American Natural Gas Co. v. United States

                    UNITED STATES COURT OF CLAIMS

The issue presented is whether or not plaintiffs are entitled to deduct from their ordinary income the full amount of the loss. ¹

They are entitled to do so, if at all, only by virtue of section 117(j) of the Internal Revenue Code of 1939, as amended by the Revenue Act of 1942. This section reads:

     (j) Gains and losses from involuntary conversion and from the

There can be no doubt that the conversion of the property in question was under compulsion, and we think it was involuntary, but we do not think it comes within the sort of compulsory or involuntary conversions described in the limiting clause, which is enclosed in parentheses. It can only come within that involuntary conversion which is the result of a requisition of property or a condemnation thereof, or the threat or imminence of requisition or condemnation, and we do not think it was the result of either. American's ownership of the property had become unlawful after the passage of the Public Utility Holding Company Act, and, because it was unlawful, it was ordered to dispose of it. Defendant did not take it at all, neither for its own use nor for the use of another, nor did it threaten to do so.

This will become apparent from a reading of the Public Utility Holding Company Act of 1935 (49 Stat. 803), and the circumstances surrounding the sale.

This Act directed the Securities and Exchange Commission to require all utility holding companies to simplify their corporate structure and to eliminate therefrom all holdings which were not necessary or appropriate to the operation of an integrated public utility system. Section 11(a) of the Act required the Commission "to examine the corporate structure of every registered holding company and subsidiary company thereof, the relationships among the companies in the holding-company system of every such company and the character of the interests thereof and the properties owned or controlled thereby to determine the extent to which the corporate structure of such holding-company system and the companies therein may be simplified, unnecessary complexities therein eliminated, voting power fairly and equitably distributed among the holders of securities thereof, and the properties and business thereof confined to those necessary or appropriate to the operations of an integrated public -utility system." ²

Under section 11(b)(1) the Commission was charged with the duty "to require by order, after notice and opportunity for hearing, that each registered holding-company, and each subsidiary company thereof, shall take such action as the Commission shall find necessary to limit the operations of the holding-company system of which such company is a part to a single integrated public-utility system, and to such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated public-utility system; * * *."

Any order made thereunder was made subject to judicial review. Under subsection (c) of section 11 it was required that any order issued should be complied with within one year, subject to the right in the Commission to extend the time. Under subsection (d) of section 11 the Commission was authorized to apply to a court for the enforcement of its orders.

Acting pursuant to the authority therein granted, the Securities and Exchange Commission on March 8, 1940 issued an order for a hearing directed to American and the other holding-companies forming a part of the system. The order recited that its system was not confined to a single integrated public utility system and, accordingly, ordered that hearings be commenced and that the companies be required to file an answer. The companies answered, asserting their right to continue their operations under their present system, but they nevertheless expressed a willingness to cooperate with the Commission, to avoid controversy, and, so, they proposed a plan for the disposition of certain properties of the system, and the grouping of the remaining assets into three geographical areas.

On June 13, 1941, the Commission issued a statement of tentative conclusions holding that the system as then constituted did not meet the standards of integration set out in the Public Utility Holding Company Act of 1935, and that, among other things, American's ownership of stock in the Detroit Edison Company must be disposed of. The Commission directed that the companies show cause why an order should not be entered in conformity therewith. The companies answered, vigorously protesting the Commission's proposed order, but the Commission, notwithstanding, on August 5, 1941, issued its decision directing, among other things, that American dispose of its Detroit Edison Company stock. The order provided that the companies should proceed "with due diligence to comply with the foregoing order, and shall make application to the Commission for the entry of any further orders necessary or appropriate for that purpose." Jurisdiction was retained for the entry of such orders as might seem necessary and appropriate.

The companies submitted their first plan on November 1, 1944, some three years later, and applied for its approval, but this was refused by the Commission on June 2, 1945.

On June 26, 1947, the companies filed another plan, known as Application 31. On September 2, 1947, the Commission delivered its opinion, in which it stated that the plan appeared to be deficient in not providing for prompt compliance with the original order of August 5, 1941. Thereupon, the companies filed an amendment to the plan on September 18, 1947. Hearings on this amended application were ordered.

On October 28, 1947, the companies filed a second amendment to the application, in which it was stated that the Detroit Edison stock would be disposed of by December 31, 1948, and proposed an immediate sale of 450,000 shares thereof. On November 19, 1947, the Commission issued an order in which it authorized the sale of the 450,000 shares of Detroit Edison stock.

