DocketNumber： Docket No. 4856-78.
Filed Date： 2/18/1981
Status： Non-Precedential
Modified Date： 11/21/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
TANNENWALD,
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly. The stipulation of facts, with accompanying exhibits, is incorporated herein.
Petitioners, Numa Co., Ltd., and subsidiaries, including Halbert's, Inc. (hereinafter collectively referred to as petitioner), are corporations incorporated under the laws of the State of Ohio, with their principal places of business in Akron, Ohio, at the time of the filing of the petition herein. Consolidated income tax returns were filed for each of the taxable periods involved with the Cincinnati Service Center, Cincinnati, Ohio.
Halbert's, Inc. (hereinafter sometimes*683 the corporation) was organized under the laws of the State of Ohio on January 2, 1970. The original shareholders of Halbert's were Gary C. Halbert (Halbert) and Dennis B. Halinger (Haslinger).
Halbert and Haslinger had originally formed a partnership, H & H Sales, in the late fall of 1968, for the purpose of developing a direct mail sales catalog. During 1969, Halbertdeveloped various ideas for the catalog, and the partnership determined to go into business selling genealogical and heraldic products by mail. The partners thereupon formed the corporation Halbert's, Inc., for the purpose of engaging in that business. Halbert and Haslinger each received 10 shares of the corporation's common stock, which constituted 50 percent of the corporation's issued and outstanding stock. Haslinger became president and treasurer of the corporation. Halbert became vice-president and secretary.
The primary product developed by the corporation was the surname research report which was a one or two page account of the origin and history of a particular surname, accompanied by a reproduction of the earliest or the most prominent coat of arms (if any) associated with that name. The corporation*684 marketed its surname research reports in the following manner. First, it contracted with the Reuben H. Donnelley Corporation (Donnelley), which possessed a list of more than 70 million names of American motorists arranged by zip code (Donnelley list), to rearrange that list by alphabetical order of surnames. Then, it selected individual surnames and mailed solicitation letters to persons on the list with those surnames. The solicitation letter offered to sell the surname research report for the recipient's surname at a price which was originally set at $ 1 and later at $ 2.
On the basis of response to the original (or follow-up) letters, the corporation compiled a new list of people who had purchased surname research reports, and that list was used to solicit orders for more expensive genealogical or heraldic products, particularly $ 20 plaques decorated with coats of arms. The lists of names of persons who had purchased surname research reports came to be known as the Nancy L. Halbert File (Halbert file). The Halbert file eventually grew to include approximately 6 million names; in the process of developing it, the corporation mailed approximately 140 million pieces of mail to*685 names on the original Donnelley list. As of October, 1971, the Halbert file was approximately 10 percent developed, and was the result of about 7 million solicitation letters mailed to names on the Donnelley list.
Sales during the corporation's first full fiscal year, ended June 30, 1971, exceeded $ 3 million; net income in that year was $ 331,650 and retained earnings as of June 30, 1971, were $ 338,583, up from $ 6,933 as of July 1, 1970. Paid in capital reflected on Halbert's, Inc., balance sheet amounted to only $ 3,603. Sometime after June 30, 1972, and before October 6, 1972, the audit firm of Haskins & Sells succeeded J. K. Lasser and Co., which previously had done the auditing for the taxable year ended June 30, 1971. Haskins & Sells restated the income for Halbert's Inc., for the taxable year ended June 30, 1971, as $ 165,650, on management's recommendation, by setting up a reserve for income taxes otherwise due in the amount of $ 166,000, but not payable by reason of a net loss of a subsidiary, G.O.A., Inc., through its oil and gas well operations. The restated taxable income of Halbert's, Inc., from its operations before that loss of G.O.A., Inc., and before provisions*686 for income tax was $ 416,739 for its taxable year ended June 30, 1971. For the year ended June 30, 1972, the restated taxable income of Halbert's, Inc., from its operations before provision for a net loss of G.O.A., Inc., and before provision for income tax attributable to the covenant not to compete (here in issue) amounted to $ 903,667. *687 at an agreed price per share; similarly, provisions were made for repurchase of a deceased shareholder's stock from his estate. The agreed repurchase price per share was to be set by collateral agreement, and revised periodically. By addendum to the agreement of February 1, 1970, the agreed valuation for each of the corporation's issued 20 shares was set at $ 20,000. The agreement did not contain a covenant not to compete.
