Appeal from the District Court of the United States for the Eastern District of New York.
Before L. HAND, CLARK, and PATTERSON, Circuit Judges.
PATTERSON, Circuit Judge.
The United States, after trial on the merits with jury waived, recovered judgment for $100,000 and interest against both defendants on three bonds covering use of specially denatured alcohol by the defendant Bornn, and for the further sum of $303,858.22 against Bornn alone for taxes. The defendants' appeal raises questions of law.
The bonds were given under the Denatured Alcohol Act of June 7, 1906, 26 U.S.C.A. §§ 1320-1323, supplemented by title 3 of the National Prohibition Act, 27 U.S.C.A. §§ 71-89, and under Regulations 61 of the Treasury Department. By the Denatured Alcohol Act, 26 U.S.C. §§ 1320-1323, 26 U.S.C.A. §§ 1320-1323, alcohol may be withdrawn for use in the arts and industries without payment of tax, provided it be mixed with denaturing materials making it unfit for beverage purposes. Distillers, manufacturers, dealers and others handling or using such denatured alcohol are required to keep such records, execute such bonds and render such returns as the Commissioner of Internal Revenue with the approval of the Secretary of the Treasury may require by regulations. The Act forbids the use of such tax-free alcohol for manufacture of a beverage and also forbids the recovery of pure alcohol from it by redistillation of other means except as permitted by regulations. By title 3 of the National Prohibition Act, 27 U.S.C. §§ 71-89, 27 U.S.C.A. §§ 71-89, dealing with industrial alcohol, it was provided that alcohol produced at industrial alcohol plants or stored in bonded warehouses might be withdrawn tax free to denaturing plants for denaturation, that alcohol lawfully denatured might be sold free of tax, and that the Commissioner should issue regulations respecting establishment, bonding and operation of industrial alcohol plants, denaturing plants and bonded warehouses, and respecting distribution, sale and use of alcohol, "which may be necessary, advisable, or proper, to secure the revenue, to prevent diversion of the alcohol to illegal uses", 27 U.S.C.A § 83, and so on. By Regulations 61, in force at the time the bonds were made, manufacturers desiring to use specially denatured alcohol were required to file application for permit and to furnish bond on Form 1480, the penal sum of the bond to be graduated according to the quantity to be used.
The three bonds followed the provisions given in Form 1480. They were made by Bornn as principal and Royal Indemnity Company as surety. The first, dated July 19, 1921, and for the sum of $25,000, was in support of an application made by Bornn for a permit to use specially denatured alcohol of formula 39A in the manufacture of bay rum, the estimated quantity being 5,000 gallons a month. Permit was accordingly issued on August 5, 1921. The bond recited the application to use specially denatured alcohol of formula 39A for manufacture of bay rum, and contained this condition: "Now, therefore, the condition of this obligation is such that if there be no material false statement in the application for such permit, and the said principal shall not violate the terms of such permit, and shall transport, store, and use such denatured alcohol in accordance with the law and regulations made pursuant thereto, and shall in all respects fully and faithfully comply with all provisions of law now or hereafter enacted and all regulations promulgated thereunder respecting such transportation, storage, and use, and shall pay for all such denatured alcohol illegally or unlawfully diverted, lost, or unaccounted for in violation of such permit and law and regulations at the rate of $4.50 per wine gallon, and in addition thereto shall pay all penalties and fines imposed, then this obligation to be void; otherwise to remain in full force and virtue".
The second bond, bearing no date but shown to have been executed on or about March 30, 1922, was for $25,000. It was delivered in support of an application by Bornn for a permit to use specially denatured alcohol of another formula, formula 39B, in the manufacture of rubbing alcohol, in quantities estimated at 5,000 gallons a month. The bond contained the same condition as the first bond. Permit to use specially denatured alcohol of formula 39B for manufacture of rubbing alcohol was issued on April 22, 1922.
