214) - ai

6 ,

* After an operator entered upon the property it would

take from six ‘weeks to two months of preparatory work

- before he could mine coal. Even thén the operation is

unprofitable. A drift mine must be developed by driving

a main entry, air courses, cross sections and rooms to

create enough ventilated working areas so.that a suffi-

cient daily tonnage can be produced to make the mine prof-

itable. It took the operators from six months to a year

and often longer to complete the development of their

mines and reach the production stage when the mines -

became a profitable operation, and in some mines, they

extracted all of the coal without ever attaining sufficient

daily tonnage to make the mine profitable. (R. 115, 116,

128, 187, 154, 215)

_ Paragon agreed to and'did handle all marketable coal

‘which the several operators produced. Paragon has an

exclusive contract with John’ McCall Company to handle

_ all coal processed by Paragon. Coal delivered by ‘the op- |

re > erators and others is delivered to Paragon’s tipple, where

it is processed, dumped into: railroad cars and sold to

John McCall Company f.o.b, at the tipple. Paragon’s only _

contact: with the coal is the brief period of time it is go-

(R. 107, 254)

Although ‘Paragon agreed to handle all of the operators’

pie, it agreed to pay only for marketable coal. If the

’ operators delivered outcrop coal or\other coal of inferior

quality, Paragon could refuse to = because it agreed

to handle only coal which was marketable. Also, Paragon

paid less for solid shot coal than for machine cut coal bé-

cause solid shot coal is less desirable from a marketing

standpoint. Finally, Paragon had no obligation to’ pay the

operators for any adverse mining conditions. In drift

. mining it is not unusual to encounter water in the mine.

When this occurs the mine operator must set piimps-and---

draw the water to the outside of the mine. While this is

being done, production ceases and sometimes it takes days

- or even weeks to clear. a watered mine. (R..54, 106, 116,

117, 214) |

The mine operators frequently encountered “rolls”,

which is the term used to describe the situation where

the seam of coa] which is generally 24 to 30 inches thick

diminishes to a few inches. ‘Thus, the mine operator has

no coal to mine but must continue to drive through the

sandstone. This is very expensive: because of the hard-

ness of the sandstone, which must be broken by. explosives

and then hauled to the outside.of the mine. It was not un-

usual for the several mine operators to be confronted with

rolls which took weeks to go through. The mine operators -

received nothing for going through rolls, even though it

was more difficult and costly than the mining of coal.

(R. 116,117, 123, 162, 168)

The areas of coal originally leased to some of the op-

erators involved in this litigation were enlarged by mutu-

al agreement—the designated-areas were never decreased.

(R. 78, 79, 83)

The agreements were silent as to who was. entitled to

> depletion and they contained no termination date and

nothing was said between the parties on this’ subject.

Paragon knew that: the operators would engage*in large

expenditures of time and money in preparing their re-

spective sites for mining, would have to operate for a peri-

od of development before their mines would become profit-

able;-they would encounter adverse mining conditions

_ Which would be costly to overcome, and the- operators

could recoup therefrom only if they. were able to continue

mining. The operators were encouraged by Paragon to

make the investments: essential to ‘the development and

preservation of the mineral property. They made ‘these -

‘investments in time and money and assumed most of

_ Paragon’s obligation under its leases because they under-

stood that their operations could not be terminated until —

they had mined their respective areas to exhaustion and

8°

that they would receive a fair price based on the conditions

of the coal market for the coal which they produced. (R.

54, 65, 106, 115, 120, 187, 145-147, 156, 170, 178, 178,

_ 185, 186, 215)

: Respondents and the other mine operators involved in

these. proceedings have mined coal under their respective

‘agreements from the time they were made, during the

“period from 1952 to 1957, until the present time. Dur-

ing this period, the agreements have been adhered to by

both parties in accordance with the terms as described

above. (R. 180, 131, 141, 143, 212,°213) .

Prior to April 1957 when the case of Stilwell v. United

States, 250 F.2d 736 (4 Cir. 1957) was decided, Paragon

was aware of the operators’ claim that they had a right

to mine their respective areds to exhaustion and that the

price which they were to be paid for coal produced could

be changed only on the basis of a change in the market

price of coal. This claim of the operators was sustained

“by: the court below in the Stilwell case. Thereafter, Para-

gon asked the respondents and Stilwells to sign written

agreements which they refused to do because such agreé-

ments did not correctly reflect the terms of oral agree-

ments under which they were operating. . Paragon took

no further action, and from that time until the present has

accepted ‘benefits under such agreements without any ef-'

‘fort to negotiate the differences or to have them adjudi-

cated. Since’ Paragon has accepted. the coal produced”

and ‘has. made changes in the price per ton only when

there were significant changes in the market price of

coal, the operators were not aggrieved and have had no

‘occasion ‘to negotiate or adjudicate the aJleged. differences

in the terms of their agreements with: Paragon.* (R. 56,

154)

5A tax case is not the: best forum to decide disputed terms of

an oral agreement. The simple, direct and most inexpensive way

to determine whether Paragon had the right to terminate at will ©

—— e a

SUMMARY. OF ARGUMENT

Under the guiding principles of this Court as expressed

most recently in Parsons v. Smith, 359 U. S. 215, and

Treasury Department Regulations and Rulings, the coal

Mine operators are entitled to share with Paragon the

depletion allowance for the following reasons: |

1. The substantial investments made by. the. oper-

ators in the development and operation of their coal

mines establishes their capital investment in the coal .

‘in place. Said capital investments resulted from the

fact that Paragon was unwilling or unable to make

such investments in its own behalf and the coal

mine operators relieved Paragon of its investment

obligations in this respect thereby satisfying the cri-

teria that the taxpayer claiming a share of the de-

' pletion allowance must. possess a‘ capital investment

in the mineral in place.

2. The oral leases or contracts were silent on the

matter of termination, but because of the substantial

investments made by the operators in the coal in’

place, the operators’ rights could not be terminated

would be for it to bring an action of ejectment in Buchanan County

where.the agreement was made. Or, if, as the Commissioner con-

tends, Paragon could fix the price per ton at will, all it had to do

was decrease the price without a corresponding decrease in the

market price-of coal, then the operators would be in a position to

‘ take action. Paragon did neither—it preferred to, take the benefits

of the agreement.as understood by the operators. Paragon is not

without resourceful\counsel. The terms of the agreements here -in

question could have been, decided long ago and for a fraction of

the expense it has spent in connection with this tax litigation if

Paragon had so desired) Possibly, Paragon concluded that its

_ chances of success in a local court were not good and it would be ”

better to pursue the costly route of tax litigation. The’ operators

had no similar opportunity to judicially test. their right to mine

‘the designated areas to exhaustion. The operators were in posses-

'. sion of the mines and, as ‘far as they were concerned, Paragon was

living up to its bargain with them in every respect.

at the will of. Paragon without cause, particularly

where the parties intended the coal operators to mine

as long as.coal was obtainable and could be ob-apraend

sold. |

8. The return of the coal mine ania invest-

ments was dependent upon the extraction of the

mineral and they shared with Paragon an interest.in. -

_ the proceeds. from the sale of coal because théy were |

paid only for marketable coal and the price per ton

was subject to change in accordance with changes in

the market price of coal.

4. The position of the Commissioner, namely, that

. thé’operators were being paid for services and that

Paragon was legally free to set the price paid to the

. operators at any level. it chose, is speculative in na-

ture, not supported by the record and is contrary to

the determination of the court-below and to the pub-

lished position of the Treasury —— in

G. C. M. 22730, 1941- 1 C.B. 214. ©

5. The position | taken by Paragon that the right to

depletion is dependent - ‘upon ° “ownership of the min-

eral property” is contrary to all decided cases, the

Internal Revenue Code and the Regulations thereun-

der. Paragon’s. contention that the application of the

several factors listed in Parsons v. Smith, supra, in-

dicates an absence of an economic interest being

vested‘in the operators is in conflict with the facts of

this case.

; ARGUMENT

It is not- difficult to state the gener al principles which

govern the depletion allowance—the problem arises in ap-

plying these principles “according to the peculiar con-

ditions in each case” as required by the statute. Respond- .

ents’ agree with this Court’s statemerit of the controlling

principles in Parsons v. Smith, 359 U.S. 215. Respond-

ents further agree with the Commissioner’s statements

of the applicable general principles of depletion law;

namely, that the right to an allocable portion of the deple-

tion allowance depends on the ownership of an-economic

interest, that there may be more than one depletable in-

‘terest in the same deposit, that the purpose of the deduc-

tion for depletion is in recognition of the fact that the

mineral deposits are wasting assets and is intended as

compensation to the owner for the part used in production,

‘and that the deduction is available only to the owner of a

capital interest in the mineral deposit. Respondents also

agree that.the legal form of such a capital interest -is

‘unimportant ‘so long as this ownership coristitutes a capi-

tal’ asset, a right with regard to the mineral in place.

‘Respondents, submit that the operators had a capital

investment: in the coal in place and were the owners of

an economic interest as the court below found. The .

Fourth Circuit determined that the claim of the coal mine.

operators was valid under the rationale of Parsons v.

