West Los Angeles Institute for Cancer Research v. Mayer

¶4BROWNING, Circuit Judge:

¶5In August 1951, Ward Mayer and his wife and son — who, with D. F. Kinder, were the stockholders of Timber Structures, Inc. — contracted to sell the business to the West Los Angeles Institute for Cancer Research, a tax-exempt entity. The transaction was patterned after the sale and leaseback agreements described in the opinions in Commissioner of Internal Revenue v. Brown, 380 U.S. 563, 85 S.Ct. 1162, 14 L.Ed.2d 75 (1965) and 325 F.2d 313 (9th Cir. 1963). In March 1960, the Mayers1 brought this action to recover the property. The district court granted the relief sought, and we affirm, on the ground that the sale and leaseback arrangement was frustrated by Revenue Ruling 54-420, 1954-2 Cum.Bull. 128, issued in September 1954, which rejected the tax premises upon which the transaction was based.

¶6Under the plan, the Mayers sold the stock in Timber Structures to the Institute for $2,500,000 — $10,000 down, the *223balance payable under the following arrangement. It was agreed that the Institute would lease the business to a newly-formed operating company for a five-year period; that the operating company would pay 80 per cent of the operating profits to the Institute as rent; and that the Institute would return 90 per cent of the rentals to the Mayers in payment of the purchase price of the property. To make these payments possible, it was contemplated that the operating company would deduct the rental payments as a business expense and that the Institute, because of its tax-exempt status, would pay no tax on these receipts. It was contemplated that the Mayers would pay tax on the amounts which they received from the Institute at capital gain rates.

¶7However, in Revenue Ruling 54-420 the Commissioner took the position that in transactions of this type the operating company’s rental payments would be taxable to the purchasing entity as unexempt income, and payments to the selling stockholders would not be entitled to capital gains treatment. In October, 1954, when the Mayers had received approximately $350,000 of the $2,500,000 purchase price, they and the Institute were informed by the Internal Revenue Service that the ruling applied to their transaction. The district court found that this “completely frustrated the carrying out of the transaction. The tax consequences which were denied by this ruling were the keystone of the plan, without which it was wholly unfeasible and would never have been seriously considered by the selling stockholders.”

¶8Viewed as of the time of the Revenue Ruling,8 the finding seems unassailable. The Revenue Ruling did not specifically state whether the rental payments could be treated as a business deduction to the operating company, but the rationale of the ruling strongly suggested that they could not, and instead must be treated as taxable income to the operating company. This, of course, would make it impossible for the operating company to make the contemplated payments to the Institute. In any event, since the Revenue Ruling made it clear that the payments would be taxable income to the Institute, the Institute would be unable to make the contemplated pay-out to the Mayer group. It was also evident that even if the Institute were able to pay the".Mayers, completion of the transaction would be calamitous to the Mayers since the ruling denied them the anticipated benefit of capital gain treatment of these receipts.

¶9There was abundant evidence that the parties recognized that application of the ruling to their transaction rendered performance impossible. The parties agreed that no further payments under the contracts would be made, and the Institute did not renew the operating company’s original five-year lease. The Institute sought to have the ruling revoked or to exempt their transaction from its application. When these efforts failed the parties undertook negotiations looking toward rescission of the transaction, and reached an informal agreement for the return of the properties to the Mayers, subject to approval of the plan by the Internal Revenue Service.23

¶10We agree with the district-court that the circumstances would seem appropriate for application of the doctrine of “commercial frustration” or “supervening impossibility of performance,” which, as stated by the Oregon Supreme Court, “reads into” contracts “an implied condition that the promisor shall be absolved from performance if, through a supervening circumstance for which neither party is responsible, a thing, event or condition which was essential so that the performance would yield to the promisor the result which the parties intended him to receive, fails.” Dorsey v. Oregon Motor Stages, 183 Or. 494, 194 P.2d 967,. 971 (1948). See also Cabell v. Federal Land Bank, 173 Or. 11, 144 P.2d 297, 302 (1943). Compare Eggen v. Wetterborg, *224193 Or. 145, 237 P.2d 970 (1951); Strong v. Moore, 105 Or. 12, 207 P. 179, 183 (1922); and Elmore v. Stephens-Russell Co., 88 Or. 509, 171 P. 763 (1918). But see Crane v. School Dist. No. 14, 95 Or. 644, 188 P. 712 (1920).4

¶11The Institute argues that rescission of the contract on this ground would be improper for a number of reasons.