The third bond, dated August 31, 1922, for $50,000, was in support of an application made on September 9, 1922, to use specially denatured alcohol formula 39B for making rubbing alcohol, in estimated quantities of 30,000 gallons monthly. This application was the same as the second, save that the estimated quantities of specially denatured alcohol to be withdrawn were greater. The bond contained the same condition as the two earlier bonds. No formal permit was issued at the time. The bond was filed and approved, and in accordance with regulations and practice then prevalent the collector of internal revenue was directed to allow Bornn to withdraw the increased gallonages of specially denatured alcohol given in his application. The bond was regarded as effective from the time it was filed and approved. So the matter stood until the end of 1925, when by general regulation all permits were cancelled as of March 31, 1926. See Higgins v. Foster, 2 Cir., 12 F.2d 646. Bornn filed a new application on December 30, 1925, for permit to use specially denatured alcohol in manufacture of rubbing alcohol and bay rum, and in due course received a new permit on March 31, 1926, for the use of specially denatured alcohol, formula 39A for bay rum and formula 23A for rubbing alcohol. The bonds were unchanged.
At the trial there was proof that over the period from January 1, 1924, to August 31, 1926, Bornn purchased or "withdrew" large quantities of specially denatured alcohol under his permits and that while he went through the process of mixing the denatured alcohol with other ingredients into a product called rubbing alcohol, he did so merely to sell the rubbing alcohol to the trade in illicit liquor, with the design that purchasers should "clean" it of denaturants and other ingredients and sell the recovered alcohol for beverage purposes. The proof on this feature of the case was ample. Among other things, Bornn offered to supply customers with a white powder for the removal of the denaturants; he made experiments in their presence to prove the efficacy of the power; he instructed salesmen to sell to those who supplied illicit stills but to make it appear that orders came from wholesale drug concerns. The rubbing alcohol was 92 percent pure slcohol at first; later the percentage was reduced to 70. The district court found, and it is not seriously disputed here, that Bornn's sales of rubbing alcohol were in the main to persons who to his knowledge and with his assistance and procurement delivered the rubbing alcohol to stills, where the substances that had been added were removed and potable spirits recovered. The court found that at least 96,616 gallons of specially denatured alcohol, the quantity alleged in the complaint, were thus diverted by Bornn from nonbeverage use to beverage use.
The complaint contained three counts. The first was on the three bonds; it alleged that the condition that Bornn should use the denatured alcohol in accordance with the law and regulations was broken, and that by reason thereof the defendants were liable for the tax then imposed on distilled spirits at the basic rate of $2.20 per proof gallon, up to the $100,000 limit of the bonds. The second count was also on the three bonds; it charged breach of the condition that Bornn should pay $4.50 per wine gallon "for all such denatured alcohol illegally or unlawfully diverted, lost, or unaccounted for in violation of such permit and law and regulations," and damages for the limit of the bonds were claimed. The first and second counts were thus in the alternative. The third count was against Bornn alone and sought to fasten on him a tax liability for 96,616 wine gallons of denatured alcohol diverted to beverage use. The 96,616 wine gallons, it was alleged, were the equivalent of 183,571 proof gallons, and tax at the basic rate of $2.20 per proof gallon was claimed, $403,858.22, or $303,858.22 with the $100,000 liability on the bonds deducted. The district court gave recovery for the full amounts demanded, the sum of $100,000 against both defendants on the bonds, and the further sum of $303,858.22 against Bornn for taxes.
We consider first the liability of the defendants on the three bonds. As to the first bond no breach of condition was proved. The first bond was the bay rum bond. The condition in that bond, read with the recital in the bond, covered compliance with the law and regulations concerning specially denatured alcohol of formula 39A for use in bay rum. There was no evidence that any specially denatured alcohol of that formula or any bay rum made from it was misused. The condition in the bond was not broken. The government concedes that this is true if the bond is taken as it was written. The argument is that the condition of the bond was later broadened to cover specially denatured alcohol of formula 39B for use in rubbing alcohol. The argument rests on the fact that at the top of the later bonds the word "additional" appeared. It was not shown who wrote "additional" on the later bonds. Even if it were placed on the bonds by the surety or by Bornn, there was no evidence that it was understood by them to mean that a bond already on file was altered so as to cover the same risks as the later bonds. For all that appears, the word "additional" meant merely that there was in force an earlier bond of the same principal and the same surety which the bond in question did not supersede. It was error to hold the defendants liable on the first bond.
