text:
    UNITED STATES of America, Appellee, v. David Baker PIERCE, Defendant-Appellant.
    No. 74-1226.
    United States Court of Appeals, First Circuit.
    Heard Oct. 8, 1974.
    Decided Nov. 13, 1974.
    Allan R. Rosenberg, Boston, Mass, (court appointed) with whom Putnam, Bell & Russell, Boston, Mass., was on brief, for appellant.
    Robert B. Collings, Asst. U. S. Atty., with whom James N. Gabriel, U. S. Atty., Boston, Mass., was on brief, for appellee.
    Before COFFIN, Chief Judge, ALD-RICH and CAMPBELL, Circuit Judges.
   COFFIN, Chief Judge.

This selective service appeal raises what might be called a “second generation” order of call defense. Appellant does not claim that the then applicable 32 C.F.R. § 1631.7 was violated when he and four other I-A registrants were ordered, on April 22, 1971, to report for induction. His claim is that he was entitled to inspect the files of 52 registrants holding lower random sequence numbers than his, whose II-S classifications he determined from the classification Record Books (SSS Form 102) had not been subjected to annual review in apparent violation of 32 C.F.R. § 1622.-21. If inspection were to reveal that there had been a serious and flagrant failure to reclassify five or more of these registrants into I-A, appellant argues that his order to report for induction should have been voided. The district court had refused discovery under F.R. Crim.P. Rule 16(b), stating that there was no authority for extending the order of call defense beyond I-A’s and that appellant’s motion would have required judicial review of classifications in violation of 50 App. U.S.C. § 460(b) (3), thus implicitly holding that the requested II-S files were not material to the preparation of appellant’s defense.

Appellant relies on the principles we articulated in United States v. Griglio, 467 F.2d 572, 577 (1st Cir. 1972), “that we will not deem a violation of a regulation as applied to third persons a deprivation of due process as to a registrant unless it is apparent that favoritism to another or discrimination against the registrant was intended, or unless the violation is so flagrant and serious that, whether intended or not, concern for fair and efficient administration justifies the sanction of voiding an induction adversely affected by the violation.” If the apparent non-adherence to the required yearly evaluation of 52 II-S deferments is a “flagrant and serious” violation, then Griglio, argues appellant, mandates voiding his induction. Although it might well have been the case that some or all of the II-S registrants would not have passed their physical examination or would have qualified for some other non-I-A classification, appellant argues that the board, whose violation of § 1622.31 precluded the happening of these contingencies, should not be allowed to defend by speculation.

There are several problems with extending Griglio, on the facts of this case, to breaches of regulations affecting registrants beyond the immediate I-A pool from which a defendant is called. In the first place, the applicable “order of call” regulation, 32 C.F.R. § 1631.7, was limited to ordering the sequence in which I-A and I-A-0 registrants should be called up. That regulation is not violated if all I-A and I-A-0 registrants have been fairly treated visa-vis each other. It is quite a different matter to argue that although the order of call regulation was properly applied, a registrant was prejudiced because holders of other classifications should have been in the I-A pool. This suggests what we referred to in United States v. King, 455 F.2d 345, 351 (1st Cir. 1972), as “a defendant’s ideal world”, one which “would involve a justification ... of all classification decisions or series of such decisions which have removed other registrants from the list of those being called.”

As we and other courts have recognized, see, e. g., King, supra, Griglio, supra, United States v. Strayhorn, 471 F.2d 661 (2d Cir. 1972), determining when a local board’s noncompliancé with regulations should be available as a defense to a registrant himself treated in conformity with the regulations calls for sensitive and sensible line drawing. We think that, absent the most extreme circumstances amounting to a systematic breakdown, the order of call defense should be limited to proof of violation of regulations of a flagrant and serious nature which adversely affect the treatment of a registrant as compared with other I-A’s. Such a line has some rational justification. Proof that a I-A registrant with a lower random sequence number than a defendant has been by-passed through a serious failure to follow a regulation inescapably indicates prejudice to that defendant. But proof that a II-S deferment was not terminated and evaluated at the end of the year only points to the possibility that the II-S deferment is presently unjustified. Since students who are satisfactorily pursuing their courses are entitled to a II-S, it is likely that yearly evaluation in many if not most cases would lead to a renewal of the same classification. Even if the II-S classification of a registrant could be shown to be Unjustified, there remain several bridges to be crossed before that registrant could be said to belong in a group of I-A’s from which a defendant was called,. Failure to pass a physical examination, the acquisition of a classification other than I-A, or even the passage of time involved in an attempt to obtain such are some of the contingencies. In short, confining the order of call defense to treatment of I-A’s can be justified to some extent by the immediacy and directness of linkage in such a case between a serious violation of a regulation and prejudice to a defendant. Violations of regulations which result in retaining other registrants in other classifications have only a speculative and unprovable impact on a registrant who has been ordered to report. We do not view such administrative improprieties as a significant threat to the fairness of the process.