Smith, supra. Thus, it was guided by the legal princi-

ples set forth in that case

I The Coal Mine Operators Made A Capital Investment

In The Coal In Place and Could Look Only To The

Extraction and Sale of The Coal Deposit For A Return

Of Their Capital

‘, idee and Dilied of tic hinniitinent ase By The

Coal Mine Operators :

Each operator made substantial investments in their

respective mines during the development stage. The rec-.

ord makes it clear that a designated area was given to an

operator by Paragon, after Paragon did some preliminary

_ external facing work (for "rad to the Beer asa Para-

gon) and c9 ghstructed a road to the ge a of the

mine entry. Thereafter, the development of the under-

ground mine was the responsibility of the operator. Un-

‘like a strip mine-contractor, who could begin full pro-

duction immediately upon removal of the overburden with .

‘orie employee and a mechanical shovel mining hundreds,

of tons of coal.in one day, the drift mine operator could

not reach the production stage ° for several months and

‘sometimes years.

' It was necessary forthe operator to mine eitctircunia

to a sufficient depth to expose enough coal so that the full

- compliment’ of his labor- force had individual working

_areas from which they could mine coal. This required

considerable time because the working area was never

more than approximately 30 inches high, the only light .

available was that which the miners could carry on their -

persons: and equipment, the coal had to be loaded by hand

‘and only two or three miners could work in.an area at a

_ time. Moreover, if a drift mine is to be practical, the op-

erator must engage, in addition to his own labors,’ a

large number of employees, because each miner can load

but a few tons of coal per day. In addition, the first coal

mined was not of marketable quality (outcrop coal) and

_ had to be discarded. It normally required six to eight |

weeks before any marketable coal was reached by the

_ operator and several months before the mine reached the

production stage. (R 115, .116, 123, 137, 154, 215)

The coal mine operators, and not Paragon, were obli-

gated under state and federal law, to provide for the,

*The production stage is defined as that time when the major

portion of the mineral production is obtained from workings other

than those opened for the purpose of development, or when the

principal activity of the mine becomes the production of developed

ore rather than the development of additional area for mining,

Treasury Reg. -§ 1.616 - 2(b)»

7 All of the operators involved: in these iia are working

‘ miners, who devote their full time to their operations and are’in

their mines every day. In addition to the investment’ in money they

make, a substantial: investment in time and effort.

13°

safety of the mine, including the development of. air

courses as well as the main entry. Air courses are nec-

essary for ventilation of the working areas and without

them, no drift mine could be operated: The ‘burden of

the development of working. areas and the establishment

and maintenance of air courses was'the obligation of the

operators. No like capital investment is made by a strip

miner. It is quite obvious that these investments enhanced ~

the value of the coal that lay beyond.and to the side of the

main entry, cross séetions; room and air: courses, for un-

less this development was completed such coal could not be

mined. These undisputed facts refute the contention that .

the operators. did not have a capital maveapeat in the .—

coal in place,

‘Theoperators’ investments in the coal in place did not

terminate with the end of the development stage. Fur-—

ther capital investments were made during ‘later stages

of the mining operation. For example, the mine operator

had a continued obligation to maintain roof support of the

mine. As the operation progressed, all loose coal had to.:

be removed from the roof.and timbers placed on 18 inch

centers. Also, pillars of solid coal must: be left to help

support the roof. Most of the mines in _these-proceedings

extend over a mile underground and in the. Stilwell op-. -

eration, the mine at the time of the hearing (November

1961) was over 8,000 feet long. These pillars are not re-

moved until the operators reach the end of their designated

areas. At that time, the operation retreats, the coal form-

ing the pillars is extracted and the mountain settles down

closing the’ area which contained the seam of coal. Proper

roof maintenance, the setting of timbers ‘and the facing

and preparation of pillars is a capital investment, since

‘without such an investment the coal lying beyond is worth-

less because it cannot be mined if the roof falls. Each

timber and pillar enhances the value of the coal remaining

in the ground. Indeed, the pillars are in and of themselves

a valuable source of coal which can be mined most eco-

bd a

Sot ra

nomically, but they cannot be mined until ‘iin have served

their purpose of roof support.

Moreover, the progress of the mining operation on

not always. result from the extraction of coal. The par-

ticular’ seam of coal here involved, is unpredictable and —

most difficult to mine. (R. 44,°67).. The entries must be

driven from time to time through areas where nothing

but unmarketable rock is removed. This is due to the ir- -

regular nature of the seam of coal, when the coal squeezes

out into what is called a “roll”. When a roll is encoun-

- tered, the operator has no choice but to continue mining

operations through the rock in the hope that mineable coal

will be. reached before he goes broke, because the coal be-

yond the’ rolt cannot be reached unless the roll is over-

come. Since cutting machines cannot be used successfully

on the. rock the. procedure is to loosen it by explosives and

remove it from the mine. Even though this operation is

more costly than mining coal the operators receive noth-

ing for the mining. of rock. Many are the drift mine op-

erators, who have broken their financial as well as their

_physiéal back on a roll: All of the operators involved

here encountered rolls (R. 67, 101, 117, 123)—in one in-

stance an operator mined for six weeks and removed noth- |

ing but rock. (R. 123) To consider the operators’ excava- |

. tion of rock anything but a capital investment in the re- ©

' maining coal is to ignore reality.

~ By contrast, in a strip mining operation. there is no en- °

try, air course, pillars or timbering. If a strip miner en-

co rs a ‘pinched seam or /a.roll, he merely moves his

equipment further aldng the surface and begins removing

_ the overburden and the coal where the coal’ vein resumes.

Some distinctions with respect to the capital expenditures

of a deep mine, and a strip mine were recognized by the

Tax Court in. National Lead Co., 23 T. C. 988 (1955)

rev‘d on. other grounds -230 F.2d 161 (2 Cir. 1956),

aif’d - C.A. 352 U. le 313. In that case, ' the Tax Court

observed that it 1 was easy to understand that a shaft dug

from the surface to a mineral deposit lying under the sur-

face, which shaft is to be used to gain access.to the under-

lying ore and to bring the mined ore to the surface is a

- capital expenditure made to develop the ore body. The Tax

Court added that it was not readily apparent to. it that

_ any comparable expenditure was involved in the cost of

stripping overburden and cutting benches in an open

' (strip) mine. In this case the Tax Court’s conclusion

that the operators’ investments were similar to the invest-

. ments of the contractors in Parsons v. Smith, supra, (R..

222) is most difficult to understand. ‘Possibly it was prem-

ised on its obviously erroneous finding that the operators

“did not assume any-of Paragon’s obligations under its

leases’... .” (R. 214) As the court below noted “Para-

gon was under obligation to mine the property. These

operators were performing Paragon’s obligations under its

leases .. ,” (R. 255). Or possibly it was based on an er--

‘roneous ‘understanding of what constitutes an investment

or more properly a capital investment.

A capital investment is an. expenditure of money or oth-

er consideration to acquire something of permanent: Value -

for use in carrying on a trade or business—or the con-

sideration paid for a capital asset. Obviously, the removal

of outcrop coal, development of working areas, prepara-.

tion of pillars, timbering, excavation of the air courses ‘and

mining through rolls all involved expeditures by the

operator that were useful until all the coal was-exhausted.*

After they were made the operators ‘had a capital asset,

that is a developed and operating mine, which is useful

in their trade or business until the mineral bi aaa is

exhausted.

|, The doves and Jong term. expenditures of the

operators are capital in nature, even though they are

co The Stilwells, for example, have been mining in the same mine

for thirteen years and the Merritts for over ten.

deductible under Section 616 of the 1954 Code, which pro-

vides that expenditures for the development of minés are

deductible as an expense in determining income. This

provision was part of the Revenue Act of 1951. Prior

to its enactment the operators would have been required .

to carry their development costs in a capital account

recoverable through the depletion allowance.* Under pres-

ent law the deduction of development costs. is allowable —

in addition to the depletion allowance. Accordingly, -the

characterization of such expenditures as capital in nature

is in.no wise affected by their deductibility.

Under the present statute it makes no difference, there-

fore, whether these expenditures are made during the

production or development stage of.the operation. Prior to

1951, however, the difference was important since if the

expenditure was made during the development stage, the

_ jexpense had to be put into a capital account and recovered

‘through the depletion allowance. The cases dealing with

tax years prior to 1951, therefore, will show what type

‘ of expense had to be capitalized ‘and ‘hence what- -type of

expense represented a capital Anvestment in the mineral -

deposit,’° See for example National Lead Co., supra, Clear.

Fork Coal Co. v. —_ , 229 F.2d 638 (6 Cir. 1956)

‘where the court held that development consists of creat-

ing enough working places for the use of all available

machinery of the mine; Commissioner v. H. E. Harman

_ Coal Corp., 200 F.2d 415 (4 Cir. 1952) where the court

held that where machinery was “purchased not solely be-

cause of the recession of working faces but in the inter-

est of economy and efficiency such expenditures were capi-

tal investments; Alsted Coal: Co. v. Yoke, 200 F.2d 106 (4

® Regulation 94 Art. 23(m-15) (a) All seaiiiibiaiae in excess of

net receipts~ffom the mineral sold shall be charged to capital

account recoverable through depletion while the mine is in -

development stage. ;

10 Reg. 118, § 39.23 m - 15(a)(1), Reg.. 111, § 29.23 m - 15(a), Reg.

. 103, § 19.23 m- 15(a).

