1. Pursuant to a plan of creditors, the indenture securing bonds
of an insolvent corporation was foreclosed, and its properties
transferred to a new corporation in exchange for common stock and
stock purchase warrants of the latter, the common stock going
mostly to bondholders of the old corporation, but a small portion
of it, together with part of the warrants, to the old corporation's
participating unsecured creditors, the other warrants going to the
old corporation's preferred and common stockholders. Its
nonparticipating security holders were paid cash, which was
obtained in the course of the transaction by means of a loan from a
bank which the new corporation later assumed and paid.
Held, that the transaction is not a "reorganization"
under § 112(g)(1) of the Revenue Act of 1934. P.
315 U. S.
198.
To constitute a "reorganization" under clause B of that section,
the assets of the transferor corporation must be acquired solely
for voting stock of the transferee. Voting stock plus some other
consideration does not meet the statutory requirement.
2. The provision of the Revenue Act of 1934, § 112(g)(1)(B), as
amended retroactively by the Revenue Act of 1939, that, in
determining whether an exchange is solely for voting stock,
"the assumption by the acquiring corporation of a liability of
the other, or the fact that property acquired is subject to a
liability, shall be disregarded,"
is inapplicable to an indebtedness arising out of he
reorganization, such as the bank loan described,
supra, as
distinguished
Page 315 U. S. 195
from a debt of the transferor antedating the transaction. P.
315 U. S.
198.
3. Warrants entitling the holder to buy voting common stock at
so much per share are not "voting stock" within the meaning of §
112(g)(1)(B) of the Revenue Act of 1934. P.
315 U. S.
200.
4. Under clause C of § 112(g)(1) of the Revenue Act of 1934,
which requires that, immediately after the transfer, the transferor
or it stockholders, or both, be in control of the transferee
corporation, and § 112(h), which defines "control," there is no
reorganization where, at the critical date, control is in creditors
of the old corporation by virtue of shares issued to them by the
the corporation. P.
315 U. S.
201.
5. "Recapitalization" within the meaning of clause D of §
112(g),
supra, implies a reshuffling of a capital
structure within the framework of an existing corporation, and a
transaction which shifts the ownership of the proprietary interest
in the corporation is not "a mere change in identity, form, or
place of organization" within the meaning of clause E. P.
315 U. S.
202.
119 F.2d 561 reversed.
Certiorari, 314 U.S. 598, to review a judgment which affirmed a
decision of the Board of Tax Appeals overruling deficiency
assessments.
MR. JUSTICE DOUGLAS delivered the opinion of the Court.
The primary problem in this case is whether the transaction in
question qualified as a "reorganization" under § 112(g)(1) of the
Revenue Act of 1934, 48 Stat. 680, 705. Sec. 112(g) provides:
Page 315 U. S. 196
"As used in this section and section 113 --"
"(1) The term 'reorganization' means (A) a statutory merger or
consolidation, or (B) the acquisition by one corporation in
exchange solely for all or a part of its voting stock: of at least
80 percentum of the voting stock and at least 80 percentum of the
total number of shares of all other classes of stock of another
corporation; or of substantially all the properties of another
corporation, or (C) a transfer by a corporation of all or a part of
its assets to another corporation if immediately after the transfer
the transferor or its stockholders or both are in control of the
corporation to which the assets are transferred, or (D) a
recapitalization, or (E) a mere change in identity, form, or place
of organization, however effected."
Respondent filed an income and excess profits tax return for a
part of the year 1934 and for the entire year 1935, reporting a net
loss for each year. Petitioner, in determining deficiencies, made
certain adjustments on the theory that the acquisition by
respondent in 1934 of all of the assets of its predecessor,
Southwest Gas Utilities Corp., was not a "reorganization" as
defined in § 112(g)(1). The cost basis of the assets in the hands
of the old corporation had been about $9,000,000. They were
purchased at foreclosure and receivership sales for $752,000.