¶12First. The Institute contends that performance of the contract is not in fact impossible, because Revenue Ruling 54-420 was rejected in a number of subsequent court decisions which allowed operating companies to treat the rental payments as a business expense,5 and which allowed purchasing entities to claim their exemption;6 because in April 1961, after this action was commenced, the Institute offered to pay the agreed-upon purchase price in full out of funds other than rental payments from the operating company; and because in April 1965, the Supreme Court in Commissioner of Internal Revenue v. Brown, supra, 380 U.S. at 570-573, 85 S.Ct. 1162, held that in a transaction of this type selling stockholders would be entitled to capital gains treatment of the payments which they received.

¶13But the “performance” to which the Institute refers is not that contemplated by the contract. Payment in April 1961, of the balance due on the purchase price would not have accomplished the purpose for which the Mayers entered into the transaction, as the Institute knew. Commissioner of Internal Revenue v. Brown still lay in the future, and the agreed-upon purchase price taxable at capital gain rates was not the equivalent of that purchase price taxable as ordinary income. As the district court found, “The consideration bargained for by the sellers was not merely $2,500,000 but $2,-500,000 recognized by the IRS as proceeds from the sale of a capital asset and entitled to capital gain treatment.” 7

¶14Nor could the result for which the Mayers contracted have been achieved by payment of the unpaid balance of approximately $2,150,000 (over 85 per cent of the purchase price) in April 1965, when Commissioner of Internal Revenue v. Brown was finally decided. The evidence refuted any suggestion that the parties contemplated that performance could await the favorable outcome of an extended tax controversy. On the contrary, it is clear that the parties intended that all or a substantial portion of the Mayers’ investment would be liquidated over a relatively brief period after August 1951.8

¶15*225Second. The Institute argues that the doctrine of commercial frustration is inapplicable because the parties foresaw the possibility of an adverse tax ruling and included the default provisions in the contract to meet this contingency.

¶16The Institute places particular emphasis upon evidence indicating (contrary to the district court’s finding) that the parties did in fact foresee the possibility that the tax premises of the transaction might be challenged. But that alone would not bar rescission. We think it proper to assume that the Supreme Court of Oregon follows the now more widely accepted view that foreseeability of the frustrating event is not alone enough to bar rescission if it appears that the parties did not intend the promisor to assume the risk of its occurrence.

¶17 The ultimate question in every case is “whether or not proper interpretation of the contract shows that the risk of the subsequent events, whether or not foreseen, was assumed by the promisor. If it appears from the nature of the contract as well as from the surrounding circumstances that, although they were reasonably foreseeable, the promisor did not assume the risk of the subsequent events, the contract shows a gap subject to supplementation in accordance with rules of objective law. Conversely, if the contract, properly construed, shows that the promisor assumed the risk of unanticipated events, the occurrence of such events does not excuse performance.” Smit, 58 Colum.L.Rev. 287, 314 (1958). See also L. N. Jackson & Co. v. Royal Norwegian Gov’t, 177 F.2d 694, 699 (2d Cir. 1949); 6 Williston, Contracts § 1953, pp. 5475-5476; Restatement, Contracts §§ 288, 461.9

