The opinion of the court was delivered by: LEVET
Amended Opinion, Findings of Fact and Conclusions of Law
In this tax refund action, the plaintiff, Audrey L. Zeeman, alleges that, as a limited partner of Ira Haupt & Co., she suffered a loss of $250,000 when that firm was thrown into insolvency in November of 1963 as a result of the notorious salad oil scandal. She seeks to carry back this alleged loss against the tax paid by her and her late husband for the years 1960, 1961 and 1962. The government, in turn, denies that plaintiff is entitled to a deduction, either for a proportionate share of the partnership loss or for the loss of her investment in Haupt. The government further contends that if the plaintiff properly took a deduction in 1963 because of the alleged loss, she may not carry back the loss, as an individual taxpayer, against the tax paid on joint returns filed by the plaintiff and her late husband. The government has also put in issue the accuracy and completeness of the tax return filed by the plaintiff for 1963 and the joint returns filed by the plaintiff and her late husband for the years 1960, 1961 and 1962.
After hearing the testimony of the parties and permitting a reopening of the trial on the application of the plaintiff, examining the exhibits, the pleadings and proposed findings of fact and conclusions of law submitted by counsel, this court filed an opinion on April 14, 1967.
On May 11, 1967, motions made by both sides for further findings of fact and conclusions of law, pursuant to Rule 52(b) of the Federal Rules of Civil Procedure, were argued and the trial was reopened on May 18, 1967 on the application of the plaintiff. The government then moved, pursuant to Rule 15(b) of the Federal Rules of Civil Procedure, to amend its answer so as to include a counterclaim for taxes, timely assessed, but not yet paid for the years 1960, 1961 and 1962. The government's motion was granted on June 23, 1967.
In her reply to the counterclaim, the plaintiff denies the essential allegations of the counterclaim and, in turn, asserts three affirmative defenses and two "counterclaims." The first affirmative defense pleaded the three-year statute of limitations for assessment of additional taxes. At a hearing held on July 3, 1967, to consider evidence on the question of waivers of the statute of limitations, the plaintiff withdrew her second affirmative defense (Tr. 1277). The "Third Affirmative Defense and First Counterclaim" asserts that the assessments are void and illegal in that plaintiff was denied judicial review of the assessments in the Tax Court. Lastly, by the "Second Counterclaim" the plaintiff seeks a refund of taxes paid for 1962 because the joint return was improperly drawn so as to include her late husband's share of income of Ira Haupt & Co. for the year 1962.
Upon hearing the motions for further findings, considering the testimony and the evidence adduced at the reopenings of this trial and considering the amended pleadings, this court makes the following Amended Findings of Fact and Conclusions of Law:
1. Ira Haupt & Co. (hereinafter "Haupt") was a limited partnership during the calendar year 1963. For federal income tax purposes, it reported its income on a cash basis, using the calendar year as its reporting period. (Tr. 731; Exs. 1-4, 56-58)
2. During 1963, Haupt was engaged in a general stock brokerage and commission business in New York City. It had seats on the principal stock and commodity exchanges, including the New York Stock Exchange, the New York Produce Exchange and the Chicago Board of Trade.
3. Haupt was formed as a limited partnership on April 1, 1960, under Article 8 of the Partnership Law of New York, McKinney's Consol.Laws, c. 39, as the successor to a general partnership of the same name. A Certificate of Limited Partnership was filed in the County Clerk's office of New York County on April 21, 1960. The partnership agreement, dated April 1, 1960, and amended from time to time, was in force during the year 1963. (Tr. 24, 26, 27; Ex. 56)
4. The Haupt partnership agreement of April 1, 1960 included the following:
"7. Contract Capital of the Limited Partnership.
"(2) The term 'Contract Capital' shall be deemed to mean cash contributed by the respective partners. The Managing Partners, in their sole discretion, may, however, permit any of the partners to contribute securities in lieu thereof, and complying with the provisions of Article 33 hereof, as part of, or as his entire Contract Capital contribution."
"14. Distribution of Losses.
"(1) The losses of the partnership shall be borne by the General Partners in the following proportions:
(names and proportions omitted)
"(2) The net losses of the Limited Partnership shall be debited at the end of every fiscal year to the respective General Partners.