Halbert's Inc., in January, 1971, brought in William L. Miller (Miller), a corporate executive from another corporation, to be vice-president and general manager.
On April 26, 1971, Halbert's, Inc., declared a stock dividend of 9 shares of its authorized and unissued stock for each share then outstanding so that Haslinger and Halbert each wound up with a total of 100 shares of the corporation's stock.
On April 27, 1971, Halbert, Haslinger, and Miller entered into an agreement of sale whereby Halbert and Haslinger each sold Miller two shares of his stock in Halbert's, Inc., for $ 2,000 per share so that upon consummation of such sale to Miller the outstanding capital stock of the corporation was owned as follows:
| Shareholder | No. of Shares | Percent |
| Haslinger | 98 | 49 |
| Halbert | 98 | 49 |
| Miller | 4 | 2 |
*688 The agreement of sale contained a waiver of the restrictions imposed by the stock purchase agreement, dated February 1, 1970, to which the corporation agreed.
The price of $ 2,000 per share for such sale to Miller was set by adjusting the agreed valuation per share under the February 1970 stock purchase agreement adjusted for the 9 for 1 stock dividend.
Also, on April 27, 1971, Halbert, Haslinger, Miller, and Halbert's, Inc., entered into a modification of the stock purchase agreement of February 1970, whereby Miller agreed to be bound by its terms. Again, there was no provision for a covenant not to compete.
On June 21, 1971, the shareholders of the corporation (Halbert, Haslinger, and Miller) and the corporation entered into a Statement of Stock Valuation and Purchase Price, which placed a value of $4,500 per share on the 200 outstanding shares of the corporation's stock.
Miller, by a letter dated June 22, 1971, to Halbert, offered to purchase all of Halbert's stock in the corporation for $ 750,000 cash, contingent upon arranging financing. Miller's offer did not contain or refer to any covenant not to compete by Halbert. The amount of his offer was the least amount*689 that Halbert would take for his stock ownership. The parties to the stock purchase agreement executed an appropriate waiver of its restrictions for the purposes of the prospective purchase and sale.
Miller did not purchase Halbert's stock in the corporation because he was unable to obtain the financing, and the sales agreement, therefore, lapsed in accordance with its terms.
On or about October 8, 1971, the shareholders and the corporation resolved inter alia to enter into a written agreement whereby the corporation would purchase all of the shares of the corporation's stock owned by Halbert. Said resolution was made and adopted in corporate minutes and, pursuant to such resolution, a written contract for the sale and purchase of Halbert's stock in the corporation was entered into by and between the corporation and Halbert on or about October 8, 1971. Concurrently with the execution and the delivery of the contract, Halbert, Haslinger, and Miller, as shareholders of the corporation, and the corporation executed a written consent to said stock sale by Halbert.
The aforesaid resolution specifically provided in part --
that the Corporation purchase from Gary C. Halbert the*690 98 shares of without par value, common stock owned by him of the Corporation for the total purchase price of $ 750,000.00, the sum of $ 150,000.00 to be paid in cash and the balance by the issuance and delivery of the Corporation's Subordinated Debenture in the sum of $ 600,000.00, all as set forth in the certain Agreement between the Corporation, Gary C. Halbert and Nancy O. Halbert, a copy whereof being attached hereto and marked Exhibit "B" and hereby made a part hereof * * *.
The pertinent provisions of the October 8, 1971, agreement were as follows:
1.
2.
6.
7.
8.
9.
10.
The transaction was closed with $ 150,000 being paid to Halbert and the Subordinated Debenture of Halbert's Inc., delivered to him. Concurrently with the closing*697 of the contract of sale, Halbert resigned as an officer and director of the corporation.
Halbert was approximately 33 years of age when he sold his interest in the corporation.
Both Halbert and the corporation were represented by their respective attorneys in negotiating, drafting and executing the October 8, 1971, contract for the sale of Halbert's stock. Specifically, both Halbert and the corporation had been advised of the tax consequences of an allocation of a portion of the consideration of the October 8, 1971, contract to a covenant not to compete with the corporation.
The first draft of the October 8, 1971, contract or agreement, as prepared by the corporation's attorney, contained a broad covenant not to compete, which subsequently was made narrower at Halbert's request to limit such clause to the area of genealogical and heraldic products in surname research reports.