Another justification for holding the line at I-A’s is the inherent difficulty of drawing any other line. If appellant’s attack on the basis of the apparent failure to conduct an annual review of the fifty-two II-S deferments is allowed, there exists no basis in principle for confining discovery and attack to those who have noted some prima facie violations from a review of the Classification Books. An assiduous registrant might very well conduct his own survey of the status of holders of II-S deferments, of those claiming family obligations, of those claiming temporary disability, or of those who are supposedly working in an essential occupation. He could, by filing a detailed affidavit casting suspicion on the continued justification of such classifications, gain access to files, and launch a major attack on a host of board decisions or failures, to revise decisions. He would understandably not be impressed by the argument that only evidence of violations from the Classification Books could entitle a registrant to mount an expanded order of call defense. He could rightfully respond that his averments of abuse of discretion in applying substantive regulations should carry more weight than a simple failure to conduct an annual review. If equal treatment is afforded, each I-A called for induction could require justification of all of a board’s decisions made at any time prior to his call with regard to all holders of lower random sequence numbers.

Appellant’s answer to this “parade of horribles” is that such challenges would result in local boards cleaning house and acting properly. By the same token, to bar such a defense as he asserts would reduce the pressures on -a board to adhere faithfully to all pertinent regulations. Our response begins with the recognition that the selective service system is somewhat special, both in mission and in the scope of its freedom to act. Its mission is to provide manpower in times of military necessity. Its power to act in the process of classification and induction has been subjected to substantially limited judicial oversight. 50 App. U.S.C. § 460(b)(3); Clark v. Gabriel, 393 U.S. 256, 89 S.Ct. 424, 21 L.Ed. 418 (1968); Fein v. Selective Service System, 405 U.S. 365, 92 S.Ct. 1062, 31 L.Ed.2d 298 (1972).

It is from this perspective that we view appellant’s argument for the availability of an expanded defense of breach of a regulation which possibly but indirectly has affected the timing of a registrant’s induction. Classification decisions are being made daily; there is always room for board discretion both in classifying initially and in reclassifying or deciding not to reclassify. To the extent that this discretion exists, there is room for disagreement. And to the extent that reasonable persons could differ about a decision, there is room to claim a prima facie breach of a regulation. Moreover, errors of judgment will inevitably be made; when they are made, it is likely that the challenging registrant will claim them to be “serious and flagrant”. In short, the availability of an “all classifications order of call defense” would open up the prospect of increased uncertainty in meeting draft calls and incalculable complexity in the preparation and conduct of prosecutions. Having in mind the speculative contribution to fairness of the kind of board-ranging discovery sought by appellant, we think this prospect of administrative disruption precludes the extension of Griglio, except in the rarest of cases, to a defense based on draft board treatment of registrants other than the defendant and other registrants classified I-A.

Appellant cites two cases which have allowed discovery of the files other than those of I-A’s. We have already noted one of them, Sundstrom, where the district court, from an abundance of concern, did allow evidence from the files of twenty-three persons in other classifications. The propriety of this scope of discovery was not apparently in issue before either the district court or the court of appeals. The other case is United States v. Hughes, 5 SSLR 3757, No. 72 Cr. 405 (S.D.N.Y., Oct. 18, 1972), where the court, noting that over a substantial period many registrants’ files had been neither reviewed nor reclassified, based its order allowing discovery of certain files on the observation that “Wrongful classification is no less egregious than failure to call up a I-A registrant with a higher priority.” Wrongful classification is indeed egregious, but for the reasons we have set forth, we do not look upon the order of call defense as the guarantor of overall fairness in the selective service system.

Affirmed.