¶18In the present ease the district court found, on substantial evidence, that the Mayers did not intend to assume the risk of an adverse tax ruling, and, implicitly, that the express terms of the contract, including the default provisions, were not intended to provide for this contingency. As the district court said, “the selling stockholders made it clear throughout the negotiations that they were relying on the transaction not being challenged. They repeatedly stated they were not buying a controversy or a lawsuit with the government over the validity of the promised tax advantages.” The court credited testimony that Ward Mayer did not accept the default provisions as adequate protection against an adverse tax ruling but requested assurances that the property would be returned if the tax assumptions underlying the transaction were challenged, and that he was given such assurances by representatives of the Institute.910 In the light *226of these circumstances, it would be untenable to conclude that the parties intended that the Mayers should assume the risk of an adverse tax ruling simply because such a ruling was, in a sense, “foreseeable” and because the contract did not expressly excuse performance in the event of its occurrence.

¶19Third. The Institute argues that equitable relief is barred by the doctrine of “unclean hands” since the parties deliberately omitted from the contract an express provision that the transaction would be rescinded in the event of an adverse tax ruling, in order to conceal this understanding from the Internal Revenue Service.

¶20The version of the incident accepted by the trial court was as follows. Ward Mayer wished to have the oral understanding regarding rescission included in the contract but was dissuaded by representatives of the Institute, who purported to be experts in such matters. They did not suggest that the existence of such an understanding would render the transaction any the less entitled to tax treatment which the parties sought. On the contrary, they argued that it would be an “extraneous provision,” not relevant to the legitimacy of the transaction from a tax point of view. They urged that it be omitted “as a matter of policy,” only “because an examining Revenue Agent plight be led to believe that no one would be hurt by IRS disapproval and would for that reason alone disapprove it.”

¶21In Oregon, as elsewhere, the decisions offer no clear-cut formula for determining when a plaintiff’s wrongful conduct will bar equitable relief. In Oregon, as elsewhere, that determination must be based upon an examination of all of the circumstances and a balancing of all of the factors deemed to be relevant. Taylor v. Grant, 204 Or. 10, 279 P.2d 479, 486-488 and 281 P.2d 704, 705 (1955); Fadeley, The Clean hands doctrine · Case Law">Clean Hands Doctrine In Oregon, 37 Ore.L.Rev. 160, 186-187 (1958). See generally, Johnson v. Yellow Cab Co., 321 U.S. 383, 387-388, 64 S.Ct. 622, 88 L.Ed. 814 (1944); Restatement, Restitution § 140, Comment b (1937).

¶22The relative strength of the policy infringed by the litigant is an important consideration in determining whether relief will be denied (Fadeley, supra, 37 Ore.L.Rev. at 170), and the public policy offended by the deliberate concealment of significant facts from the taxing authorities is a vital one. But however important the policy may be, its violation cannot be considered in isolation. It must still be evaluated in the light of attending circumstances. Although the governmental policy involved *227was important and its breach deliberate, the Supreme Court of Oregon granted relief where, in light of all the circumstances, to deny a remedy would “work injustice and wrong.” Taylor v. Grant, supra,279 P.2d at 488.

¶23We think the circumstances of this case justified the district court’s determination that the clean-hands maxim should not be applied. No injury resulted to the public generally, since the anticipated tax benefits were denied despite the concealment, nor did injury result to third parties or to the Institute.11 The Mayers’ offense, though serious, was mitigated by the circumstances that their motive, as found by the district court, was not to gain an unjustified tax advantage by concealing a relevant fact, but rather to assure an evaluation of the transaction on its merits by excluding an extraneous fact which might improperly influence the examining agent.12 The parties were not in pari delicto.13 The agents of the Institute, purportedly possessing an expertise which the Mayers lacked, stood in a superior position. They were the active parties, the Mayers reluctantly agreeing to the omission in response to their urgings. And the forfeiture which would be visited upon the Mayers if relief were denied would be extreme.14

¶24Perhaps none of these factors alone would have justified lifting the bar of the maxim; but the district court thought their concurrence did,15 and we agree.