Then, on December 30, 1947, the Commission entered an order approving application No. 31, as amended. It directed, among other things, that the Detroit Edison stock be disposed of, 450,000 shares in December 1947, 400,000 shares in May 1948, and 250,000 shares in October 1948, the balance to be distributed to the stockholders as dividends. In the meantime American had received a stock dividend from Detroit Edison of 128,920 1/2 shares; the Commission ordered that these shares be disposed of in conformity with its order of August 5, 1941.

American sold 450,000 shares of the Detroit Edison stock in January 1948 at a price of $ 19.06 a share; in April 1948 it sold another 450,000 shares at a price of $ 19.73 a share; in August 1948 it sold 190,000 shares at a price of $ 20.01 a share; and in November 1948 it sold 192,734 shares at a price of $ 19.546 a share. The balance of the stock was distributed to its stockholders.

Plaintiffs say these sales were involuntary conversions which resulted from "an exercise of the power of requisition or condemnation or the threat or imminence thereof," as these words are used in section 117(j), supra. Plaintiffs concede that in order to receive the tax benefits of section 117(j), a compulsory or involuntary conversion must be one which results from one of those things mentioned in the parenthetical clause of that section, in this case, requisition or condemnation or the threat thereof; but they argue, first, that the order of divestment issued by the Securities and Exchange Commission was an exercise of the power of requisition or condemnation; or, in the alternative, they say, since the Act empowered the Commission to apply to a court to appoint a receiver to take over the assets of the company and enforce the order, that the order amounted to a threat to requisition or condemn the property.

We cannot agree. The order of the Securities and Exchange Commission was neither a requisition nor a condemnation, nor the threat of either. It was nothing more than an order by the Commission for plaintiffs to dispose of property the possession of which by plaintiffs was prohibited by the Public Utility Holding Company Act. It was an order for plaintiffs to comply with the law. The Act required that "the properties and business thereof [of a public utility system] be confined to those necessary or appropriate to the operations of an integrated public utility system"; the Commission thought that American's ownership of the Detroit Edison Company stock was not necessary for this purpose; and, so, it required American to dispose of that the possession of which by it was no longer lawful.

By no means can this be considered an exercise of the power of eminent domain. The United States did not take the property; it did not take it for public use or for any use at all. On the contrary, in ordering the sale of the stock, Congress was exercising, through the Securities and Exchange Commission, its constitutional power to regulate interstate commerce. The Supreme Court has held that the Public Utility Holding Company Act of 1935, which authorized such an order, was a valid exercise of such power. American Power & Light Co. v. Securities and Exchange Commission, 329 U.S. 90; North American Co. v. Securities and Exchange Commission, 327 U.S. 686; Electric Bond & Share Co. v. Securities and Exchange Commission, 303 U.S. 419.

The purpose of the Act was to eliminate the evils then existing in public utility holding companies, and to protect the public from the abuses inherent in them as they were then constituted. It was an Act to promote the public welfare. It was no part of its purpose to condemn or to requisition the companies' property. The Supreme Court, in North American Company v. Securities and Exchange Commission, supra, said that "Congress enacted the Public Utility Holding Company Act of 1935, 49 Stat. 803, in order to correct grave abuses which it had found in the use of the holding company device in the nation's electric and gas utilities industries." It further said at pp. 705-6:

     This broad commerce clause does not operate so as to render the

     * * * there is no basis here for assuming that in limiting the

The Public Utility Holding Company Act does not differ in principle from many other statutes that prohibit the possession of things which the legislative authority considers inimical to the public welfare; for instance, narcotics, whisky, firearms, property that is unsafe or unsanitary, or otherwise a nuisance, etc.

In Mugler v. Kansas, 123 U.S. 623, it was argued that a Kansas prohibition statute constituted a taking of private property without just compensation, as required by the due process clause of the 14th Amendment. The Court, at pages 668-9, said:

     As already stated, the present case must be governed by

Plaintiffs say that the term "requisition or condemnation" as used in the Act means something more than the exercise of the power of eminent domain. We do not think it does. It seems clear to us that the words mean the taking or the threat of taking property by some public or quasi-public corporation -- by some instrumentality that has the power to do so against the will of the owner, and for the use of the taker. That is the common, well-recognized meaning of those words and there is nothing to indicate that Congress used them in any other sense. Plaintiffs were required to dispose of their property, but the United States did not take it, nor did it prevent plaintiffs from getting for it its full market value at the time of the taking.