"(3) The Limited Partners shall not, in any event, be required to bear any share of the losses of the Limited Partnership beyond their respective Contract Capital contributions, or be personally liable for any debts or obligations of the Limited Partnership; the General Partners jointly and severally agree furthermore to make good any deficiency in the Contract Capital contribution of any of the Limited Partners due to losses suffered by the Limited Partnership."
"38. Expense Accounts. Expenses incurred by General Partners in connection with their activities on behalf of the Limited Partnership shall be reimbursed to such extent only as the Managing Partners may from time to time authorize and approve. It is contemplated that the Limited Partnership shall reimburse primarily the out-of-pocket expenses of such General Partners when traveling outside the City of New York, New York, and when entertaining present customers of the Limited Partnership. The General Partners are, however, expected and required to apply a reasonable portion of their salaries and profit participation towards the entertainment of prospective customers and similar promotional and other expenses; the amount of their salaries and profit participation have been, and will be, determined with a view of the necessity of incurring such additional expenses."
5. The plaintiff was admitted, with the approval of the New York Stock Exchange, as a limited partner of Haupt on July 1, 1963, in accordance with the terms of the partnership agreement. She consented to be bound by those terms and agreed to contribute $250,000 as her contract capital. (Exs. 18, 59, 64, 79). On July 1, 1963, the plaintiff transferred to Haupt cash and securities having a value of approximately $251,500. This resulted in an overage, at the time of transfer, of approximately $1,500 in terms of her required contract capital. The cost basis of the cash and securities transferred to Haupt by plaintiff was not less than $251,000. (Tr. 575, 582, 588; Exs. 13, 59).
6. Following the execution on July 1, 1963 of the Certificate of Admission of the plaintiff as a limited partner of Haupt, a Certificate Amending the Certificate of Limited Partnership was circulated among, and signed by, all the general and limited partners except one. One signature was still missing when the firm ceased to operate on November 20, 1963; the execution of the certificate was not completed nor was the certificate filed in the County Clerk's Office of New York County. (Tr. 82-85, 93; Exs. 59, A)
The Haupt-Allied Relationship
7. During 1963, Haupt began a business relationship with Allied Crude Vegetable Oil Refining Corporation (hereinafter "Allied"), under which Haupt made substantial loans to Allied. Haupt also acted as a broker for Allied for the purchase on the New York Produce Exchange and the Chicago Board of Trade of spot and future contracts to buy cottonseed oil and soybean oil.
8. The loans to Allied, hereinafter called "export loans," were provided for in a Letter of Intent exchanged by the parties, under which Haupt agreed to lend from time to time up to $2,500,000 to Allied against actual export orders, secured by warehouse receipts for cottonseed oil or soybean oil issued by American Express Warehousings Ltd., a subsidiary of American Express Co., or Harbor Tank Storage Co. (hereinafter "Harbor Tank"). Harbor Tank operated a tank storage farm at Bayonne, New Jersey, under a lease with Allied.
9. At the outset of the aforesaid business relationship between Haupt and Allied, Haupt asked for and received from Allied a statement of its balance sheet as of a current date. The balance sheet, supplied in May of 1963 by Anthony DeAngelis, President of Allied, had been falsified by him and it reflected exaggerated inventories of cottonseed and soybean oil. (Tr. 389-392, 394, 465-466, 846, 848; Exs. 91, 132)
10. Haupt lent Allied $2,500,000 on May 28, 1963, pursuant to the Letter of Intent, on a demand promissory note, and received as security a warehouse receipt.
11. Although the Letter of Intent was never revised, employees of Haupt successively enlarged these loans to Allied, which ultimately exceeded $13,000,000, each time receiving as collateral additional warehouse receipts and export contracts.
12. In Haupt's role as broker for Allied, Haupt, for the account of Allied, entered into contracts for the purchase of cottonseed oil and soybean oil for future delivery dates on the New York Produce Exchange and the Chicago Board of Trade. Under the rules of these commodities exchanges, a small fraction of the purchase price, called "original margin," was required to be deposited with the clearing house of the exchange. As the market price of the particular futures fluctuated from day to day, additional margin was required to be deposited by the purchaser if the market price dropped below his contract price, called "variation margin." Margin was refunded if the market price rose above the contract price. Under the rules of the commodities exchanges, the broker was required to put his own credit behind the futures contract by assuming liability under the contracts both for margin and the purchase price.