¶25Fourth. The Institute argues that suit was barred by limitations, and that in any event the Mayers waived any right they may have had to rescind the transaction.

¶26Despite the literal language of ORS 12.040, the Oregon Supreme Court, at least in suits “of purely equitable cognizance,” has followed the general rule that statutes of limitations apply in equity only by analogy. The effect of expiration of the period limiting an analogous action at law is only to shift to the plaintiff the burden of establishing that his equitable suit is not barred by laches.16 McIver v. Norman, 187 Or. 516, 213 P.2d 144, 153, 13 A.L.R.2d 749 (1949); City of Pendleton v. Holman, *228177 Or. 532, 164 P.2d 434, 439 (1945); note, 29 Ore.L.Rev. 153, 154-55 (1950).17

¶27Having received notice from the Internal Revenue Service that Revenue Ruling 54-420 applied to their transaction, the Mayers allowed five and a half years to pass before they filed suit. But it is well established in Oregon law that mere lapse of time does not constitute laches. The question is whether the enforcement of the claim would be equitable. This is to be determined by an examination of all of the circumstances of the particular case. The factor of greatest significance is the presence or absence of injury to another. Indeed, the Oregon courts have repeatedly stated that such injury is an essential element of the defense. Brusco v. Brusco, 407 P.2d 645, 647 (Sup.Ct.Ore.1965); County of Lincoln v. Fischer, 216 Or. 421, 339 P.2d 1084, 1096 (1959); Kelly v. Tracy, 209 Or. 153, 305 P.2d 411, 421 (1956); McIver v. Norman, 187 Or. 516, 213 P.2d 144, 152 (1949).

¶28In the present case the first year of delay resulted from the Institute’s unsuccessful efforts to induce the Internal Revenue Service to change its position. During all but approximately ten months of the remaining period, the parties were negotiating with the Service and with each other for the return of the property to the Mayers. It was not until May 1959, the district court found, that the Institute unequivocally announced that it would not return the properties. Compare Kelly v. Tracy, 209 Or. 153, 305 P.2d 411, 420 (1956). Suit was filed ten months later.

¶29As we have noted, the parties treated the contract as frustrated shortly after notification of the applicability of Revenue Ruling 54-420. There is nothing in the record to indicate that the Institute subsequently changed its position in any way which would lead to its prejudice if the transaction were now rescinded. The Mayers have retained exclusive possession and operating control of the business. All of the risks of the enterprise have been theirs. There is no suggestion that evidence has been lost, or that the Institute’s defense has been otherwise embarrassed. No injury to third parties is asserted.

¶30The Institute relies upon a single circumstance to establish injury to them from the Mayers' delay in filing suit — the value of the property has increased substantially.18 But an enhancement of the value of the property involved does not alone convert delay into laches. County of Lincoln v. Fischer, supra,339 P.2d at 1098; McIver v. Norman, supra, 213 P.2d at 153-154 and 205 P.2d at 140. Indeed, as in this case, an interim appreciation in value may strengthen the equities of the party seeking return of the property. Where the subject matter is speculative and subject to rapid fluctuation in value, as are oil and mining properties, the doctrine of “speculative delay” may bar a claim to ownership if the claimant asserts his interest only after the risk has passed and the value of the property has become apparent. McIver v. Norman, supra, 213 P.2d at 153. But that is not this case. As we have noted, the risks of the enterprise remained with the Mayers. Moreover, the properties were not highly speculative in character, and to the extent that the enhancement of their value was the product of managerial effort, the effort was that of the Mayers.

¶31As to waiver, the district court found that the Mayers “did not intend to and did not elect to affirm the transactions” after the promulgation of the revenue ruling. This finding is amply supported. There was evidence that the Mayers pressed for the return of their properties from the time the Institute’s *229efforts to avoid the application of Revenue Ruling 54-420 failed, until the Institute unequivocally rejected the Mayers’ claim ten months prior to suit.

¶32The judgment is affirmed.