Cir. 1952) where expenditures by a second coal operator

to remove water and debris and to retimber a dormant

"mine were held to be development costs and chargeable to

_- capital to be recovered through depletion; United States

Gypsum Co. v. U. S.52 AFTR 1819 (D.C.N.D. Ill. 1957)

aff'd 253 F.2d 738 (7 Cir. 1958) where the .court held

that. expenditures for an additional mine entrance, exten-

~ sion of the main haulage track and extension of an air

shaft are development expenditures, and Repplier Coal

Co, v. Commissioner, 140 F.2d 554 (3 Cir. 1944) cert. de-

nied 328 U.S. 736, where cost of constructing a tunnel

even after the deyelopment stage. was past was found to.

be of a capital nature. For a comparison of oil well de-

velopment costs and mine development costs, see Burnet

v. Petroleum Exploration, 61 F.2d 273, 276 {4 Cir. —

‘aff'd 288 U. S. 467.

It can be seen from the above that the operators hele

_made substantial capital investments -in the coal by their

expenditures. The investments involved were not the in-

vestments of Paragon, even though some were made to.

earry out Paragon’s obligations under’ its leases. It mat-

ters not that Paragon has not parted with its. capital in-

_ terest other than passing on to the operators the invest-

. ment risks and dbligations that attend: development. of the

_.mines. A capital interest in the operators can be created

. by their own investment. In G.C.M. 22730 1941-1 C. B.

214,216 he Commissioner concluded that:

: [T]he view that a lessor, or sublessor or as-

idiee parts with no capital interest, though the les-

see, or sublessee or assignee acquires a capital inter-

est upon: the execution or assignment’ of a lease, -pre-

’ sents no logical difficulties, as the lessee interest,

though it may have, great potential value, ordinarily

‘becomes valuable oily upon investment by the lessee |

"in exploitation or by reason of discovery. .

“at p. 221] The lessee or assigneé, like the is

sor or —— who retained a share interest in pro-

ie | aie

duction .'... but passed on to the lessee the invest-

ment obligations and risks that attend development

.. for a share in production, has parted with no capi-

tal interest but has merely in turn given another a.

right to ‘share in production iii consideration of an —

‘ investment made by such other:person. . . .””

. Since Paragon was, financially unprepared and unwilling

_to assume the investinent risks -of the. development of the

thines but passed them on to the opérators, neither Para-

~ gon, nor the Commissioner is warranted in asserting that

the operators did not obtain: a capital interest merely be- -

- cause Paragon did not’ intend to part with its capital in- _-

terest. The operators’ capital. investment obviously took _

place as:shown above; their capital interest in ‘the coaJ

was thereby credted. The Tax Court’s conclusion that the.

| 4p vg paid nothing for the coal] and had no legal title”

. to the coal. is therefore refuted. Lega title is not deter-.

. Ininative and the investments made’ by the operators in the

coal] in place clearly vindicates the Fourth Circuit’s rever-

: sal of the Tax Court. *. eat me eae

Bee iy ‘mineral in, place has often _been + characterized as a ©

« “reservoir of capital investments”, G.C:M. 22780, supra. —

. One ‘who furnishes money or is pledged to the develop-

ment ‘of the property is regarded as making an invest-

ment. in ,the mineral in place. Surely, both Paragon

and the operators had a share in this reservoir since they

pooled their resources, funds and energies leading toward :

’ the extraction,of the mineral. Neither could recover, proc-

_ -.ess and sell the mineral without the other and the deple-

tion allowance is an attempt to compensate each party for:

_- the exhaustion of the mineral: When the area is mined

~ —~to exhaustion, both Paragon and the operators will be re-

- quired to look for new ayeas to mine. In the case of the

* operators, they will be able to move some of their equip-

- ment but most of their investment .will lie useless in‘the

vacant mine. If they are to continue in the-same busi-

ness, the operatofs will be required to reinvest the funds —

. . A

rou 7

Cea

, 19 aaamel

they recover thsongk the depletion divvanes: in another

‘mine in the same manner that Paragon will move its tip- —

ple and find new sub-leases in another sector. The inter-

ests of both Paragon and the operators are being depleted

as the coal is mined—both therefore have an economic in- .

terest in that coal until it is exhausted.

2. The ‘Operators’ Capital Investments Were Made.

' Pursuant to Agreements Which Gave Them A Con-

- tinuing Right To. Mine Their Areas To Exhaustion. —

In Parsons v. Smith, supra, the strip miners insisted

_ that they did not wish to be bound by a contract “which

would take a long time since if an opportunity opened

up [the strip miners] wanted to go back to road building.”

‘ The strip miners there involved were primarily road build-

ers who were using | their road building equipment to tem- ‘

porarily strip mine coal, and they could not. be. damaged

| by a short term notice of termination: In a ‘ten day period

the strip miners could load all of the coal from which

. they had removed the overburden. Their investmerit was

in road building equipment and in the relatively fixed cost

of removing a known quantity of overburden. -

Unlike the taxpayers in Parsons v. Smith, supra, the -

“operators here would be seriously prejudiced by a termina-

’ tion of their operations. Their investments were long .

term investments. Their present costs of the constructior®

of an air course for ventilation was made with the under-

Standing that it would-be used for all the coal to:be mined.

, Their expense of removing. rock during a pinch or roll was

“made with the thought in mind that there would be re-

movable coal on the other side that they could mine. Their

_efforts in making pillars, timbering and in draining the

* mine ‘were ‘made solely with the view of reaching all of

_ the coal in their designated areas.

The fact that the coal mine operators would be fequired

to make long range investipents would have been obvious ~~

to anyone familiar with drift mining operations and was

implicitly recognized at the time the agreements were

made. It was known specifically by Clyborne, the con-

trolling stockholder and directing head of Paragon, be- ~

cause the investments which his corporation | was obligat-

ing the operators to make, were the precise investments

_ which he personally refused to make and which his cor-

poration was unprepared and unwilling to. make. (R.

84-36, 253) Indeed it was the policy of Paragon to en-.

courage its operators to make such investments.

Paragon remained silent on the matter of termination

at the time the agreements were negotiated for good

. reasons. If it had reserved a right to terminate, the

» agreements would not. have been made. Respondent Wat-

son stated the position of the operators when he testified

“Well, I knew this, we had a certain boundary of coal

‘which was given to us and told we could mine it out. If -

we had not had that assurance, we certainly would never’

‘have invested the sums of money that we did in the prop- .

erty.” (R. 178) And, Meadows, not a respondent, testi-

fied that Paragon made it clear that Meadows could mine

all the coal in his boundary and that if he “had the

least bit of idea they could run me off overnight I woufdn’t

have invested my money there...”. (R. 183)

The Tax Court correctly found that the right of termi-

nation was not specifically discussed at the time the agree-

‘ments were made. Then, even though respondents and.

Paragon were before the Tax Court as adverse, but equal

parties—both as petitioners having an equal burden of

proof—the Tax Court concluded that because the agree-

ments did not contain a specific statement that they were

-. not terminable at will of Paragon or because. they did not

contain a specific statement that the operator had the

right or obligation to mine to exhaustion that as a matter

of law the operators did not have such rights. The Tax

Court did so inthe face of its own finding as to the intent

of the parties that: (R. 215) |

“It was anticipated by both parties that a contractor

[coal mine operator] would continue mining in the .

location assigned to him as long as the coal could be

mined and sold at a profit and as long as the con-

tractor employed proper mining methods and ‘pro-

duced coal meeting Paragon’s specifications.” .

The court below properly concluded that this finding

as to the intent of the parties, negated the.Tax Court’s

‘conclusions as to the legal rights of the parties under the

contract. In reaching its conclusion the Tax Court also

ignored the relative position of the contracting parties,

the purposes to be accompilshed by the contracts, the na-.

ture. of the consideration involved on each side and the.

time and extent of performance by the parties. When

these are considered, it is clear that Paragon did not, as

a. matter of law, reserve a right of termination at will

and without cause. The. court below stated: the principle

-well when it said: (R. 254)

“It would be inequitable indeed to hold that Paragon —

might remain silent on this point until the operators

had invested their time and money and then take the

benefit of the operator’s efforts at will and without

cause. [citations omitted)”

In a mineral lease where there are no provisions to the

contrary, the lessee has the right to terminate at his will,

but a corresponding right to terminate is not vested with

the lessor, see Summers, Oil & Gas Vol. 2, 2 Ed. § 235,

discussed, infra, beginning at page 44, and Donley, The

- Law of Coal, Oil and Gas In W. Va. & Va., (1951), $57 -

p. 70.-The reasons for this rule of law are obvious; the

long term investments made by the lessee in development

of the property should’ inure to his benefit and to subject

that right to’ termination without cause by the lessor

would work dan unwarranted hardship. Conversely, no

such right is given the lessor for if the lessee terminates,

the lessee’s investments which have enhanced the value

- of the mineral. property accrue to the benefit of the lessor.