      . The government made the argument, on which the district court partially relied, that examination of other classifications would place a court in violation of 50 App. U.S.C. § 460(b)(3), which proscribes judicial review of the classification or processing of any registrant except as a defense to a criminal prosecution against the registrant. We are reluctant to place our decision on this ground. While appellant seeks, in a sense, judicial review of classifications of other registrants, it is not a review which changes those classifications. If the review is successful from the point of view of one in appellant’s position, the result is simply to void his induction order. The board is free to issue a new order, although presumably it would have taken action to correct any deficiencies found in the files of other registrants. Any such changes, however, would have been board initiated and only remotely and indirectly the result of “judicial review”.

      . Indeed, this occurred in United States v. Sundstrom, 359 F.Supp. 1252 (S.D.N.Y.1973), aff’d, 489 F.2d 859 (2d Cir. 1973), where the defendant was apparently allowed to scrutinize the files of twenty-four men, only one of whom was classified I-A. The court laboriously endeavored to go through all the files to determine whether the board had acted arbitrarily in not reclassifying young fathers who had left their wives and children, and I-X registrants with medical, mental, or moral problems of uncertain continuity. Its final conclusion, affirmed by the court of appeals, was that no systematic preferential treatment of deferred elassifica-tions had been shown.

      . Our approach is influenced by these characteristics and is not intended as impliedly rejecting other kinds of analysis respecting challenges based on violations of regulations by other agencies. Bee, Note, Violations by Agencies of Their Own Regulations, 87 Harv.L.Rev. 629 (1974); cf. Safir v. Gibson, 417 F.2d 972 (2d Cir. 1969); Morton v. Ruiz, 415 U.S. 199, 232-235, 94 S.Ct. 1055, 39 L.Ed.2d 270 (1974).


source: Caselaw Access Project

author: ADAMS, Circuit Judge:

license: Public Domain

text:
    In the Matter of BRISTOL ASSOCIATES, INC., Debtor. Appeal of GIRARD TRUST BANK.
    No. 74-1178.
    United States Court of Appeals, Third Circuit.
    Argued Sept. 9, 1974.
    Decided Nov. 5, 1974.
    As Amended Nov. 25, 1974.

      Leon S. Forman, Howard T. Glassman, Wexler, Weisman, Maurer & Forman, Philadelphia, Pa., for appellant.
    Lewis H. Gold, Adelman & Lavine, Philadelphia, Pa., for appellee.

      Before ALDISERT, ADAMS and RO-SENN, Circuit Judges.
   OPINION OF THE COURT

ADAMS, Circuit Judge:

The Court is here asked to determine whether a Pennsylvania lender, who takes as collateral for a loan a security interest in a lessor-borrower’s lease and in the rents thereunder, must comply with the filing provisions of Article 9 of the Uniform Commercial Code to perfect its interest against attack by a Receiver in bankruptcy.

In 1969, Bristol Associates, Inc. as lessor, entered into an Agreement of Lease, letting certain store premises for a period of 10 years to the Commonwealth of Pennsylvania, agent for the Pennsylvania Liquor Control Board. Two years later, in 1971, in consideration for a loan, Bristol gave Girard Trust Bank a promissory note and, as security, assigned to Girard its interest in the lease. Girard did not record its security interest in the real estate lease by filing a financing statement under Article 9 or make any other public record of the assignment of the lease.

The following year, in 1972, Bristol filed a petition under Chapter XI of the Bankruptcy Act, 11 U.S.C. § 701 et seq. (1966), and a Receiver was appointed. Apart from the first month’s rent from the Commonwealth inadvertently paid to Girard, the Receiver retained all rentals and applied them to Bristol’s business operations. Girard thereupon filed a reclamation petition with the Bankruptcy Court to recover the rentals paid to the Receiver under the lease that had been assigned. The Bankruptcy Court denied the petition, and the denial was affirmed by the district court. 369 F.Supp. 1 (E.D.Pa. 1973).

Under section 70(c) of the Bankruptcy Act, 11 U.S.C. § 110, and section 9-301 (3) of the Code, the Receiver assumes the rights of a lien creditor. In this status, the Receiver takes priority over those other creditors of the insolvent debtor who hold unperfected security interests. Unperfected secured parties are relegated to the pool of general creditors.