Respondent used the former figure as the basis in computing gains
and losses on the acquired assets. Thus, it deducted some $75,000
as bad debts. Petitioner, in using the lower figure as the basis,
allowed that deduction only to the extent of $1.26. Deficiencies
computed on that theory showed a net income, rather than a net
loss, for each year. The Board of Tax Appeals rejected the
Commissioner's view. [
Footnote
1]
Page 315 U. S. 197
The Circuit Court of Appeals affirmed the judgment of the Board.
119 F.2d 561.
The old corporation was burdened with some $2,870,000 face
amount of first lien bonds, certain unsecured claims, and issues of
preferred and common stock. There was a default in interest on the
bonds in May, 1932. A bondholders' committee was formed which
obtained the deposit of about 85% of the bonds outstanding. Members
of the committee became directors of the old corporation, and,
beginning in the fall of 1932, were in control of it. In 1934,
equity receivers were appointed by the Delaware chancery court. A
plan of reorganization was formulated which was approved by the
court. The plan called for the formation of a new company which
would acquire the assets of the old in exchange for voting common
stock and Class A and Class B stock purchase warrants. Most of the
common stock issued under the plan was to go to the bondholders; a
small portion, together with the Class A warrants, was to be issued
to the unsecured creditors. Class B warrants were to be issued to
the preferred and common stockholders. Pursuant to the plan and a
court order, the assets securing the bonds were sold by the
indenture trustee at a foreclosure sale in 1934. They were bid in
by the bondholders' committee for $660,000. The unpledged assets
also were sold at public auction, and were bought in by the
committee for $92,000. Respondent was thereupon formed, and the
committee transferred all the assets of the old corporation to it.
The Board found that the fair market value of the assets at that
time was $1,766,694.98. The stock and warrants of respondent were
distributed pursuant to the plan. Nonparticipating security
holders, owning $440,000 face amount of obligations, received about
$106,680 in cash. The cash necessary to make this payment was
obtained by a loan from a bank. The loan was assumed by the
respondent, and later repaid by it. About 49,300 shares of
common
Page 315 U. S. 198
stock and 2,760 Class A warrants were issued to the creditors;
over 18,445 Class B warrants were issued to the stockholders. Class
A warrants carried the right to buy one share of common stock at $6
a share during 1934, the price being increased $1 per share each
year until expiration in 1938. Class B warrants carried the same
right, except that the price was $10 a share during 1934, and was
increased by $5 per share each year until expiration in 1938. There
were 1,760 Class A warrants and 4,623 of the Class B warrants
exercised. On the basis of the fair market value of the assets at
the time they were acquired in the reorganization, respondent
computes that the Class A warrants had a value of $29 each, and the
Class B warrants a value of $25 each.
Under the statute involved in
Helvering v. Alabama Asphaltic
Limestone Co., ante, p.
315 U. S. 179,
there would have been a "reorganization" here. For the creditors of
the old company had acquired substantially the entire proprietary
interest of the old stockholders.
See Helvering v. Minnesota
Tea Co., 296 U. S. 378. But
clause (B) of § 112(g)(1) of the 1934 Act effects an important
change as respects transactions whereby one corporation acquires
substantially all of the assets of another.
See S.Rep. No.
558, 73d Cong., 2d Sess., Committee Reports, Revenue Acts
1913-1938, pp. 598-599. The continuity of interest test is made
much stricter.
See Paul, Studies in Federal Taxation (3rd
Series), pp. 36-41. Congress has provided that the assets of the
transferor corporation must be acquired in exchange "solely" for
"voting stock" of the transferee. "Solely" leaves no leeway. Voting
stock plus some other consideration does not meet the statutory
requirement.
See Hendricks, Developments in the Taxation
of Reorganizations, 34 Col.L.Rev. 1198, 1202-1203. Congress,
however, in 1939, amended clause (B) of § 112(g)(1) by adding,
"but in determining whether the exchange is solely for voting
stock the assumption by the acquiring
Page 315 U. S. 199
corporation of a liability of the other, or the fact that
property acquired is subject to a liability, shall be
disregarded."