It was the mutual intent and purpose of Paragon and

the operators that pursuant to their oral agreements the

operators would immediately enter upon the premises, pre-

‘pare and develop their respective mines and produce coal...

—This consideration was of value to Paragon, since it re- ©

lieved Paragon of undertakings which it was obligated

to perform under its leases and enhanced the value of

such leases. Obviously, the operators could cease opera-

‘tions only if they were willing to lose the investments

which they had made in the mineral property. / But, even

if the operators could cease operations, the agreements are

not lacking in mutuality. Phillips Petroleum Co. v. Buster,

241 F.2d 178 (10 Cir. 1957), certiorari denied 355 U. S. o

~ 816 involved an oral agreement which was challenged as —

void for indefiniteness, uncertainty and lack of mutuality.

In sustaining the a the a arcane stated at

p. 1838:

“* * * Harmonizing in full measure with the general

principle of law obtaining elsewhere, it is the rule in .

‘Oklahoma that the destruction of contracts or agree-

ments for vagueness and uncertainty is disfavored;

and that if a contract or agreement is sufficiently *.

definite and certain in its totality that the intention Sot

of the contracting parties. can be. ascertained |

‘reasonable certainty, it is-not’ void for indefiniteness |

and uncertainty even though it fails to enter into all —

of the details respecting the subject matter, especially

where there has been ‘partial performance.

* * * *

“Anothér ground of attack upon the judgments is

that the oral agreements lacked mutuality of obliga- ©

tion. The channel of the argument is that there was ,

no agreement in respect to the term or duration of

the agreements; that, there was no agreement respect-

ing the extent. or length of time plaintiffs would ir-

rigate their lands; that there was no agreement con-

cerning the yolume of gas plaintiffs would take; that

there was no ee: that ona would not

change to some other type of fuel; that they could

‘ take or not take gas at their own whim ‘or caprice;

‘and that in the event they should cease to take gas,-

Phillips would be without recourse-or remedy. *

The oral agreements for the furnishing of gas for the

operation of the water wells having been entered into

’ with the\mutual intent’ and purpose that plaintiffs

would act in reliance thereon, plaintiffs having acted

fin such reliancé by making substantial expenditures.

in the drilling r the completing of the drilling of the

— ~~ wells and in preparing the land for irrigation, and

_ plaintiffs being in, reasonably certain danger of suf-

fering irreparable injuries for which there would be

no adequate remedy ‘at law if the furnishing of gas

. were discontinued, equity finds support in the law of

. .Oklahoma for intervening arid restraining the threat- _

ened discontinuance of the furnishing Rs, Rot eee

‘The Tax Court never found as a fact that Paragon had

a right of termination; it merely concluded without cit-

ing any authority or reasons that “It seems unlikely that

the parties would have contemplated granting the con-

tractor [operator] the nonterminable right to mine specific

areas to exhaustion without also’ obligating him to so mine —

it.” (R. 228) Sinte such an agreement is not lacking: in.

‘mutuality and Paragon could suffer no detriment, but

would. benefit from the investment of the operator in the

‘leased property if.the operator ceased mining the “un-.

likelimess” of” the Tax Court’s conclusion is élearly re-

futed. .

Accordingly, the conclusion of law by the Fourth Cir- ;

cuit as to termination should be sustained. If the Tax.

Court’s finding of fact is correct that nothing was said

by either party as to termination, then by implication

of law, the right of the operators to mine to exhaustion -

~ should be that found by the Fourth Circuit. -If the issue

is to be decided on past events, then it can be shown that

none of the operators here involved or Paragon ever ter-

minated a contract at will. If the issue is to be decided

24 Me.

by what the usual] mineral lease contains it must be held

that a right to terminate at will is not usually given a

lessor. If the issue is to be decided on the finding of the

Tax Court as to the intent of the parties, then the opera-

tors again must be sustained for the Tax Be grsts specifi-

cally found that the parties “anticipated . . that a con-

tractor [operator] would continue mining i in the location

assigned to him as long as the coal could be mined and

'. gold at.a profit...” If the issue of termination is to be

* decided upon what provision the reasonably prudent man

familiar with drift mining would include in an agreement, ~

the conclusion that Paragon had no-right to terminate at

will without cause must again be reached.

Respondents do not understand the Commissioner to |

contend otherwise. Apparently, it is the Commissiorer’s

position that the operators could be forced out by Paragon

exercising an alleged “power” to lower prices.

3. The Operators Could Look Only To , The Extraction

and Sale of The Coal For A Return of Their In

vestments

In Parsons +. Smith, supra, the strip miners were to be

paid a fixed sum for each ton mined and delivered which |

was agreed to be in “full compensation for the full per-

_ formance of all: work and for the furnishing of all [labor]

_ and equipment required for. the work”. On the basis of

such an agreement, this Court determined that the strip

miners “agreed to lopk only to the landowners for all '.

sums to become due them under their contracts” and that \

such an agreement was “a personal covenant and did not’

grant or purport to grant an interest in the coal in place.”

In the case’ at bar the intent, understanding and rights of -

the parties was quite different.

Paragon was not interested in paying for services, work

or the furnishing of equipment required for the work.

‘Paragon was seeking someone to assume its obligations -

under its leases to develop and operate drift mines and

extract all mineable and marketable coal. Moreover,

Paragon made it clear that it was willing to accept and

pay only for marketable coal. It would not accept outcrop

coal because it was not marketable (R. 54), and Para-

gon would not pay as much for “solid shot” coal as it .

would for “machine cut’ coal because “solid shot” coal -

will not bring as much on the market (R. 106). Also,

Paragon deducted from the amounts due the: operators

the weight of any rock and other amounts that were

cleaned from the coal at its: processing plant. (R. 49)

’ Paragon understood fully that the seam of coal was un-

predictable and irregular, that it was a very thin .seam

“which in some plaées pinches out entirely”. (R. 44) It

was fully aware that there would be times when the

operators would be working their entire labor force ex-

cavating rock and not producing any coal at all. Under

the agreements the operators were to receive nothing for

such efforts and expenditures.

In Parsons v. Smith, supra, | the strip mine operators

“were guaranteed a fixed price per ton. The mine opera-

tors here had‘no such guarantee—their income -(return

of their investment) was dependent upon the market price

. of coal: This was the understanding and it was adhered

to by the parties. Whenever there was’a significant. in-

crease in the market price of coal, the operators expected

and received an increase in the price for their coal. And

conversely when there was a decrease in the market, they

expected and accepted a decrease. Like any busjness man .

who is compelled to take less for a marketable commodity,

the operators grumbled and complained, but Rag made

no issue of the decreases because they knew that the coal

market was depressed. In Parsons v. Smith,-supra, the

changes in price were made only on the bai is of and to

reflect increases in labor costs and materiajh required by

the strip miners—the market price of the /eoal never en-

: sf 26 . x : ete

tered into the sgrement in a way. Here, the. market

price was the controlling factor. .

The Tax Court correctly found that it was ediiratiae

- between Paragon and the operators that the price per ton

to be paid the operators would vary from time to time and

that it did so vary depending upon the market price for

'. the coal over extended periods. (R..214) It also attri-. .

buted the variation “to some extent on labor costs” when

' there was no evidence to support such a conclusion. Some

of the increases occurred at a time when the United Mine

- Workers negotiated increases in their labor contracts. But

_ Paragon was not a union operation, and neither were the

operators here involved. The particular wage agreements. .

negotiated by the U. M. W. caused a general increase in

the market price of coal and this was the basis for Para-

gon’s changing the. price paid the operators. Actually,

Paragon was not concerned with the labor costs of the

: operators and knew nothing about such costs.

Stilwell, (R. 114) Lee Merrif@®, (R: 136) G. W. Merritt, .

(R. 147) Watson (R. 169, 17@ and Meadows (R. 180)

testified that under their respective agreements the price

per ton would increase or decrease according to changes.

in the coal market. This testimony was_ neither. contra-"

_ dicted nor challenged by Paragon—indeed it was corro-

borated by Clyborne. He stated. that the “price continued

until there was some change in the market s betantially,

then we would raise or lower it.” (R. 56)

' Woods testified that the prices which Paragon received

for tHe various sizes of coal on. the commercial. market ~

changed daily. The operators were. producing. raw coal

or what is referred to as “run of mine” coal. The price

for “run of mine” coal does not vary daily with the prices

for the various grades of processed coal on the commer-° ”

cial market. Admittedly, the price received by the op-_

erators per ton did not vary on a day-to-day basis with

the price received on the commercial market by. Paragon

a ; 27 | : *

for the various grades of coal which it processed and sold.

