Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Feb 21, 1945
4 T.C. 806 (U.S.T.C. 1945)

Docket No. 2495.



Forrest S. Single, Esq. for the petitioner. Henry C. Clark, Esq., for the respondent.

Debt determined to be worthless under circumstances where collection could not be successfully enforced against solvent debtors. Forrest S. Single, Esq. for the petitioner. Henry C. Clark, Esq., for the respondent.

This proceeding involves a deficiency in income tax in the amount of $1,938.99 for the taxable year 1940.

The sole issue involved is whether petitioner is entitled to a bad debt deduction amounting to $12,000 under section 23(k)(1) of the Internal Revenue Code.


The petitioner is an individual residing at New York, New York, where he is engaged in the business of printing bank and brokers' stationery. His income tax return for the taxable year 1940 was filed with the collector of internal revenue for the second district of New York.

Between 1927 and 1932 petitioner made a number of loans in an amount aggregating approximately $241,500 to the Hedger Transportation Co., a corporation. The loans were evidenced by promissory notes maturing at different times and carrying interest at the rate of 6 percent per annum. Interest was paid regularly and the various notes were paid as they came due, except as hereinafter set forth. During the years 1929 to 1932, the Hedger Transportation Co. paid bonuses to petitioner aggregating $17,270. These bonuses were paid from time to time as money was loaned to the Hedger Co. by petitioner. The amount of bonus to be paid was arrived at by the parties for the individual loan transaction, but a bonus was not paid on every loan. The bonuses were in addition to interest and were considered as additional consideration for the loan. They were not looked upon in any way as repayments on the principal of the loans and the amounts received as bonus were reported in income by petitioner in his income tax returns for the various years.

On December 31, 1931, the amount owed to petitioner was $21,000. During 1932 petitioner loaned an additional $10,000 and received a repayment of $1,000. The outstanding balance due January 1, 1933, was $30,000. This amount was represented by several promissory notes which were secured by a mortgage on three barges. The petitioner foreclosed on the barges and realized $18,000 from the sale thereof, which amount was applied on the notes, leaving a balance of $12,000 due. In the meantime the Hedger Transportation Co. had gone into bankruptcy. To cover the balance petitioner accepted six promissory notes of $2,000 each, all of which carried interest at the rate of 6 percent per annum. The maturity dates were spaced one month apart, with the first note maturing on December 1, 1933, and the remaining notes maturing on the first day of each succeeding month thereafter for the next five months. These notes were signed by W. E. Hedger, an individual, and bore the endorsement of ‘Eben-Baxter-Harstedt Co., Inc.,‘ by the president and the treasurer of that company, and the endorsements of three individuals, Charles H. Baxter, George W. Harstedt, and S. N. Eden, who were the principal officers of the above corporation. W. E. Hedger had been the principal shareholder and the principal officer of the Hedger Transportation Co. and was an endorser on the corporation's notes. When that company become defunct Hedger personally became the debtor on these new notes.

Each of the notes were presented for payment at maturity and upon the principal debtor's failure to pay they were duly protested. The Eben-Baxter-Harstedt Corporation had gone out of business, but demand was made upon the endorsers in their capacity as individuals. After considerable negotiation it was orally agreed among the parties that the debt should be extended and that new notes should be taken. The three individual endorsers wanted to split up their liability on the notes and it was thus proposed that new notes be taken from Hedger and that petitioner accept supporting notes from the individual endorsers aggregating the total amount due. It was agreed that Hedger would execute six new notes, four in the amount of $1,050 and two in the amount of $3,900, and that the endorsers would in turn execute and deliver to petitioner their supporting notes aggregating the same amount, to be presented for payment approximately two weeks after default on any one of the new Hedger notes. Duly executed notes were obtained from Hedger and were taken by petitioner's accountant to Eben, who retained the notes and told the accountant he would send the notes to petitioner, along with proper supporting notes of the three individual endorsers. The old notes were not surrendered. The first of the new Hedger notes matured April 15, 1934, and the remaining notes were to mature each three months thereafter. Petitioner approached the endorsers a number of times in order to secure repayment of the old notes or to get all of the new notes executed and delivered to him, but each time he was ‘stalled off.‘ A day or two before the first of the Hedger notes matured, the notes, without the supporting notes of the individuals, were sent to petitioner, with instructions to present the due note for payment. When petitioner asked Eben about the supporting notes he was assured that he would get them in the future, but was told to go ahead and present Hedger's note now. Payment of the Hedger note was refused. Thereafter petitioner tried to obtain payment of the debt from the principal obligee and/or the individuals, but was unsuccessful.