Section 112(f) of the Internal Revenue Code of 1939 uses the same words as those with which we are concerned. Such a provision first appeared in the Revenue Act of 1921. They were used to take care of situations resulting from the sinking of ships by submarines or their requisition by the Government for its use, as is shown by the letter of the Secretary of the Treasury to the Committee on Ways and Means when the Revenue Act of 1918 was under consideration. It read, in part:

     During the war, in the case of property requisitioned for war

The Tax Court so understood these words in 112(f). See Dear Publication & Radio, Inc. v. Commissioner, 31 T.C. 1168. In a previous case, in Credit and Investment Corp. v. Commissioner, 47 B.T.A. 673, it also had so construed the words.

In the Dear Publication & Radio case there was involved a New Jersey statute which required the dissolution of a corporation in case of a deadlock among the management. In order to prevent this dissolution, the taxpayer sold his stock in the corporation. He claimed that this was an involuntary conversion through requisition or condemnation or the threat thereof within the meaning of 112(f). The Court of Appeals for the Third Circuit affirmed the Tax Court, holding that a sale under such conditions was not an involuntary conversion "under threat or imminence of requisition or condemnation." Dear Publication & Radio, Inc. v. Commissioner, 274 F. 2d 656.

Plaintiffs say that the threat to resort to court for the appointment of a receiver, in case of failure to comply with the Commission's order, was a threat to requisition its property; but, manifestly, this is not so. The purpose of the appointment of a receiver was to force compliance with the Commission's order, not to take the property for public use. The order was issued to carry out the mandate of an Act passed pursuant to the power of Congress to regulate commerce, not under the power of eminent domain. Once the order was complied with and assurances given of future compliance, the property, or the amount received from a sale of any part of it, would be returned to its owner. No part of it was or would be taken for public use. None of it was requisitioned or condemned.

It results that plaintiffs' petition must be dismissed.

It is so ordered.

FINDINGS OF FACT ¹

The court, having considered the evidence, the report of Trial Commissioner W. Ney Evans, and the briefs and argument of counsel, makes findings of fact as follows:

1. Plaintiff American Natural Gas Company (hereinafter referred to as "American") is a New Jersey corporation. Prior to June 15, 1949, its name was American Light & Traction Company. For each of the calendar years 1944 and 1945, American, along with a group of affiliated corporations, filed consolidated Federal excess profits tax returns, and for each of the years 1944 to 1948, inclusive, filed consolidated Federal income tax returns, and paid the taxes therein shown to be due. The affiliated group consisted of the named plaintiffs in this action and two other corporations which have since been dissolved.

2. Onand prior to August 5, 1941, American was a subsidiary company of The United Light and Railways Company (hereinafter referred to as "Railways") and of United American Company, both of which corporations were, in turn, subsidiary companies of The United Light and Power Company (hereinafter referred to as "Power") as the term subsidiary company is defined in section 2(a)(8) of the Public Utility Holding Company Act of 1935 (hereinafter referred to as the "act"), title 15 U.S.C. Section 79 et seq. American was itself a holding company and owned controlling interests in a number of public utility companies, as the terms public utility company and holding company are defined in sections 2(a)(5) and 2(a) (7) of the act. American also had substantial stock interests in other companies. In 1937 and 1938, American, Railways, United American Company and Power all registered as holding companies under section 5 of the act. All such holding companies and their subsidiary companies were members of The United Light and Power Company holding company system, as that term is defined in section 2(a)(9) of the act.

3. On and prior to August 5, 1941, American was the owner of 1,289,205 shares of the common stock of The Detroit Edison Company (hereinafter referred to as "Detroit Edison"), comprising approximately 20.3 percent of the common stock of that company.