This was not the agreement. It is clear, however, that

whenever there was.a substantial’ or significant change

in the ‘market price of coal, either up or down, the op-

erators’ price per ton was changed accordin ly. This was

‘the agreement—the price per ton was not’ fixed by the

terms of the agreement—but was mopendent upon the —

3 state of the market. -

The Tax Court and Paragon place great weight on. the

~ ‘fact that changes in price were not made retroactively

and, thus, when an operator delivered coal to Paragon he _

.. knew the “fixed” price per ton he would receive before

' he delivered thé coal. (R. 222) True, but the price was

not fixed and the operator did not know what price he

would receive for. coal next week, next month or next .

year. When the agreements were made, the operators

intended to recover their investments from the unmined

coal over the period. it would take to mine theii respective

‘areas to exhaustion. Yet because the operators knew on

. a given day what they would receive for the 100 or so

tons mined..on that day, it is contended that they were

being. paid a fixed sum and were thus relying on the per-

-sonal covenant of Paragon without regard to the market

price of coal.

.Paragon was the payor, but it refused to give the op-

' erators its personal covenant.: Under their agreements the

operators weré required to look beyond Paragon to the

market price of coal for the return of their investments.

Actually, the price to be paid the operators for the coal °

they agreed to mine was unknown both to Paragon and -

the operators at the time the agreements were made. By

~ mutual agreement it was made dependent on factors be-

yond the control of either party. ‘In this respect this case

is distinguishable from Parsons v. Smith, supra.

| _. 28

II. Analysis of the Commissioner’s Brief ~ .

1. Statement of Facts. —

The ‘Commissioner’ s statement. of facts is most. incom- .

. plete and is not an adequate basis for'a determination of

this case. In ‘addition, many of. the matters stated as

‘fact are inaccurate,

The Commissioner contends that ‘the operators “did

not assume any of Paragon’s obligations under<its leases”.

- (Comm’r Br. 4, footnote 2)

The most burdensome obligation of Paragon under its

leases was the’ obligation to develop the mineral property

and remove the coal in the most effectual, workmanlike and ~

proper manner and in conformity with the “laws of

State of Virginia and thé United States regulating the

working of mines, drifts, gangways and other necessa

and appropriate openings for airways, and ventilating

‘passageways and to drive the regular size of gangways

and airways through such portions of the seams of coal

as may prove faulty, or may not yield mineable and mer-

chantable coal and to leave pillars and suppports neces-

sary for the support of all entries and gangways and “

mine and recover all coal which by the exercise of

and proper .mining methods is practical to recover. Ex.

16-P, Page 4, Paragraphs VII and VIII). Paragomdid

‘ not have the funds to.fulfill these obligations and Clyborne |

did not wnt to expose his personal funds’ to the dangers —

inherent in meeting these obligations. (R. 35, 45, 55)

These are the obligations of Paragon, which the opera- —

tors assumed. Indeed, they more than assumed Paragon’s

_ obligations jn this-respect. In some of its leases Paragon

was obligated to remove only 85% of the mineable and

‘merchantable coal; the operators. agreed to- extract all

_mineable and merchantable coal. (R,-211, 254, 255).

The Commissioner refers repeatedly to the agreement

_of the operators to ‘deliver -all coal which they mined to

| ™ 7 ee Sue

oO. we”, : re \ ' ;

Paragon; (Comm’r. Br. 5,7) but he omits the other-part .

‘of the bargain. Paragon agreed to accept and pay for

_all marketable coal prpduced | by the operators. (R. 54).

’ al gbligation in this respect, not a one-—

ion for, the’ operators delivering all marketable

, it agreed to accept all such coal

and pay an “agteed price ‘which \was — to change on

the basis’ of market cond ons. |

Nexirit is contended that Paragon ce and changed at

will the price per ton paid thé operators. This statement

_-—~Ys refuted by the discussion at. pages 24 to 27 of: this

brief. In, addition, Clyborne in testimony given in Sep-

tember 1955 (in.a case which did not involve the.issue of

- . depletion) when asked about the agreements here involved 9

* answered as follows: (Ex. 78, p. 13) :

“That is right, the prite varies from time to time ac-

cording to market cortditions.”

The Commissioner’s contention is also refuted by the

conduct of Paragon. The first change was a negotiated

increase which occurred in February 1952. (R. 118, 119)

‘Thereafter Paragon initiated the price changes, but every

change occurred at the time when there was a corres-

ponding change in the. market price of bituminous coal. —

Although Paragon had a burden of proof equal to that of .

- respondents, it did not introduce any evidence with. refer-

<8 ence to the price it received from its’exclusive sales agent,

_.. John McCall Company for coal sold during this period. It

sold its coal in competition with other wholesalers and

processors and in the absence of any evidence from Para-

gon’s records (which could have been produced easily by .

Paragon) it is fair to. assume that the changes. in Para-

gon’s prices were in accord with changes in the. general.

market for. bituminous coal. The | record contains a sched-

‘ule of prices paid the operators .(R.230, Ex. 74) and

the Average Price Index of Bituminous Coal for the peri-

. proceeds is

. ?

- o igs fe e

Siw j “ ‘ : : . > ‘

g ; oss ae é

oe ra : ao ° ° : .

2 . .

- - 80 | :

nae. , “fe ‘ me ook Cie ae

od hefe involved is disclosed "by the United States Depart-

ment of Babor.. (R. 248-252, Ex. 98) Comparison of

: oe Commissioner’s claim that the operators’ right to

payment‘ Aye depend: upon the existence of: sales ©

ness of pr¢ rig and selling coal. The operators would

‘ 0: deliver the coal to Paragon’s tipple and it would process. -

it, dump it. in-railroad cars and ‘it was sold to John Me- ©

Call Company f.o.b. tipple arid John McCall Companyy,

takes it from there.: ¢R. 107) ge

It is stated that ‘the ‘operators “were’ free to quit at

_ any time” (Comm’r Br, 6) “If the operators quit, they

would not only lose their investment in the mineral Props .

-erty, but would also:leaye to Paragon’s benefit. the en-

hancement of the coal deposit resulting from their ex-

4 - penditures and efforts. ‘G. W. Merritt stated that the mat-

ter clearly whett he testified, “After. I got my investment

-) in ‘there, <I couldn’t: quit” (R.°156) and Watson... stated

.. that if they had quit “that developinent, effort and work’

_and expense. would have been lost.” ( R. 173)

Other erroneous factual statements of the Commis-

- sioner haye already been discussed and answered in this

‘brief. aie ‘£

~s “r

| | 2 Argument of the. Commissioner ~ .

As ‘previously -indicated,” resp

ASS : espondent doesnot dispute ,

_* the legal principles stated: by the Commissioner, but it”

is submitted that hts application of these principles: to this

on.

ao, gl

ee.

greeny a

‘ ) }

PRN }

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‘

hte

/ ace

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a ae

case ia unrealistic and unrelated tothe facts. It is con-

tended‘ that the operators aré required to deliver the coal —

at whatever ptice Paragon chose and if they refused td

mine at the offered* price, Paragon ‘could substitute, other

operators to do the mining. This statement is pure. spec-

ulation and is contradicted by the record...

It is trué that the operators agreed to’ deliver all coal :

_~ to Paragon. But, it is equally true that Paragon agreéd

to accept ‘and pay for all marketable coal produced ‘by the

operators. .Thus, both parties had tamy obligation. to each

other. The price per ton was set “agreement, but was

subject to change on the basis of changes in the market

tions and substitute another operator in -Un-

der the facts of this case neither the law, nor the opera-

*- tors is as helpless as the Commissioner supposes. ° &

Let us assume that at a time when the operators were

receiving $4.25 per ton, there was a significant. increase in

the price’for coal, and Paragon decided to reduce the |

price to $4.00, $3:50 or $3.00 per ton and the’ operators

refused to deliver coal to Paragon at such a price. Ob-

' viously, Paragon could not substitute another operator be-"

cause the. present opjrators had legal possession of the _

property. Paragon could bring an action, of ejectment and

the issue before the court would be whether the parties

had abided. by. the terms _of the agreement. - If Payagon

elected not to bring an action of “ejectment, but sisted »

in its reffisal to pay the proper price for the coal, the

operators could declare # br ich. of the agreemént and .°

sell the coal to’ one of the other coal. processors in the

aréa. .From the proceeds of such sales they could with-

hold the proper price per ton and remit. the balance to

. ‘Paragon. If Paragon wanted te stop such, action, -it would —

be compelled to bring a legal suit in whichthe issue would | |

. @ wee .° ;

ser?

-0

“9

at M3

Catt § soe ®

. 32

be whether ‘the parties had abided by the terms of the .

agreement. ° q ; Bey . ig oe ~

In any legal action the position of the operators would | c

not be difficult to sustain. Coal mining is the only it

dustry of any conseq ee in Buchanan County, Virginia — ‘

- and \people there are as’ knowledgeable as to.changes in —

coal prices, as little-leaguers are to the batting ave’

of Mickey Mantle.” (R. 91, 143) The operators cou ae

‘eompel Paragon -to show the price it was receiving for. _

~ eoal at all relevant times and from such data ‘@ court 2

_¢ould wreadily .deterntine whether the reduction in price to —

‘the operators was’ i-accordance with or contrary to any

change in the market price coal. Moreover, there are

_ standards by which the rights of the operators could be de-

-.termined. Paragon was purchasing ¢oal from operators on.

~mineral properties on which: it did not hold,the lease. On .