Petitioner did not accept the Hedger renewal notes without the supporting notes of the individuals, and when he brought suit on May 25, 1936, in the Supreme Court of the State of New York, the suit was based upon the old endorsed notes, with Hedger, the Eben-Baxter-Harstedt Corporation and Eben, Baxter, and Harstedt, as individuals, all named party defendants. In answer to the complaint the defendant corporation denied that the notes were delivered by Hedger for value and denied it had received notice of demand, refusal, or protest. It alleged that it was an accommodation endorser without consideration moving to it, and that, by petitioner receiving the new notes from Hedger without the knowledge or consent of the endorser, the corporation was relieved of all liability. The corporation affirmatively alleged repayment; usury; that its accommodation endorsement was ultra vires; and that petitioner was carrying on a banking business without a license and by reason thereof the notes were null and void. Hedger denied that he had received any value for the delivery of the notes and affirmatively alleged repayment, usury, and that petitioner was carrying on a banking business without a license. The defenses set up by the individual endorsers were substantially the same as the above. Although the complaint was filed in 1936, the case was not set for trial until May 1940. Just prior to the time that the case was to be heard petitioner was advised by his attorneys that it was unlikely that he could win the pending suit. Accordingly, petitioner authorized his attorneys to withdraw and close the case. The case was dismissed in 1940 ‘with prejudice.‘ The statute of limitations with respect to the original endorsed notes expired not later than May 1, 1939. Accordingly, after the dismissal of the suit further action upon the notes in question would undoubtedly not have been successful in view of the fact that the statute of limitations would have been raised in defense.

Petitioner sought a deduction in his income tax returns for 1936 on the ground that the debt of $12,000 had been ascertained to be worthless, but the deduction was disallowed by the respondent on the ground that petitioner had not exhausted his possibilities of collection.

The principal obligor on the notes had an income of $19,500 in 1939 and over $19,000 in 1940. The individual endorsers of the notes were solvent. In the deficiency notice the respondent determined that the bad debt deduction in the amount of $12,000 claimed by petitioner was not allowable under the provisions of section 23(k)(1) of the Internal Revenue Code.

The debt of $12,000 became worthless in 1940.



The petitioner is seeking a bad debt deduction in the amount of $12,000. The debt is represented by notes that matured in the latter part of 1933 and during 1934, and remained unpaid. Petitioner does not claim that the debtors were unable to pay, but rather that they refused to pay and that the circumstances of the transaction were such that it was highly improbable that he could successfully secure a judgment on the notes. After having instituted a proceeding for that purpose, he was advised by counsel that the pending suit would not likely result in a judgment in his favor and that substantial court costs would likely be incurred if the pending action were litigated. Whereupon the suit was dismissed ‘with prejudice.‘

The respondent takes the view that petitioner, by this action, recognized the merits of the defenses which had been set up against him, was owing to him or that it has now become worthless. The defenses which are urged by the respondent as having that effect are that the transaction was usurious and that the obligation had been extended. Considering the effect of the first of the defenses which had been interposed, it is to be noted that under the laws of the State of New York corporations are expressly prohibited from interposing the defense of usury and the statute so providing has been extended by construction so as to prohibit an accommodation endorser of a corporation's paper from availing himself of that defense. Hubbard v. Tod, 171 U.S. 474, and cases cited therein. The maker of the notes upon which petitioner relies was an endorser of the original corporate obligation and upon an extension of the indebtedness he became the principal obligor. There is no evidence whatsoever that the transaction to which the other individuals became a party by virtue of their endorsements was in any manner usurious. Under the circumstances, it seems to us that the defense of usury by the marker and the endorsers would not warrant a conclusion that the notes were invalid or unenforceable.

With respect to the extension, it is apparent from our findings of fact that the transaction through which the debt was to be renewed was not a completed one. Petitioner insists that it was not his intention to extend the indebtedness unless the notes to be taken from the maker of the endorsed notes were augmented by the supporting notes of the individual endorsers. These individual supporting notes were not forthcoming and petitioner, when it became evidence to him that the supporting notes would not be executed, relied solely upon the endorsed notes, and they were the basis upon which he brought suit. In the circumstances, we think it clear that the notes that are properly the subject of the controversy here are the endorsed notes and that the renewal note which was obtained is of no consequence. The obligation was either renewed or it was not renewed, and petitioner may not now be required to rely upon the later note.

We do not decide the question of whether the dismissal of the suit against Hedger and the endorsers ‘with prejudice‘ serves as a bar to further proceedings. The petitioner makes no such argument on brief. His position is that after the suit was dismissed in 1940 the statute of limitations could successfully be interposed in affirmative defense to any subsequent suit and, in view of the attitude of the debtors, it was evident that they would interpose such defense should further suit be instituted. In these circumstances there was no way open to petitioner to collect the debt.

In summary, it seems to us that the petitioner has established that the sum of $12,000 was owing to him and that this sum became uncollectible in 1940. It was in that year that the suit to collect the debt was dismissed ‘with prejudice‘ under the circumstances set forth in our findings. The statute of limitations would have been a good defense if there were still available to petitioner the right to further pursue the matter, and the course of conduct of the debtors made it clear that they would avail themselves of all technical defenses open to them. The fact that the debtors were financially able to pay was of no moment in the circumstances. The debt became worthless in 1940 and constitutes an allowable deduction.

Decision will be entered for the petitioner.

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