4. On March 8, 1940, the United States Securities and Exchange Commission (hereinafter referred to as the "Commission") commenced proceedings against Power and the other members of its holding company system, including American, to determine what action such companies should be required to take to limit the operations of the holding company systems of each of the respondent registered holding companies to a single integrated public utility system, as required by section 11(b)(1) of the act. ² The Commission's Notice and Order for Hearing alleged in part that:

     55. The holding-company system of said The United Light and Power

5. On or about May 2, 1940, Power and its subsidiaries, including American, filed a joint Answer to the Commission's Notice and Order for Hearing, alleging that the Power holding company system satisfied the requirements of section 11(b)(1) and that:

     Each of the answering respondents which is a registered holding

     It is contemplated that the investment of the holding company

     In addition to its subsidiaries, American Light & Traction

     (b) The elimination from the holding company system of American

     7. The proposed requirement of Paragraph (b) of the order of June

     Applying the interpretation of the law as set forth in the

     It is hereby ordered, pursuant to Section 11(b)(1) of the Public

10. By an Amended Application filed December 22, 1944, American made the following statement:

     Consummation of the foregoing transactions is not a condition

     f. That the Detroit Edison stock owned by American Light may not

     In addition, I wish to point out that the Commission gives your

     The latter part of the Commission's first tentative conclusion

     It should not have come as a surprise to the management at this

     The Amended Plan required American Light to sell for cash such

16. In February of 1947, prior to disposal by American of its Detroit Edison stock, Detroit Edison declared its intention to declare and pay a common stock dividend of 10 percent on its outstanding shares of common stock. American accordingly filed an application, designated Application No. 30, for authority to receive an additional 128,920 1/2 shares of Detroit Edison common stock, representing and agreeing that such additional shares would be held subject to the provisions of the Commission's Order of August 5, 1941. By order of March 20, 1947, the Commission approved American's receipt of such additional shares of Detroit Edison common stock subject to the condition that they should be held subject to the terms of the Order of August 5, 1941. Upon distribution by Detroit Edison of the stock dividend on May 1, 1947, the total number of shares of Detroit Edison common stock held by American was increased to 1,418,125 1/2 shares.

17. Subsequently, on June 26, 1947, American and Railways filed with the Commission, in substitution for Application No. 21, a new application designated Application No. 31. Application No. 31 recited the fact that, on November 30, 1946, the Federal Power Commission had issued a certificate of public convenience and necessity authorizing Michigan Wisconsin Pipe Line Company, a subsidiary of American, to construct its proposed natural gas pipeline from Texas to Michigan and Wisconsin. Application No. 31 therefore proposed that American should continue in existence as a registered holding company owning an integrated gas utility system. Application No. 31 further proposed that:

     2. When the plan is approved, American Light will discontinue the

     Under the provisions of the plan submitted in Application No. 31,

19. On September 18, 1947, American and Railways filed a First Amendment to Application No. 31, which added the following provision to the Plan, among others:

     11. Notwithstanding any other provision of the Plan:

     The justification offered for postponing the divestment of

     2. During the year 1948, American Light will discontinue the

     The second proposal is to sell promptly 450,000 shares of Detroit

     Further ordered that American Light & Traction Company be and

     In 1941 Railways was ordered to dispose of its interest in

     It is further ordered and recited that the steps and transactions

25. On January 6, 1948, following the opening of bids, American filed with the Commission its Amendment to Application in Response to Commission's Order of November 19, 1947, in which, after reciting the amounts of the bids received and the proposed application of the proceeds to American, the following statement appears:

     Inasmuch as both the sale of the 450,000 shares of Capital Stock

     It is further ordered that the following transactions are

26. Acting in compliance with the Commission's Order of August 5, 1941, and the Order of December 30, 1947, American carried out the following transactions:

(a) On March 25, 1948, American filed with the Commission an "Application in Response to Commission's Order of December 30, 1947," requesting approval of the sale by American of 450,000 shares of Detroit Edison stock at competitive bidding and also requesting authority to purchase such number of shares of Detroit Edison stock as might be necessary to stabilize the price of such stock. On April 7, 1948, American filed its "First Amendment to Application in Response to Commission's Order of December 30, 1947." This amendment stated:

     American Light contemplates that the proceeds of the sale of

(b) On June 28, 1948, American filed with the Commission Application No. 2 in Response to the Commission's Order of December 30, 1947, requesting approval of the sale by American of 190,000 shares of Detroit Edison common stock at competitive bidding and also requesting authority to purchase such shares of Detroit Edison stock as might be necessary to stabilize the price of such stock. On August 5, 1948, the Commission issued its order approving said application. On August 11, 1948, following the opening of bids, American filed its Third Amendment to Application Number 2 in Response to Commission's Order of December 30, 1947. On the same date, the Commission issued its Supplemental Order Pursuant to Rule U-50 approving said sale. Thereafter, on August 13, 1948, American sold 190,000 shares of Detroit Edison common stock to the high bidder, Blyth & Co., at a price of $ 20.01 per share, making a total consideration of $ 3,801,900.

