The opinion of the court was delivered by: LEIBELL
I am filing, together with this opinion, Findings of Fact and Conclusions of Law. The typewritten record of the trial testimony covered 1,039 pages, plus 248 pages of the Schwarz deposition. Mr. Schwarz was a former Vice-President of Juilliard. In addition, several hundred exhibits were received in evidence. The Findings of Fact are quite detailed, and familiarity with the Findings is assumed. In this opinion I shall discuss the principal legal questions raised by counsel. The facts will, of course, be referred to, but in an abridged form, to the extent that may be necessary to show the applicability of certain principles of law laid down in the decided cases.
In its complaint in this action the plaintiff, Juilliard, alleged three causes of action for refunds of part of its excess profits taxes paid for the years 1942, 1943 and 1944. But only the second cause of action need be considered, because it combined the 1942 and 1944 claims for refunds and reasserted them for the year 1943, which the parties have stipulated is the applicable tax year.
The Commissioner of Internal Revenue disallowed two items claimed to be deductible as 'ordinary and necessary (business) expenses' under Section 23(a) (1)(A) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(a)(1)(A). The larger item, $ 410,219.31, represented a payment made by Juilliard to the Treasurer of the United States on January 29, 1943, in settlement of a treble damage action instituted by OPA against Juilliard on November 19, 1942, for violations of Maximum Price Regulation 163 (MPR 163). The smaller item, $ 4,184.63, represented a net payment of overcharges for other violations of the Regulation, subsequently reported by Juilliard to the OPA and paid January 21, 1944. Those two items, if they had been allowed, would have resulted in the reduction of Juilliard's excess profits taxes for 1943 by $ 335,667.20, the amount claimed as a refund (plus interest) in the second cause of action herein.
The Office or Price Administration instituted an action against Juilliard, in this Court on November 19, 1942, charging that during 1942 Juilliard had violated MPR 163 and had overcharged its customers approximately $ 250,000, on which treble damages were sought. That action was finally settled January 29, 1943, and Juilliard paid to the Treasurer of the United States $ 410,219.31, three times overcharges of $ 136,739.77, as calculated at the time the settlement was made. In 1943 while making a recanvass of its records Juilliard discovered certain additional overcharges and, after taking a credit for certain undercharges, paid over a net balance of $ 4,184.63 to the United States Treasury on January 21, 1944, without the exaction of any treble damage penalty by OPA. Just how this net figure was arrived at will be hereinafter discussed.
Juilliard claims that the overcharges of $ 136,739.77 were innocently made, were due to a misunderstanding of the Regulation or to inadvertence, and were not the result of any wilful violation of the OPA Regulations or the result of any negligence on Juilliard's part in calculating the ceiling prices permitted by the OPA Regulations, or any failure on Juilliard's part to take practicable precautions against violating the Regulation, MPR 163. The same contention is made in reference to the overcharges involved in the payment of $ 4,184.63.
In the case at bar the plaintiff also contends that it was so harassed and its business was so jeopardized by the publicity attending the OPA violations suit, that plaintiff was forced to settle and paid the treble damages under duress. Plaintiff was restrained by the provisions of the 'order to show cause' issued November 19, 1942, from selling twentyseven specified styles of woolen and worsted goods, until new reports on ceiling prices had been submitted to the OPA and approved. Over $ 300,000 of Juilliard's outstanding accounts were held up by the OPA suit. To meet that situation plaintiff asked and was permitted to receive and deposit in a separate fund the amounts due it on outstanding accounts from customers to whom it had sold the challenged fabrics.
There was considerable testimony on the issue of duress. Those who were responsible for the institution of the OPA action against Juilliard undoubtedly made every effort to publicize the action as the first major suit against an OPA violator. Juilliard had violated the Regulation in fixing the ceiling price on most of its woolen and worsted fabrics for women's wear, especially on its best sellers. The OPA would not agree to any payment in settlement of the overcharges unless the settlement figure was calculated on a treble damage basis. That was what the Act, at the time, seemed to impose, and it was also the policy the OPA intended to follow. But in calculating the overcharges the OPA was considerate, especially in allowing the so called Stottville markup, and in doing so treated that phase of Juilliard's ceiling price problem as a hardship case, as set forth in some detail in the Findings of Fact. Whatever 'duress' resulted from the OPA suit had its origin in Juilliard's violation of MPR 163, and was a direct consequence of the application thereto of the legal sanctions provided in Section 205(a) and (e) of the Emergency Price Control Act, 50 U.S.C.A.Appendix, § 925.