13. Haupt required original and variation margin from Allied for the futures contracts purchased for Allied. Haupt accepted warehouse receipts, purportedly issued by American Express Warehousing and Harbor Tank, as collateral against which Haupt advanced margin for Allied.
14. The volume of oil under futures contracts bought by Haupt for Allied's account rose steadily from May to November 1963 so that by November 18, 1963 the contracts purchased for Allied numbered about 15,000. The drop in the market value of these contracts on November 18 and 19, 1963 equalled $750 per contract. This represented a drop in value for all the contracts of about $11,000,000.
15. The market price had declined on November 14 and 15, 1963 and the decline continued even more precipitously on November 18 and 19, resulting in margin calls upon Haupt of over $5,000,000 on November 15 and an additional $9,000,000 and $4,000,000 on the two succeeding trading days.
16. On November 18, 1963, Allied filed a Petition for an Arrangement under Chapter XI of the Bankruptcy Act, which was dismissed on December 6, 1963. A financial statement filed with the petition, as of July 30, 1963, showed Allied to have a capital deficiency of $30,000,000 as early as July 30, 1963. Allied was adjudicated a bankrupt on December 6, 1963. As of November 19, 1963, the total assets of Allied, as to which there was no dispute, were $7,097,000 and the total liabilities, as to which there was no dispute, were $131,000,000. (Tr. 459; Exs. 37, 95)
17. On November 19, 1963, the New York Produce Exchange forced the liquidation at a fixed price of all Haupt's cottonseed oil futures contracts held for the account of Allied. On November 20, 1963, Haupt liquidated all of its soybean oil futures contracts held for the account of Allied on the Chicago Board of Trade. The loss from these liquidations was $18,193,874, resulting in an indebtedness of Allied to Haupt in that amount. (Tr. 128-131)
18. On November 20, 1963, the New York Stock Exchange suspended Haupt's trading privileges, and shortly thereafter the commodities exchanges also suspended Haupt from trading. (Tr. 48, 240, 243)
19. Within a few days after November 30, 1963, the warehouse receipts held by Haupt, or for its account by banks, were presented to American Express Warehousing for payment in the belief they were valid. At that time, American Express Warehousing rejected the warehouse receipts on the grounds that they were forged. (Tr. 305-306)
20. On November 21, 1963, the total claims against Allied recorded on the books of Haupt, exclusive of trading commissions, were divided among three principal categories:
(1) Export loans made to Allied
between August 15 and No-
vember 4, 1963 $ 10,070,819.25
(2) Futures trading losses charged
to Allied $ 18,193,874.00
(3) Margin advances for Allied's
account, due to original mar-
gin on future trading, made
between October 1 and No-
vember 19, 1963 $ 3,107,629.27
making a total of $ 31,372,322.52
(Tr. 131-132, 192, 193; Exs. 9, 10, 11, 65, 75)
21. On November 25, 1963, creditor banks, the New York Stock Exchange and Haupt entered into an agreement providing for the orderly liquidation of Haupt's business and appointing a liquidator, who was an officer of the New York Stock Exchange. Under the agreement each general partner of Haupt executed a power of attorney on behalf of himself, the partnership and all the general and limited partners, appointing the liquidator as his agent as a member of the partnership for the purpose of liquidating Haupt in an orderly fashion. The liquidator was given wide powers and each partner of Haupt agreed to refrain from doing any act, as a member of Haupt, that he had authorized the liquidator to do on his behalf. (Ex. 62)
22. Each of the export loans and margin advances to Allied outstanding on November 21, 1963 was secured by warehouse receipts, which have not been honored. Those receipts, supposedly issued by American Express Warehousing, were rejected by that concern as outright forgeries. (See Finding 19). The receipts issued by Harbor Tank were fraudulent because they did not reflect actual oil in the tanks. (Tr. 492-494)
23. On December 30, 1963, American Express Warehousing filed a Petition for an Arrangement under Chapter XI of the Bankruptcy Act. In that proceeding, its liabilities were reported at $144,570,781.15 and its assets were reported as $368,683.64. Haupt's claim against American Express Warehousing was $18,461,637.44.