53 Stat. 871. That amendment was made to avoid the consequences
of
United States v. Hendler, 303 U.
S. 564.
See H.Rep. No. 855, 76th Cong., 1st
Sess., pp. 18-20; S.Rep. No. 648, 76th Cong., 1st Sess., p. 3. And
it was made retroactive, so as to include the 1934 Act. 53 Stat.
872. But, with that exception, the requirements of § 112(g)(1)(B)
are not met if properties are acquired in exchange for a
consideration other than, or in addition to, voting stock. Under
that test, this transaction fails to qualify as a "reorganization"
under clause (B).
In the first place, security holders of the old company owning
$440,000 face amount of obligations were paid off in cash. That
cash was raised during the reorganization on a loan from a bank.
Since that loan was assumed by respondent, it is argued that the
requirement of clause (B), as amended in 1939, was satisfied. But,
in substance, the transaction was precisely the same as if
respondent had paid cash plus voting stock for the properties. We
search the legislative history of the 1939 amendment in vain for
any indication that it was designed to do more than to alter the
rule of the
Hendler case. That case dealt with a situation
where an indebtedness which antedated the transaction in question
was assumed by the transferee. There, the debt assumed clearly was
a "liability of the other" corporation. The situation here is quite
different. The rights of the security holders against the old
corporation were drastically altered by the sale made pursuant to
the plan. The sale not only removed the lien from the property and
altered the rights of the security holders in it; it also limited
and defined the rights of the individual creditors if they elected
to take cash, rather than participate in the plan.
See
Weiner, Conflicting Functions of the Upset Price, 27 Col.L.Rev.
132, 137-138. In
Helvering v. Alabama Asphaltic Limestone Co.,
supra,
Page 315 U. S. 200
we regarded the several steps in a reorganization as mere
"intermediate procedural devices utilized to enable the new
corporation to acquire all the assets of the old one pursuant to a
single reorganization plan."
Under that approach, part of the consideration which respondent
paid for the properties of its predecessor was cash in the amount
of about $106,680. The fact that it was paid to the bank, rather
than to the old corporation or its creditors, is immaterial. The
requirement to pay cash arose out of the reorganization itself. It
derived, as did the requirement to pay stock, from the plan
pursuant to which the properties were acquired. It was a necessary
incident of the court decree which wiped out the liability of the
old corporation and substituted another one in its place. Though
the liability assumed had its origin in obligations of the
transferor, its nature and amount were determined and fixed in the
reorganization. It therefore cannot be labeled as an obligation of
the "other," or predecessor, corporation within the meaning of the
1939 amendment. Nor can the property be said to have been acquired
"subject to" that liability within the purview of that amendment.
The words "subject to" normally connote, in legal parlance, an
absence of personal obligation. That seems to be the case here, for
the preceding clause of the amendment covers the case of
"assumption."
In the second place, the warrants which were issued were not
"voting stock." Whatever rights a warrant holder may have "to
require the obligor corporation to maintain the integrity of the
shares" covered by the warrants (
see Berle, Studies in the
Law of Corporation Finance (1928), pp. 136-142), he is not a
shareholder.
Gay v. Burgess Mills, 30 R.I. 231, 74 A. 714.
Cf. Miles v. Safe Deposit Co., 259 U.
S. 247,
259 U. S. 252.
His rights are wholly contractual. As stated by Holmes, J., in
Parkinson v. West End Street Ry., 173 Mass. 446, 448, 53
N.E. 891, 892, he "does not become a stockholder, by his contract,
in
Page 315 U. S. 201
equity any more than at law." At times, his right may expire on
the consolidation of the obligor corporation with another.
Id. If, at the time he exercises his right, there are no
authorized and unissued shares to satisfy his demand, he will get
damages not specific performance.
Bratten v. Catawissa Railroad
Co., 211 Pa. 21, 60 A. 319.