If the assignment of the lease to Girard is a transaction within the scope of Article 9 and if Girard’s interest has not been perfected, then Girard cannot successfully assert its security interest against the Receiver. If, however, the assignment of a lease is excluded from Article 9, the filing and perfection provisions of that Article are not applicable, and Girard’s security interest in the lease and in the rents from the lease would not be subordinated to the Receiver.

The apposite statutory provisions and official Comment provide:

§ 9-102 Policy and Scope of Article.
(1) Except as otherwise provided in Section 9-104 on excluded transactions, this Article applies so far as concerns any personal property and fixtures within the jurisdiction of this State
(a) to any transaction (regardless of its form) which is intended to create a security interest in personal property ....
(3) The application of this Article to a security interest in a secured obligation is not affected by the fact that the obligation is itself secured by a transaction or interest to which this Article does not apply.
Comment 4. An illustration of subsection (3) is as follows:
The owner of Blackacre borrows $10,-000 from his neighbor, and secures his note by a mortgage on Blackacre. This Article is not applicable to the creation of the real estate mortgage. Nor is it applicable to a sale of the note by the mortgagee, even though the mortgage continues to secure the note. However, when the mortgagee pledges the note to secure his own obligation to X, this Article applies to.the security interest thus created, which is a security interest in an instrument even though the instrument is secured by a real estate mortgage. This Article leaves to other law the question of the effect on rights under the mortgage of delivery or non-delivery of the mortgage or of recording or non-recording of an assignment of the mortgagee’s interest. See Section 9 — 104(j).
§ 9-104. Transactions Excluded from Article. This Article does not apply
(j) . . . to the creation or transfer of an interest in or lien on real estate, including a lease or rents thereunder.
Comment 2. The exclusion of leases and other interests in or liens on real estate by paragraph (j) merely reiterates the limitations on coverage already made explicit in Section 9-102(3). See Comment 4 to that section.

We are required to apply the law of Pennsylvania to issues such as the one before us. In Re Royal Electrotype Corp., 485 F.2d 394 (3d Cir. 1973). However, the Pennsylvania courts have made no ruling on the interplay of sections 9-102 and 9-104 to resolve the question whether a real estate lease used as collateral falls within the ambit of Article 9. Therefore, it is incumbent on the federal court not only to apply the relevant state law, but to ascertain what that law, in fact,.is.

Our analysis proceeds from the statute. We must give effect insofar as possible to the language and intent of the legislators, giving each section a meaningful interpretation while not eclipsing any other portion of the statute.

The question confronting us here thus becomes whether “an interest in real estate” subsequently employed in a “transaction which is intended to create a security interest” is covered by section 9-102, placing the transaction under the Code, or by section 9 — 104(j), placing the transaction outside the Code.

The Receiver contends that, when the borrower assigned the lease to the lender, the transaction came within the ambit of Article 9 and its provisions for perfecting security interests. In support of this position, the Receiver advances as a syllogism that Article 9 expressly covers security interests in all personal property; that a lease in Pennsylvania is personal property; and that the transaction in question here therefore falls within Article 9 coverage. Section 9-104(j) would, under this analysis, be read narrowly, exempting from Article 9 only those transactions touching on the real estate itself, such as the creation of a lease or mortgage; subsequent uses of the lease or mortgage, “intended to create a security interest,” would not be excluded. Under the Receiver’s approach the “transfers” excluded from Article 9 by section 9-104 (j) would be only those where no intent to create a security interest was present, for example, transfers of blocks of mortgages and the sale of real estate on which outstanding leases were transferred as part of the sale.

The Receiver would place the lease within the scope of section 9-102, Comment 4, supra, asserting that, analogous to the promissory note, the lease evidences an obligation to pay. Although the Receiver concedes that the underlying lessor-lessee contract is excluded from the Code by section 9-104 (j), he nevertheless maintains that its use as security could, under a reasonable interpretation of the language, fall within section 9-102(3). If section 9-104(j) is construed narrowly, claims the Receiver, so that the “transfers” it excludes do not cover transfers as security pledges, a consistent reading of the two sections emerges.

Girard argues in opposition that section 9-104 (j) explicitly exempts from compliance with the provisions of Article 9 any transfer of an interest in realty, no matter what the purpose. Under this reading of the statute, it becomes irrelevant whether a lease is considered realty or personalty under the state law for other purposes. Even if the lease is deemed personalty, its transfer is claimed by Girard to be the subject of express exclusion from the provisions of Article 9.