(c) On October 26, 1948, American filed with the Commission Application Number 4 in Response to Commission's Order of December 30, 1947, requesting approval of the sale by American of 192,734 shares of Detroit Edison common stock at competitive bidding and also requesting authority to purchase such shares of Detroit Edison stock as might be necessary to stabilize the price of such stock. On November 9, 1948, the Commission issued its order approving said application. On November 16, 1948, following the opening of bids, American filed its Third Amendment to Application Number 4 in Response to Commission's Order of December 30, 1947. On the same date, the Commission issued its Supplemental Order Pursuant to Rule U-50 approving said sale. Thereafter, on November 18, 1948, American sold 192,734 shares of Detroit Edison common stock to Blyth & Co., the high bidder, at a price of $ 19.546 per share, making a total consideration of $ 3,767,178.76.

(d) On December 30, 1948, American sold its remaining one-half share of Detroit Edison common stock for $ 8.52 and on December 10, 1948, sold certain stock rights acquired on November 10, 1948, for $ 3.64.

(e) During the year 1948, American distributed to its common stockholders, in lieu of cash dividends, a total of 137,091 shares of the common stock of Detroit Edison. Such dividends were paid quarterly on the basis of one share of Detroit Edison common stock for each 75 shares of American common stock. Cash distributions were made in lieu of distribution of fractional shares of Detroit Edison common stock.The distribution dates and number of shares of Detroit Edison stock distributed were as follows:

                          Shares

27. American's gross proceeds from the sale of its 1,282,734 1/2 shares of Detroit Edison common stock and rights were $ 25,024,590.92. American's expenses in connection with said sales totaled $ 128,498.57, making its net proceeds therefrom $ 24,896,092.35. Of the 192,734 shares of Detroit Edison common stock sold by American on November 18, 1948, 300 shares, for which American received $ 5,863.80, had been acquired as stabilizing purchases on August 12, 1948, pursuant to an order of the Commission authorizing such purchases as an aid to the public marketing of the offered shares. The stabilizing shares had thus been held by American for a period of less than 6 months at the time of sale. Accordingly, American's net proceeds from sales of Detroit Edison common stock held for more than 6 months totaled $ 24,890,228.55.

28. For the years 1944-1948, inclusive, plaintiffs paid Federal income and excess profits taxes in the following net amounts, including interest:

    Year    Excess profits tax      Income tax

30. On the same date, March 14, 1952, American also filed claims for refund of income taxes for the calendar years 1946 and 1947 and for refund of excess profits taxes for the years 1944 and 1945 resulting from adjustments to the consolidated net income of the affiliated group for other taxable years. All such claims for refund were denied by the District Director of Internal Revenue on September 17, 1954, to the extent that the claims for refund related to the claims made herein.

31. At the request of counsel for American and Railways, the Bureau of Internal Revenue, under date of March 4, 1949, issued a ruling holding that, in accordance with the provisions of section 371(c) of the Internal Revenue Code, no gain would be recognized to the common stockholders of American as a result of the receipt by them of shares of common stock of Detroit Edison distributed by American during 1948. The above ruling also stated as follows:

     The cash distributed in lieu of fractional shares of American,

No finding is made on the basis for the Detroit Edison stock, based upon the identification (or tracing) method of valuing it, since no such claim was made in the claim for refund.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiffs are not entitled to recover and their petition is therefore dismissed.

² An integrated public utility system was defined as one which "may be economically operated as a single interconnected and coordinated system confined in its operations to a single area or region, in one or more States, not so large as to impair * * * the advantages of localized management, efficient operation, and the effectiveness of regulation; * * *."

² This proceeding was identified as File No. 59-11. The Notice and Order for Hearing is in evidence as Exhibit 1. On December 6, 1940, proceedings under section 11(b)(2) were instituted by the Commission, under File No. 59-17. The Notice and Order for Hearing is in evidence as Exhibit 3. Subsequently, the proceedings in Files Nos. 59-11 and 59-17 were consolidated.

³ American expressly agreed that shares of Detroit Edison stock purchased for stabilization purposes would be held subject to the outstanding orders of the Commission and the provisions of Application No. 31, in the same manner as shares of such stock were then held.