The second bond and the third bond covered the withdrawal and use of specially denatured alcohol of formula 39B for manufacture of rubbing alcohol. The condition was that Bornn should comply with the law respecting use of specially denatured alcohol and should pay $4.50 per wine gallon for all specially denatured alcohol diverted by him in violation of law. In effect, Bornn and the surety company made a contract with the government that if it would allow Bornn to withdraw specially denatured alcohol free of tax for the purpose stated in the applications, Bornn would obey the law regarding use of denatured alcohol and would pay to the government $4.50 per wine gallon for any alcohol diverted to unlawful uses, up to the limit of $75,000. What Bornn actually did was to concoct his rubbing alcohol out of the denatured alcohol and induce dealers in unlawful liquor to purchase it. The district court found it to be the fact that his purpose in withdrawing specially denatured alcohol and mixing it with a small amount of other ingredients to form what he called rubbing alcohol was merely to sell his product to those who supplied illicit stills with alcohol for redistillation. That such conduct was an unlawful diversion of the specially denatured alcohol admits of no doubt. It was a plain violation of the Denatured Alcohol Act and also of section 4 of title 2 of the National Prohibition Act, 41 Stat. 309, 27 U.S.C.A. § 13. See Higgins v. Foster, 2 Cir., 12 F.2d 646; Bilodeau v. United States, 9 Cir., 14 F.2d 582; Helvering v. Druggists' Specialties Co., 3 Cir., 76 F.2d 743. There is no reason why the defendants should not be required to do what they agreed to do, pay $4.50 per wine gallon for all specially denatured alcohol unlawfully diverted, not to exceed the total of $75,000 fixed by the bonds. See United States v. Frost, 5 Cir., 80 F.2d 341, 343. At $4.50 per wine gallon the gallonage diverted came to far more than $75,000.
The defendants say that there was no diversion of the specially denatured alcohol, that Bornn's misconduct had to do only with rubbing alcohol and that rubbing alcohol was not covered in the bonds; hence there was no breach of the condition in the bonds. United States v. Hartford Accident & Indemnity Co., D.C., 15 F.Supp. 791, is an authority in support of the argument. We find it unconvincing. With the finding that Bornn obtained the specially denatured alcohol to the end that it might be passed on to purchasers in the form of rubbing alcohol and then cleaned of denaturants and other ingredients and used for beverage purposes, it is accurate to say that the specially denatured alcohol was diverted to beverage purposes, the rubbing alcohol being only an intervening step. Various Items of Personal Property v. United States, 282 U.S. 577, 51 S. Ct. 282, 75 L. Ed. 558; see also Bilodeau v. United States, supra.
The defendants also say that the provision for payment of $4.50 per wine gallon for diverted alcohol was an invalid penalty. The attack in reality is aimed at the regulations, for the regulations. We see no reason to doubt the validity of this provision in the bonds. Congress saw fit to waive payment of tax on denatured alcohol devoted to nonbeverage uses, but took pains to direct the Commissioner to make regulations with a view to protect the revenue and prevent diversion of the alcohol to taxable uses. The Denatured Alcohol Act was still in force, Bilodeau v. United States, supra, and under that act the Commissioner was told in so many words to take bonds from manufacturers who availed themselves of the chance to get denatured alcohol free of tax. With these statutory warrants the Commissioner issued regulations requiring manufacturers who obtained specially denatured alcohol to put up a bond bearing the conditions of the bonds involved in this case. The condition that the permittee should pay $4.50 per wine gallon for all denatured alcohol unlawfully diverted was a measure aimed at preventing fraud on the revenue and diversion of the alcohol to unlawful uses, and we cannot say that it was too drastic. The rate of $4.50 per wine gallon was somewhat in excess of the nonbeverage rate of tax on distilled spirits, but was well below the beverage rate of tax. We are of opinion that the regulation calling for such a bond was fairly within the power delegated to the Commissioner, and that the ...