~ such purchases, it had to pay the market price, otherwise

the operator would take his coal to another processor. The

price picture of such purchases could be used as a stand-

Zr,

ard to determine whether any change which Paragon in-

itiated waS proper under its ‘agreement with its opera-

. tors. Also, there are other processing companies, some

_Accepting coal from the same seam and in the same area

\as Paragon. The prices they pay for’ coal mined by their

‘operators and for off lease coal is common knowledge in’

Buchanan County. The tipple price being paid-by proces-

sors in that area is as well known as any other fact~of

“economit life. Such Prive ‘changes are infrequent, but | a

when they occur everyone knows -about it.

To argue, as Commissioner does, that the operators -

were at the complete mercy. of Paragon as to price is-

pot supportable on the record. This depletion controversy.

ae with Paragon has extended over the last 8 or 9 years. If.

3 Paragon could haye controlled this situation by virtue of

% gecaly free right to,set the tipple price at, any level it

-. chose, ‘and if the operatars refused to ‘deliver coal, trans-

a \ s or

> . . &

Pa ry Saad --@

“fer their mines to another, it would have done so-Tong ago.

(See Footnote 5, supra)

‘The bargaining power of the operators arose, not. from :

_ any right that they had to quit, as the Commissioner ;

maintains, but from, the right which they had to stay’ in

‘possession of their minés and compel Paragon to abide

by the terms of the agreement.’ ee.

The improbability of the. position’ hesadopts is best -il-

justrated by his comments in footnote 4 (Comm'r. Br. p. - a

19). Therein; the Commissioner admits that Paragon could. (?

~ “not very well exercise the alleged power to lower prices —

/ since at a minimum Paragon was required to offer the

Same tipple price te all the operators. In effect, the Com-

missioner is saying that Paragon only had the power to

terminate none dr.all of its contracts at the same time; |

a most jmprobable-and unrealistic proposition, in view, of

the fact that during its taxable year endin® September 30, *

1957 on coal produced by its operators, Paragon, after

deducting royalties ‘paid to Clyborne of $154,552.07, re-

amount of $325,490.97 and paid tax on $325,490.97. (Ex.

62-BK, Statement of Net Income*From Coal Mining and |

Depletion Schedule) | es :

The court below reached the proper conclusion wheh

it stated “it was understood that the price would, and in

fact it did, vary with the market” (R. 254) and that the

“operators had a continuing right to produce coal and to ,

be paid therefor at a price-which was closely related to

the market price.” (R. 255)

The other unrealistic and unsupportable position of ‘the

Commissioner is that the operators’ rights in. the mineral

deposit_were no greater or different, than that of the office

personnel of Paragon, who likewise may be-able to demand

higher salaries when business is good. The comparative -

positions of Paragon’s office personnel and the coal mine

ported net income of $650,981.94, claimed depletion in the ~-

©.

operators are not even remotely parallel.. An office em-

ployee does not make an investment in the coal ‘in place,

works at the discretion or will of Paragon, is paid on: a.

&° them when to work or how to work, its interest is-only in

vs +

- {

) 2

gone f

time basis, is guaranteed the stipulated amount for his

services if he works the required. time and works di-

rectly’ undér the supervision of Paragon. The office :

———___

‘employee. offers only his services and Pafagon pays him

for services and continues employing him as long as such

services are satisfactory... ‘ °

and pay a mining -€ngineer desipnated by Paragon to as-

- their mines do not run together ‘and cause ventilation or

sure that they stay within their respective areas, 80 that

safety problems. The operators are not paid for services,

have no guaranteed compensation or minimunt payment,-

but. are paid solely on the basis of the mineral produced ;

4 and their income is dependent upon the value of that min-

eral on the market. The. operators employ a large number ee

of laborers and are obliged to meet payrolls and other ex-

penditures over extended periods of time when they are

receiving no income whatsoever.

Fae

No useful purpose would be served by enumerating the

remaining distinctions, nor t comment on. the “Commis-

sioner’s analogy between the operators and an employee

in the automobile industry; The facts stated above and

elsewhere in this brief demonstrate conclusively that the

_- obligations, rights, and interest of the operators in this

case ‘are quite different-from those of an employee. Para-:

gon could have offered the operators. an employment con-

co ; . Z 5 . >

. . - 4 %

...::.

. tract, but it did not want any of the expense,. burden and

— . responsibility of development and production of the drift <'

m Analysis of Brief for Paragon

Respondents: will not answer in detail Paragon’s: la-

bored discussion of the law of depletion. If, as Paragon’ —

sometimes states, the depletion allowance is available.only

to a taxpayer who owns.a capital investment *

snterest in the mineral in place, respondents agree. —

there is no dispute. But, if as Paragon sometimes states,

the depletion allowance is available only to the owner

of the-mineral in place, respondents submit that Paragon’s

position is contrary to decisions of this Court and to lan-

-, Suage which has reniained in’ Treasury Department §,

+” Regulations since 1939 without material change.

If ownership of the mineral in place were essential to

the depletion allowance, Treasury Department Regula-_ .

tions would so state, but they provide to the contrary.

i Section 1.611-1 (b)(1) of the Regulations under the

as 1954 Code provides that “Annual depletion. deductions

i are allowed only to the owner of an econamic interest in

mineral deposits or statfiding timber.” If ownership of the

mineral were to control it -would be simple to sé provide *

. -° . by eliminating the words “an economic interest in.”

The Regulations adopted as its definition of an “‘eco- .-

- + nomie interest” the following statement of this Court in

Palmer. v,. Bender, 287 U. S. 551, 557:

ea “The language of the statute ‘is broad enough to

‘oy provide, at least, for every case in which the tax-

, payer has acquired, by investment, any interest in

4 at oil in place, and secures, by any form of legal te-

. mship, income derived from the extraction.of the

oil; to which he must look for a return of his capital.”

[Emphasis supplied] |

/ sv

r a oo

prey |

< 36 . o

The presence of such terms as “at least”, “for — :

” ease,” “any interest” and “any form et. rae relation-

ship” in this classie definition forecloses’ any @ghcept 7

-'the depletion allowance is available only tothe ownfr of

the mineral deposit. Indeed the holding in i merv.\Ben- — -

der, supra, was that depletion did not depend u Z

__special-form-of egal interest in the mineral its. ———

_e—eent cases of this Court reiterate this view. -Commis-

~ sioner v. Southwest Exploration Co., 350 U. S. 308; Par-

| sons v. Smith, supra,dn the ‘latter case this Court: de-

clared at page 221, footnote 7, that the principles of Pal-

dany »

mer ‘v. Bender, supra, had been consistently -

and applied. Ard near the conclusion of its opinion in

: “The controlling fact is that) [pétitioners] had . Fee

-——- “interest in the. [coal] in oi A-*{Pletitioners.;

simply entered into contracts, terminable without

cause on short notice * * * to provide the equipment

and do the work required to strip mine and deliver

coal from those lands, as independent. contractors, ~ ise Pe

for fixed’ unit prices.” seat Picea OSE hs

Thus, under the regulations and decisions of this Court

the essential requirement is. not ownership of the mineral

in place, but ownership of an econamic interest in the coal . —

in place. whey he -<

| ar Cy ; eg

Paragon attempts to give an erroneous impression of >

this Coart’s holding in Helvering v. Bankline Oil Co., 303

-U.S. 362. At pages 27 and 29 of Paragon’s brief; Para-

gon claimis that the taxpayer in Bankline had a contract to

“extract gasoline” and that “a mere economic advantage”

arose “out of a contract to extract that mineral.” Chief —

_ Justice Hughes clearly set forth the position Of this Court

“on the matter at p. 367:- = | =i

“Tt is plain that, apart from its contracts with pro- pats

ducers, respondent ‘had no interest in the producing °y)». ”

wells-or in the wet gas in\place .... It was not en- Atte:

ni)

eae The Government’s_position on Bankline is contrary to. - °°

f - —_—__—

eee

amare Ln

, gaged in production. its contracts with pro-

ducers, respondent was entitled to deli of the

gas produced at. the wells, and to extract gasoline

therefrom, and was bound to pay td the producers the

stipulated amounts.” —-— - rp

cussion of Helvering @ Bankline Oil Company, supra, and

Helvering y.”Mountain Producers Corp., 303: U.S. “376,

with reference to the questjon of producing and processing

the General Counsel states’ at. page 220 that in Bankline:

* «| | the taxpayer's capital investment was in equip- |

pow facilitating delivery of the gas produced rather.

BS than in equipment-for-production of 9°

* that gave the producer an economic interest in the oil

and gas in place.” [Emphasis supplied } |

ing V. Mountain Producers Corp., supra, and not a ‘mere

_ completely out of context—“extraction of gasoline” from

produced gas is not the same as the extraction of ore or

gas from a mineral or gas deposit. In the sense that

‘Paragon, would employ the word “extraction”, the word *

é=

“processing” is more appropriate.