On December 12, 1963, Harbor Tank filed a Petition for Reorganization under Chapter X of the Bankruptcy Act. The liabilities of Harbor Tank as of December 9, 1963 were reported as $1,148,771.29 and its assets were reported as $73,476.29. Haupt's claim was filed for $5,855,012.50. (Tr. 478-479, 303, 312; Exs. 47, 49, 88)
24. At the request of the Haupt liquidator, Peat, Marwick, Mitchell & Co., an accounting firm which had been engaged as auditors of Ira Haupt & Co., prepared a statement of financial condition of Haupt as of November 25, 1963. This firm also submitted an amended statement to the liquidator as of December 31, 1963.
On the statement as of November 25, 1963, the auditors removed the Allied account from the balance sheet and charged it against net worth. The net worth shown on that balance sheet was a deficit of $25,252,419.32. On the statement prepared as of December 31, 1963, the net worth deficit of Haupt was reported at $25,897,423.53.
These statements showed establishment of a $2,000,000 reserve against some of the potential obligations of Haupt, but no attempt was made to assign a value to any causes of action that did or might accrue to Haupt as a result of the debacle.
Both of the said statements were prepared from the books of Haupt, without audit, and the auditors did not express an opinion as to the accuracy of the statements. (Exs. 89, 90)
25. The Haupt partnership tax information return for 1963 reported a loss of $31,846,409.48 for 1963. (Ex. 4)
26. On March 23, 1964 a petition was filed in this court by certain of the limited partners of Haupt, not including the plaintiff, to have Haupt involuntarily adjudicated a bankrupt. On March 30, 1964, a petition was filed in this court by certain of the general partners of Haupt for leave to continue Haupt as a debtor-in-possession under Chapter XI of the Bankruptcy Act. On June 10, 1964, the Referee in Bankruptcy dismissed the Chapter XI proceeding and thereafter, on June 26, 1964, adjudicated Haupt a bankrupt. This decision was affirmed on appeal by the District Court and the Circuit Court of Appeals.
27. I find that Haupt was insolvent on November 20, 1963 at the time of its suspension by the New York Stock Exchange and that its business was beyond any reasonable hope of rehabilitation. (See Findings 16-24)
28. Beginning in 1964, a number of suits and claims were filed by or on behalf of Haupt as a result of the Allied debacle. Haupt filed claims against Allied, Harbor Tank and American Express Warehousing Ltd., all of which are insolvent. Law suits were commenced, either by the trustee or derivatively by some of the limited partners against American Express Co., the parent of American Express Warehousing Ltd., the New York Produce Exchange, the New York Stock Exchange, various insurance companies and the creditor banks. While the total damages demanded exceeded $160,000,000, the damages sought in many cases overlap and involve subrogation rights in various proportions. (Exs. A, Q-W, Y-AA) All of the damages sought were on causes of action which arose in 1963 except for one suit, on the part of the limited partners, for an accounting. The acts in question in this suit began in 1963 and carried over to 1964. (Ex. Q)
29. All of the foregoing suits have been opposed and liability denied by the respective defendants. No recoveries have resulted to Haupt or to any of its partners under any of these suits. I find that these suits did not provide a reasonable enough prospect of recovery of the plaintiff's investment at the end of 1963 to warrant a denial of the deduction of the loss for 1963.
Plaintiff's Causes of Action
30. Plaintiff joined with other limited partners of Haupt in a letter dated November 29, 1963, addressed to the New York Stock Exchange, the creditor banks and others, objecting to breaches of the Limited Partnership Agreement and also objecting to the agreement of November 25, 1963. (Ex. 105)
31. After the limited partners' initial demands for preferential treatment in the Haupt liquidation were rejected, the Stock Exchange and creditor banks proposed to submit to arbitration the question of the amount of overages, if any, of the limited partners and to pay the amount of overages to which the arbitrator found each limited partner entitled. This offer was rejected by the limited partners. (Tr. 697; Ex. 86, pp. 3-4)
32. The limited partners were told on December 18, 1963 by counsel to the committee advising the liquidator under the November 25, 1963 agreement that it was extremely unlikely that the limited partners would be given any consideration ahead of the creditor banks and the Stock Exchange, except with respect to their "overages" as determined by arbitration. (Ex. 87A)
33. On December 23, 1963, the limited partners submitted a proposal which provided that everything over $4,000,000 of the capital contributions of the limited partners be paid as soon as possible; that repayments of $2,000,000 of the contract capital be guaranteed by the Stock Exchange and/or the creditor banks; and that the remaining ...