The fact that the OPA January 29, 1943 settlement involved payment of treble damages by the taxpayer Juilliard, while important, is not of itself dispositive of the case. It only labels the payment made by Juilliard as a 'penalty'. The important question is whether the taxpayer's violation of the statute or regulation was innocent and inadvertent, or was wilful or the result of negligence and the failure to take practicable precautions to avoid the occurrence of the violation. In every case that question must be decided 'ad hoc', as Judge Hand observed in Jerry Rossman Corporation v. Commissioner of Int. Rev., 2 Cir., 175 F.2d 711, 713. This court has followed that course in the case at bar.
Where a treble damage payment in an OPA action in made pursuant to a court adjudication that the overcharges had been made knowingly, and wilfully exacted, (Lentin v. Commissioner of Internal Revenue, 7 Cir., 226 F.2d 695) or that they were the result of taxpayer's negligence or the failure to take practicable precaution to avoid the occurrence of the overcharge, the doctrine of 'res judicata' comes into play. In a later tax case, where the amount paid by the violator is claimed as a deductible business expense, the court will take the penalty nature of the payment as already adjudicated. George Schaefer & Sons v. Commissioner of Int. Rev., 2 Cir., 209 F.2d 440, 441.
Juilliard's attorney, Mr. Burke, negotiated the settlement and Juilliard's Board of Directors approved it. The settlement provided for treble damages. The OPA as part of the negotiation of the settlement, waived any claim for the first period of MPR 163 (June 22 to September 8, 1942), and limited its claim to the so-called second period, which followed the adoption of Amendment 4 of the Regulation, effective September 8, 1942. As part of the settlement plaintiff was allowed the so-called Stottville markup of 20%, instead of being limited to a company-wide markup of 9.8%. But, after all these concessions, the OPA insisted that the balance of the overcharges be trebled.
If treble damages are demanded and paid by an alleged violator of an OPA price regulation, the amount thereof is, as a general rule, considered a penalty and is not deductible as 'an ordinary and necessary business expense' in calculating the violator's Federal taxes. The reason for the disallowance of any deduction of a penalty from the violator's income or excess profits taxes is that any such deduction would reduce the amount of the penalty payment, destroy the punitive effect of the payment as a deterrent, and would frustrate the policies of the Emergency Price Control Act. Commissioner of Internal Revenue v. Heininger, 320 U.S. 467, 64 S. Ct. 249, 88 L. Ed. 171. To establish the right to a deduction the taxpayer has the burden of showing that the violation of the Regulations was innocent and was the result of an inadvertent error. American Brewery v. United States, 4 Cir., 223 F.2d 43, 46. If the violation of the OPA Regulation was wilful, or the result of negligence or of a failure on the part of the violator to take practicable precautions against the occurrence of the violation, the deduction will not be allowed. Jerry Rossman Corporation v. Commissioner of Int. Rev., supra.
Until The Chandler amendment in June 1944, the courts had no alternative but to impose treble damages and no equitable defense of the lack of wilfulness or of inadvertence could be considered. Bowles v. American Stores, 78 U.S.App.D.C. 238, 139 F.2d 377, certiorari denied 322 U.S. 730, 64 S. Ct. 947, 88 L. Ed. 1565; Bowles v. Indianapolis, 7 Cir., 150 F.2d 597, 600. But even where the payment by the manufacturer is of the exact amount of the overcharge, as single damages, it may not be deducted as a business expense for tax purposes if the violation was wilful, or the result of negligence or a failure to take practicable precautions. George Schaefer & Sons v. Commissioner of Int. Rev., supra. And where the amount paid by the alleged violator of the Regulation represents single damages, the burden of proof is, nonetheless, on the taxpayer to show that the violation was of such a nature that the allowance of the tax deduction would not frustrate any sharply defined policy of the Act. Jerry Rossman Corporation v. Commissioner of Int. Rev., supra; Commissioner of Internal Revenue v. Heininger, supra.
Juilliard's overcharges, which formed the basis of the trebled damages of $ 410,219.31 paid by Juilliard to the Treasurer of the United States on January 29, 1943, in settlement of the OPA action against Juilliard instituted November 19, 1942, involved three principal fabrics (A-2391, W-4648, and W-4649) and about twenty 'others', comparatively minor, as set forth in the following schedule:
A2391 $110,098.30 $330.294.90
W4648 7,258.20 21,774.60
W4649 17,450.58 52,351.74
Other 1,932.69 5,798.07
Fabric A-2391 was Juilliard's biggest seller. Close to one-half of Juilliard's total yardage sales were of this fabric. It was also one of Juilliard's high priced fabrics. Any error in figuring its ceiling price per yard, under MPR 163 was bound to run into big money. In determining the ceiling price under MPR 163, Juilliard over-calculated the manufacturing cost of fabric A-2391, by including twice therein labor and overhead items totalling about thirty-three cents a yard. The evidence as to how the duplication of the labor and overhead charge occurred shows that it could have been prevented in the New York office of Juilliard, when two different sets of figures were reported from its Providence mill. Indeed, the duplication was noted by an employee, Elgin, who called it to the attention of his superior, Mr. Schwarz. By his phone talks to Boyer, the Superintendent of the Providence mill, Mr. Schwarz only increased the possibility of the error finding its way into the ceiling price of fabric A-2391 as reported to the OPA on October 19, 1942. The likelihood of that happening should have been clear to Mr. Schwarz. He was on notice. He should have called the matter to the attention of his assistants who were preparing the OPA reports under Amendment 4 and made certain that they correctly figured the A-2391 ceiling price. This error in the ceiling price of A-2391 was due, at least, to negligence and cannot be excused.