Beginning at, page 58 Paragon asserts that certain leg-

islation supports its position. - Its. first contention is that

ad ‘

when Congress enacted the words “each separate interest

owned by the taxpayer in each mineral deposit” in“ Sec. ;

614 (a) LR.C. 1954, it meant, that a taxpayer must own

the mineral deposit before it is entitled to depletion. As

indicated immediately above this is not the view of the

Commissioner as expressed by regulations under the 1954

Code: nor is it the view of this Court which has repeated-

ly held that the law of depletion requires an economic -

rather than a legal interest 4n_the mineral ‘deposit. Sec-

tion 614 deals primarily with unitization and not Ahe allo-

cation of the depletable interests. - : eH

Next, Paragon insists that under Section 631 (c) of the

1954 €ode, the depletion deduction in the case of coal’

leases belongs indivisibly to. the lessee. Section 631 (c)

provides that in certain situations an owner who disposes.

of coal under any form or.type of contract by virtue of

which he: retains an economic interest in such coal shall

not be entitled to the-allowance for percentage depletion,

but is entitled to capital gains. treatment, In- the case of’

certain owners Congress substituted one form — ef; tax -

treatment for’another. Congress did not, however, change

the principle long recognized by the Courts and still a

part of our tax law that a number of taxpayers may - si

hold “an economic interest in.a mineral deposit and share

in the depletion allowance, Sections 1.611-1(c) (1) and

(2) of the Regulations refer to “several owners of eco- —

nomic interests” and “in the case of a ‘lease or other con-.

tract providing for the ‘sharing’ of ‘economic interest in

a mineral deposit, or standing timber:”. [Emphasis sup- .

plied] .. ; |

‘In Section 631(c), Congress defined the word “owner”

to mean “any: person who owns an economic interest: in. —

the coal in place including a sublessor.” Yet, Paragon

insists repeatedly the ownership for purposes of . deple-

tion means‘ownership of the mineral deposit in place.”

’ ee

a er

: . 2 : 2 ; ° ; ‘ ve

B 3 39 [-. f

The Treasury Department has, ot by. regulation, ‘nor

has the Government ‘in litigation, placed such an inter~

_ pretation’ on these sections—ewven thaugh the statute has

been in existence for twelveyears. Paragon does not cite

3 ‘any Committeé Reports,/Treasury Department . Rulings

or decided cases in support of its interpretation.

Begining at pa | 70. of its brief, Paragon. discusses _

\ the several: facto umerated in Parsons-v. Smith, supra,

‘indicative of tye’ absence of an economic interest, and.

Paragon: atterfipts to apply. those factors to the instant

‘. ‘case. Its assertions are refuted by an examination of the

4 ‘

1. Paragon states that» the operators investments were-

in théir equipment, all of Which was movable—not in the

coal in place. This ‘assértion is fully answered‘at pages

". 41 to 19 of this brief. ,

2: Paragon contends that the operators’ investments in|

equipment were. recéverable through depreciation—not

depletion: — The -operators had some equipment. on which

they claimed depreciation, but the major portion of their

investment was in the coal in place as indicated under 1

“above. It should be noted that every dollar that Paragon ~

has expended in this enterprise has been deducted for tax

purposes as a business expense or through depreciation or

authorization. (R. 84) Thus, Paragon’ has no ‘investment

whatsoever that it is not recovering in some manner other.

'*3. It is asserted that the contracts were completely ter- :

minable without cause on short notice. Such assertion’ is

“answered at pages 19-to 24 of this brief and comment.

‘here will be limited to. the points raised by Paragon.

First,’ Paragon contends: that “Paragon could. not give.

an absolute fonterminable right to mine to exhaustion in

view of the landowners .reserved rights under the Para-

gon lease to terminate in the event of noncompliance with -

. . : >.

. e ¥

. ” . .

o . <

‘ had F- _ P

a f e

the terms. of the. lease. ‘Most leases are terminable in casé 7

of default and if Paragen could terminate only at ie?

penalty of losing its entire interest in the mineral deposit

it could hardly be regarded as an agreement in which

Paragon has an absolute right to cancel at any time with-

— out cause or condition. Ce Ee 3 |

In Commissioner v. Southwest Exploration Company;- —

‘ gupra, eg a the right to drill for oil, but. it °

was Pp i that “if Southwest should | default in

. the performance or observance, of any of the terms, cove-

nants ‘and stipulations, its right to drill and produce oil

. could be-_cancelled. (p. 315) Thus, by default Southwest

could. terminate’ the rights of the. upland owners, but this _ : a

was not deemed Significant and the upland owners were

allowed depletion: As noted in that case the “tax law deals

in economic: realities, not legal abstractions”.

Next Paragon argues ' that this case should be decided. on-

the basis of a clause in an ingonsistent sentence, quoted

out of context, from two fexhibits. Exhibits 86 and 87.

. (R.'281-246) were offered by Paragon and ‘received by

the Tax. Court for impeachment,purposes only. (R. 161)

- Now, after the trial is concluded, Paragon, having dis-

avowed any such purpose ‘at the trial, insists that these

' exhibits are independently probative: as admissions. These

exhibits were prepared, by C. J. Stull. G. W. Merritt

testified that Earl Bowman brought the documents to

~ Grundy one night, asked Merritt to sign them—which he -

‘did—and that Merritt took them downstairs and had them

notarized.‘ Merritt never met Stull and did not know _ é

whert he got his information. Merritt denied reading

‘the documénts and stated that he never made. such state-

ments te anyone and they were not correct. (R. 156-161)

Merritt did not swear that he read these documents; nor

did he-sign on the page containing the verification. A no- |

tary. public signed the verification, but whether she. read

it or asked Merritt. about it is not known. The informa- .—

a aati ca a ue +

‘tion-which Stull used was obtained from Bowman from

‘some undisclosed source. Bowman is a former employee

_ of R. C. Persinger & Company, accountants for the re-

d , ‘spondents. At the time of trial Bowman ‘was working:for .

the accountant who does the accounting work for Paragon.

"(Tax Court Transcript 1227-30). ° ede

If Exhibits 86 and 87 are to be used to ‘impeach: Mer-"

Boas Ne ritt or if they are independently probative as admissions

— the entire:document. should ‘be examined. — =o

Both exhibits contain in the Statement of Facts section

a go) ae following: ee Ys

es Pees - 1, “The partnership “was obliged: to extract all mineable

coal in tHe~area_allocated to it”. fEmphasis supplied} ~ |

ae . The above statement is hardly consistent with a right to.”

Seat eee terminate. my : -

5 e

\ ve

2. “The question a right to terminate never arose. -

_. between the partnership and Paragon” [Emphasis sup-

Pe plied |» | ie ‘ eae

” Jf the question never arose, how could the contract have.

specified the right of te ination. by either party. Later

‘in the Argument section\ of éach protest it. is stated:

-. :. ‘party at any time, but the question never arose between: —

i the partnership and Paragon.” i Bae

3: ‘As indicated, if the question. never r arose-tiow could the.

a*.~ agreement specify the right of termination. The sentence:

. is inherently inconisistencé. If Merritt’s testimony is to be

impeached -it should be. done with clear and consistent

_° statem@nté and not by/a document, which in the main .cor-

~ roborates his testimony, but which-contains one inconsis-

_ tent sentence. -’ nae sae. :

- Bach document contaips the

“statement that’ the agree-

_ment: was similar to the agreement considered by the —

. > °

eee» < = - _

9 . .

¢ ‘ . > a “é

4 . eo ~ 2 . *

§ e

- * ° ; ev - :

“ « - ‘aa :

. : iY . J °

s . ~

: . « ‘ . R.

ae ‘ \ : 3

? i

’

e Pst aa ®

To (ie ae

court below in Stilwell v: United States, 250. F.2d 736

°° $(4 Cirt1957): As Paragon concedes the court below de- .

. . termined in the Stilwell case that. the agreement was not

eee ty. pc ay ep Br. 74) A fair examination of the.

provisions, including the inconsistent’ sentence relied on by

Paragon, leads to the conclusions they were. the same as

_ the. Stilwells, that is, not terminable as the court’ below .

Having insisted that Merritt changed his testimony, _

Paragon seeks to'explain it by arguing that fiminability’

did not assumie any importance in decisional law until the -

decision in United States v. Stallard, 273 F.2d 847 (4 Cir. aed

- 1959). According to Paragon, Merritt was not concerned

about terminability until sometime after December 1959

when he became aware of the headnote in the Stallard /

. ease. To make this theory, of Merritt’s shortcomings

plausible, Paragon mus ignore, as it does, the headnote .

_ and controlling nding the court below’ in Stilwell v.

mately five months before Exhibits 86 and 87 were signed.

The. headnote’ in Stilwell mentions in an important way ~

the fact that the contract was not terminable at will. In

addition, the court below in discussing the crucial factors

iso with Paragon and contained the identical terms ee

ditions.. Also, his‘mines were adjacent, to Stilwell’s"

most .daily- contact with }the Stilwell .

- ”

~ ‘ ; y :

o . ?