And see Van Allen v. Illinois
Central R. Co., 7 Bosw. 515. Thus, he does not have, and may
never acquire, any legal or equitable rights in shares of stock.
Lisman v. Milwaukee, L.S. & W. Ry. Co., 161 F. 472,
480,
aff'd, 170 F. 1020. And he cannot assert the rights
of a shareholder.
See Hills, Convertible Securities, 19
Calif.L.Rev. 1, 4. Accordingly, the acquisition in this case was
not made "solely" for voting stock. [
Footnote 2] And it makes no difference that, in the long
run, the unexercised warrants expired, and nothing but voting stock
was outstanding. The critical time is the date of the exchange. In
that posture of the case, it is no different than if other
convertible securities had been issued, all of which had been
converted within the conversion period.
Nor can this transaction qualify as a "reorganization" under
clause (C) of § 112(g)(1). That clause requires that, "immediately
after the transfer," the "transferor or its stockholders, or both"
be in "control" of the transferee corporation. "Control" is defined
in § 112(h) as
"the ownership of at least 80 percentum of the voting stock, and
at least 80 percentum of the total number of shares of all other
classes of stock of the corporation."
Here, "control" at the critical date was not in the old
corporation or its "stockholders." The participating creditors had
received, pursuant to the plan, rights to receive over a majority
of the stock of the new company even though all of the warrants
Page 315 U. S. 202
allocated to stockholders had been issued and exercised. The
contrary conclusion was reached in
Commissioner v. Cement
Investors, Inc., 122 F.2d 380, 384, on the theory that the
bondholders of the insolvent predecessor company could be regarded
as its "stockholders" within the meaning of § 112(g)(1)(C), since
they had acquired an equitable interest in the property, and were
empowered to supplant the stockholders. We have adopted that theory
in
Helvering v. Alabama Asphaltic Limestone Co., supra, in
determining whether the bondholders had retained a sufficient
continuity in interest so as to bring the transaction within the
statutory definition of merger or consolidation contained in the
revenue acts prior to 1934. But it is one thing to say that the
bondholders "stepped into the shoes of the old stockholders" so as
to acquire the proprietary interest in the insolvent company. It is
quite another to say that they were the "stockholders" of the old
company within the purview of clause (C). In the latter, Congress
was describing an existing specified class of security holders of
the transferor corporation. That class, as we have seen, received a
participation in the plan of reorganization. For purposes of clause
(C), they must be counted in determining where "control" over the
new company lay. They cannot be treated under clause (C) as
something other than "stockholders" of the old company merely
because they acquired a minority interest in the new one. Indeed,
clause (C) contemplates that the old corporation or its
stockholders, rather than its creditors, shall be in the dominant
position of "control" immediately after the transfer, and not
excluded or relegated to a minority position. Plainly, the normal
pattern of insolvency reorganization does not fit its
requirements.
Clause(D) is likewise inapplicable. There was not that
reshuffling of a capital structure within the framework of an
existing corporation contemplated by the term "recapitalization."
And a transaction which shifts the ownership
Page 315 U. S. 203
of the proprietary interest in a corporation is hardly "a mere
change in identity, form, or place of organization" within the
meaning of clause (E).
Reversed.
MR. JUSTICE ROBERTS did not participate in the consideration or
decision of this case.
[
Footnote 1]
The petition for review by the taxpayer contended that this
transaction was a "reorganization" within the purview of §
112(g)(1), and therefore that the carryover basis provided in §
113(a)(7), was applicable. No other issues were raised or
considered by the Board or the court below. We pass only on that
question, leaving open such other questions as may be appropriately
presented to the Board.
[
Footnote 2]
The contrary view, expressed in a letter by the Commissioner
dated January 27, 1937 (1937 C.C.H.Vol. 3, Par. 6118), does not
have the status of a formal ruling of the Treasury, nor does it
seem to reflect an established course of administrative
construction.