Juilliard also erred in pricing fabric A-2391 on a 'similar' fabric basis, instead of as a 'new' fabric. The base fabric (W-4512) to which Juilliard claimed fabric S-2391 was similar, was not a proper base fabric for A-2391 when the allowable tolerances were applied to W-4512, in determining whether or not A-2391 was a 'similar' fabric. No mention of A-2391 was made in the October 19, 1942 letter accompanying the reports filed with the OPA.
Juilliard's errors in relation to fabric A-2391 were all its own. They were not due to any figures furnished by outsiders as in Jerry Rossman Corporation v. Commissioner or Int. Rev., supra, where the 'finishers' of Rossman's 'greige' goods furnished incorrect figures as to the amount of shrinkage.
Fabric S-2391 received a ceiling price of $ 2.825 per yard for settlement purposes, using the 'new' fabric formula, and the Stottville markup on the corrected manufacturing costs of the fabric. In 1943, after the OPA action had been settled and Juilliard was making a general recanvass of its base period fabrics, Juilliard discovered in April 1943 among its fabrics manufactured in the applicable base period, a fabric known as A-2313. Juilliard alleges that this fabric was, in fact, a fabric to which A-2391 was 'similar', and that the ceiling price of A-2391 should have been computed under the pricing method of 'similar' fabrics after September 8, 1942 (when Amendment 4 to MPR 163 went into effect) using fabric A-2313 is a base fabric. The ceiling price computed on a 'similar' fabric basis for A-2391 using A-2313 as a base fabric would have been $ 2.975, fifteen cents per yard higher than the 'new' fabric price submitted by Juilliard to OPA in negotiating the settlement figure of $ 410,219.31 on OPA's money damage claim. Juilliard argues that if it had been known when the settlement was made, that there was this base fabric A-2313 and that it could be used in computing ceiling price for fabric A-2391, the treble damage amount of the settlement would have been reduced by $ 132,223.62. Juilliard argues that the settlement figure for fabric A-2391 resulted from a 'mutual mistake' of the parties, and caused Juilliard to be held for a higher overcharge than it had actually made; and that 'to the extent of 15 cents a yard on A-2391, Juilliard was not only not guilty of a wilful or negligent violation of the regulation, it was guilty of no violation at all'. A ceiling price for fabric A-2391, using A-2313 as the base fabric, was specifically approved for the year 1943 by the OPA in a letter dated September 28, 1943.
On November 19, 1942 OPA filed its complaint against Juilliard. It contained three claims or causes of action. Injunctive relief was sought under Count I and Count III. Monetary damages of $ 250,000 trebled to $ 750,000, were sought under Count II of the complaint. Issue was joined when Juilliard filed its answer in the form of a general denial on December 29, 1942. Preliminary discussions and negotiations got underway between the legal representatives of both sides. A formal settlement was finally arrived at. It was set forth in three stipulations. One was the basis of a Consent Judgment approved by Judge Mandelbaum and filed with the Court on February 1, 1943, which granted injunctive relief. Originally each stipulation was dated January 29, 1943. However, the date on the stipulation attached to the Consent Judgment was changed to read January 30, 1943. This is of no consequence.
The stipulation attached to the Consent Judgment contained the following 'Whereas' provision: --
'Whereas this case has been settled by separate stipulation of even date, and pursuant to the provisions of that settlement the parties desire to effectuate signature and entry of final judgment herein,
'Plaintiff and defendant hereby stipulate and consent to signature and entry of final judgment herein in the form attached hereto.'
The Consent Judgment, before making provision for the required injunctive relief sought under Count I and Count III of the complaint, contained the following recital: --
'The Administrator of the Office of Price Administration filed his complaint herein November 19, 1942 and the above named defendant appeared and filed its answer to such complaint; the cause of action alleged in Count II of the complaint has been settled by stipulation between the parties dated January 29th, 1943; no testimony having been taken, the defendant consents to the entry of this judgment without any findings of fact on condition that neither such consent nor this judgment shall be evidence, admission or adjudication that it has violated any law of the United States; * * *'
Count II of the complaint was settled by a stipulation (a second stipulation) dated January 29, ...