Halbert was not aware, or made aware, during the negotiations that Halbert's, Inc., proposed to allocate on its books part of the $750,000 to the covenant not to compete.
Halbert personally did not regard the covenant not to compete as an important part of the contract of October 8, 1971. In fact, *698 Halbertdid not intend to compete with the corporation, and Haslinger as president of Halbert's, Inc., knew that Halbert planned to go into book publishing.
Halbert's understanding was that the purchase from him by the corporation was a straight stock sale, without any allocation to the covenant not to compete. He would not have signed the October 8, 1971, contract if in fact any part of the $ 750,000 purchase price for his stock had been allocated in the contract to the covenant not to compete.
Neither the October 8, 1971, contract nor the note executed by the corporation to Halbert were contingent upon Halbert's performance in respect to the covenant not to compete in the October 8, 1971, contract.
Halbert reported the $ 150,000 cash payment received in 1971 and the $ 100,000 in payment of principal, plus interest on the debenture, received in 1962 and 1973 in their entirety as gain from the sale of a capital asset, i.g., the stock in Halbert's, Inc. The corporation deducted annual amortization on a six-year basis for the sum of $ 309,000 as allocated by the corporation on its books and records to the covenant not to compete.
OPINION
The issue in this case is whether petitioner's*699 allocation of $ 309,000 *700 not carried either burden and that respondent should prevail.
*701 We see no need to engage in a detailed discussion of the various legal principles which have been judicially developed over the years as guidelines for decisions in cases such as this. See, e.g., ; . We think the sufficient to set forth the various factual elements which have led us to the conclusion we have reached. We do think it appropriate, however, for us to note that the very transaction involved herein has already been considered by this Court. See , wherein we held that there should be no allocation to covenant not to compete. In so noting our prior decision, we hasten to acknowledge that it is not binding upon us in this case where we have a different record upon which our conclusion must rest, , is applicable herein.
*702 The main thrust of petitioner's argument is that the fair market value of Halbert's stock was $ 4,500 per share (or an aggregate of $ 441,000) established by agreement of the shareholders of the corporation on June 21, 1971, and that the excess of the purchase price over that value ($ 309,000) can and should be determined to be the value of the covenant not to compte. Assuming
We recognize that there is some indication in the record that the corporation took steps to attempt to hold Halbert to the covenant not to compete, but such efforts merely show that the corporation considered that it had an enforceable obligation. It is not determinative of the issue as to whether an allocation of a part of the consideration paid to Halbert should be made to the covenant. Similar reasoning disposes of petitioners' contention that merely because Halbert was willing to be bound by the covenant, it follows that it had economic realty and therefore a value should be assigned*706 to it.
Similarly, we think that the indications in the record that the bank, which provided the financing for the initial $ 150,000 payment, required a covenant not to compete should be accorded little, if any, weight. Not only was the testimony in this regard uncorroborated, but it seems to us that any concern of the bank would merely go to the need for an enforceable covenant and have no significant relevance to the question of whether a portion of the purchase price should be allocated thereto.
The long and the short of this case is that both in terms of "intent" and "economic reality" (see petitioners have failed to carry their burden.
1. The consolidated return for the taxable year ended June 30, 1972, showed a taxable income for Halbert's Inc., of $ 1,213,344.↩
2. This figure was arrived at by valuing the stock in accordance with the shareholders' valuation of$ 4,500 per share for 98 shares (or $ 441,000) and allocating the balance of the $ 750,000 purchase price to the covenant.↩
3. The decided cases are unclear as to the proper standard of proof in cases such as this, where is an express covenant not to compete but no allocation has been made to it in the agreement between the parties; the applicable test sometimes turns on whether the issue is the intent of the parties or the "economic reality" of the covenant (see discussion of the two-pronged rationale utilized by the courts in or whether it is petitioner or respondent who is attacking the lack of allocation in the agreement. Compare ; ; ; ; ; . The respondent herein does not seek to apply the rule of , which has not been accepted by this Court. See , on appeal (5th Cir., Oct. 3, 1979).↩
4. Compare , with . See also .↩
5. See note 1
6. We also note that the record indicates that when Miller severed his relationship in 1975, there not only was a covenant not to compete but there was a specific allocation thereto.↩
7. ; ; ; ; , affd. ; ; . We note that in