, 43

tle his case by showing it. was the same as Stilwell ;

That he signed documents at that time with an inconsis? a

- tent: statement, as to termination indicates an attitude -

of reliancé on those whom he had engaged to’ handle his:

tax matters. Such an attitude is not uncommon in Buch-

--anan County, Virginia—particularly: among coal mine

opefators who are not educated in matters of law,.ac-

-eounting. or tax procedure. It might be added that it is

not’ uncommon for’ taxpayers to sign documents without

- +yeading them. Unless Merritt: read page 8 of these Ex--

+ hibits he would not have known that he should have read

them before signing. AE an OS

-“eneral Manager Woods. Although he: did: not malig si

_ agreements here involved, Woods testified that if afi op-

erator mined properly and produced, coal and ‘complied

Paragongmakes no. ‘comment on’ the. testimony of its .

with state and federal regulations he had the right to =

stay and mine the-coal.. (R. 106)

_ Paragon contends that many. apeistors quit at will. 7

None of the operators involved in the present litigation . -

_ ever terminated his agreemént,. although some did pur-

'. chase mines, mining” rights and equipment from other —

‘operators thereby working a novation ‘and : not -a termi-

nation. (Exhibit 84) Other eon i quit, but the

_ reasons for their doing.so a

* Many drift mire operators g0 broke and are compelled .

- by: financial ‘circumstances ‘to abandon their operations

and leave their investments, but whether this is a ter: -

. minafion at will is open. to question: ‘A contract termina- —

~ pleat will is one in which there is an absolute right to_

. eancel at. any, time ‘without cause or condition. .It is

- lear that, the operators could terminate only on the con-"

dition that they leave thei# investments in their mines.

The position of Paragon that as “a matter of’ state

Jaw it/is plain that ff a contract is at the will| of one

party, jit is at the will of both” is not well taken. Cowan

s ae ; : |

not a matter of. record. ..-

_ vy. Radford Iron Co., 83 Va. 547, 3 S. E, 120 (1887) ‘is a ;

Paragon was ‘dictum, ‘which has been: thoroughly disap-

proved in later casés in other states and has not been fol-

lowed in Virginia: Summers, Oil and Gas, 2 ed: Vol. 2

Section’235 “Leases as.a Tenancy at Wil ” presents a full -

discussion of the erroneous doctrine in Cowan and its

' subsequent rejection by the Courts. Summers concludes.

that’ following the lead of the Ohio court in Brown v.

Fowler, 65 Ohio St. 507, 63 N. E. 76 (1902) ‘the federal

and state courts, except for some éarly decisions in Okla-

‘homa and Texas, had rejectedsthe erroneous doctrine that”

‘ an oil and gas lease created a tenancy at will.” nod

4 .. ‘The other cases*cited. by re are also inapposite.

-The rule which it states applies only to an agreement

whichis wholly executory and ‘consists of mutual prom- .

ises each the consideration for the -other. It does not

apply where consideration has been given for a mineral

lease, \ whiel™gives the-lessee an interest in the right to_-

explore and develope the minera’ property and th /min- ~

eral produced, éven: thought he has the privilege- of sur-

rendering the lease at any time. Lindlay'v. Raydire, 239

F.928 (D.C.E:D. Ky 1917) affirmed 249 F. 675\(6 Cir.

1918). /The Lindlay case discusses Cowan v. Radford,

pra, and notes.that it is of no value upon such ‘a ques-

tion even in the jurisdiction of Virginia. < :

What Paragon ignores is the partial and continuing

performance of the operators: Whether either party could

: have terminated before the operators began performing:

under their agreements of the rights of Paragon in. the

event of abandonment by an operator is not the question, —

but whether Paragon, after haying encouraged and ob-"

- ligated the operators to act to their detriment, could take

11 Under Virginia law, the principles applicable to oil wells are

also applicable to mines, Graham v. Smith, 196 S.E.°600 (S.C. App.

Va. 1938) . co .

- in thy coal in place. ‘This contention is answered fully

the benefits of the operators’ investments at will and

without cause. Rr ah

4. Paragon argues that as lessee it did not agree to sur-

render and did not actually surrénder any capital interest

elsewhere :in this brief. ~It’ is noted here that Paragon

‘agreed to and did surrender to the operators an interest | .

in the coal in place, its right to mine the coal,vor to de-

termine who would. mine it. ‘Before entering into agrée-

ments with the operators Paragon did ‘not own the coal.

in place, but~held the right to mine the coal and reduce ”

_ it to possession and Swnership. After, these agreements it

held the right to acquire and sell it only. The operators

held the right to mine the’ coal, reduce it to possession and

mined it did not. belong entirely to either Paragon or the

be paid in accordance with the market..

> . »

ur pe?

.5. Paragon insists that: the coal belonged entirely to it

at all’times. It has been herein Shown that ownership of

_ the mineral is not essential to the depletion allowance. The

mineral belonged to the Iandowners until it was extracted

and reduced to possession by the operators—then Paragon

could acquire it if it so elected, under its agreement with ~

the operators. to handle all marketable coal. If it was.

marketable, Paragon accepted the coal and immediately ~

after delivery sold it to John McCall Coal Company. If

the: operators’ produced coal which was not marketable

Paragon would not take it. Before and after. the coal was

operators. The latter had certain rights in the. coal at all

times. oe

6 and 7. Paragon’s contentions that the contractors -

- were to be paid a fixed sum for each ton: and that pay- °

ment. was dependent upon the personal covenant of Para-

°gon ‘without. regard to the market price of coal have al-

ready been answered, supra, at pages 24 to 27.

operated. It was the operators and not Paragon who were,

directly responsible to the federal and state coal mine

is that: (Jewell Ridge Br. 2, 3)

8. The “rigid control of the actual mining operation”

argument of Paragon is not supported by the record. It is

contended that the engineer directed the operators in de-

tail. The engineer was eelected by Paragon, but was paid

by the operators, whom he: served, with reference to all

engineering work inside the ‘mines. '(R. 60). The, engi- 4

-neer inspected the operations generally when called by

the operators. and rendered his services when needed at

their request.’ (R. 116) On the few occasions when dis-

putes arose it was the operators and not the engineer who

' resolved the differences: Actually, the. function of’ the

engineer was to assure that the various mines stayed

within their areas. Aside from this rather tenuous argu’

_ ment, Paragon cites no other facts which would indicate

any control over the mining operation. Paragon fails to .-

mention the vast number and variety of independent ac-

tions taken by the operators over which Paragon had no

control. It was interested only in receiving the produc- .

tion from tle operators” mines and indicated little inter-

est ‘and had no control over the. way such mines were

authorities for the safe.and proper conduct of their min- |

ing operations. In short, all decisions regarding the min-

‘ing of coal were made by the operators and not Paragon. .

(R. 58, 54, 118, 129, 254)

“IV. Comments of Amicus Curiae Brief of

Jewell Ridge Coal Corporation “";

In-an amicus curiaé brief filed in No. 134 Jewell Ridge

Coal Corporation seeks to influence the deliberation of

this Court by-suiggesting that if the present case is af-

firmed the Commissioner’s ‘petition in No. 262 should be

granted to consider additional arguments allegedly availa-

ble in that case. Such argument according to Jewell Ridge

’

> ay

i 47 |

+” * + * [T]here’ was an express understanding be-

tween Jewell Ridge and its contract mine operators »

that Jewell. Ridge could, as it-did, maintain complete -.

.. ynilateral control, over the amount of coal. which its

contract mine operators were from’ time to time per-

. mitted to mine.” ake Oe 2

This statement is simply not true. The terms of the

agreements between Jewell Ridge and-its mine operators

have been considered by the Tax Court on two occasions .

in recent years. Norman E. Clifton Tax Court Docket “>

No. 64659 decided April 21, 1958, Par. 58,065 P-H Memo

The court made no such finding in either case—indeed

- the contrary is true. In Norman E. Clifton, supra, the

Tax Court found as follows: ‘ee

“g Jewell Ridge agreed to accept all coal produced .

by petitioner’ [contract, mine operator] and there was .

no limitation on the amount of coal petitioner could

produce.” ee,

The arguments of Jewell Ridge are the same as those

made by the Commissioner and Paragon and respondents

will not burden this brief. with a repetitive discussion

thereof. ; *

CONCLUSION

On the basis of this Court’s decision in Parsons v.

Smith, supra, the court below concluded that the operators

‘owned an economic interest in the mineral in place. This

determination was “based-on the obligations of Paragon

under its leases, which were assumed and performed by

‘the operators, the continuing rights of the operators in

the mineral deposit and the right to be.paid for coal pro-

duced at a price closely related to the market price of

coal: In these vital respects this case is clearly disting- —

uishable from Parsons V.: Smith, supra—indeed principles -

f ws ;

48 : - peat

of that case require an: affirmance of the decisions of the

court below. e;

Paragon placed the burden of development and pro-

duction upon the operators, it agreed ‘to pay only for:

marketable coal and it was- the understanding between —

the parties that the income of the operators would be

dependent upon the market price of coal. Under these

circumstances, the depletion allowance is to be, shared by

. the operators and Paragon because they. were jointly in-

terested in ‘the development, -production,—processing -and . -

‘gale of the coal to be extracted. The decisions of ‘the.

court below should be affirmed. . re

Respectfully submitted,

-" Joun Y. MERRELL

PauL P.SENIO ,

844 Shoreham Building

Washington, D. C. 20005

Counsel for the.

Respondents in No. 237

February, 1965,

APPENDIX

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