Responding to the Receiver’s reading of section 9-104(j), Girard suggests that the Receiver would nullify the effect of that section by interpreting it to exclude from Article 9 only transactions which that Article does not purport to cover, namely, real property transactions and transfers where there is no intent to create a security interest. Girard contends that a proper reconciliation of the two sections results only from interpreting section 9-104(j) to exclude from Article 9 transactions that would otherwise fall within it, such as the transactions involved in the present litigation.

The evolution of the Code since its original enactment, the views of authorities and the realities of the pertinent business practices have persuaded us that the intent of the Legislature was to exclude from the filing and perfection provisions of Article 9 the use of a lease as collateral for a loan.

Sections 9-102 and 9-104 have both been amended since their original enactment. Together, the amendments limit the application of section 9-102 where transactions touch realty and, simultaneously, provide greater explicitness in section 9-104(j), exempting both' the creation and transfer of interests in realty. The amendments were proposed in order to clarify the Code as ambiguities in language became evident, rather than to alter the direction or scope of the Code.

As originally enacted in Pennsylvania, section 9-102 did not contain subsection (3). In 1959 subsection (3) was added, accompanied by the explanatory Comment 4. Since the effect produced by Comment 4 was not clear, the Conference of Commissioners on Uniform State Laws and the American Law Institute recommended, in 1962, that the Comment be modified. Before and after the amendment, the relevant portion of Comment 4 read:

However, when the mortgagee in turn pledges this note and mortgage to secure his own obligation to X, this Article is applicable to the security interest thus created in the note and the mortgage [which is a security interest in an instrument even. though the instrument is secured by a real estate mortgage], (Emphasis indicates the relevant 1962 deletions; brackets indicate the relevant 1962 addition.)

The changes in wording produced two effects. First, deletion of the references to mortgages distinguishes between the pledge of a note, a separate and distinct contract, and the underlying real estate mortgage. Where a promissory note and mortgage together become the subject of a security interest, only that portion of the package unrelated to the real property is now covered by section 9-102. Second, the added language makes explicit that the promissory note itself falls within the scope of Article 9 by virtue of its status as an instrument. Since a lease of real property is clearly not an instrument, inclusion of its assignment in Article 9 by reason of analogy to the promissory note would be strained. The amendments clarify the rationale of applying Article 9 to the promissory note. They refute the possibility that Article 9 reaches out to encompass every transaction colorably included under section 9-102.

The amendments made to section 9-104 lend further support to the position that the legislators did not intend to include in Article 9 the assignment of a real estate lease. As originally enacted, the Code did not contain section 9 — 104 (j); rather, section 9-104 (b) excluded from Article 9 coverage “a landlord’s lien or a lien on real estate.” Act of April 6, 1953, P.L. 3, § 9-104. Following the recommendation of the Permanent Editorial Board of the Uniform Commercial Code, the Legislature in 1959 adopted the language presently set forth in section 9-104(j). Act of October 2, 1959, P.L. 1023 § 9. The change was promoted by the Board in the interest of “greater clarification and precision as to the types of transactions entirely excluded from the operation of Article 9.” 1956 Recommendations of the Editorial Board for the Uniform Commercial Code, 257-58. The language of section 9 — 104(j) substantially broadens the earlier exclusion by providing that Article 9 does not apply to “the creation or transfer of an interest in or lien on real estate, including a lease or rents thereunder.”

Our conclusion, that lenders need not conform to the requirements of Article 9 in order to retain their security interest in a real estate lease assigned to them as collateral, is supported, apparently unanimously, by authorities who have considered this problem. Included are many of the persons responsible for the drafting of the Code and its subsequent revisions. Carl Funk, a leading expert on the Code and its application in Pennsylvania, stated that “a bank lending on the security of an assignment of a lease or of the rentals payable by the tenant need not comply with the Code in any way.”

In their treatise, Coogan, Hogan & Vagts first aver that a promissory note when used as collateral is covered by the Code even if secured by a mortgage, citing section 9-102(3) and Comment 4. However, they continue by asserting that, “[t] hough estates for years are for some purposes considered personal property, the Code would not seem to cover the mortgage of a lease on realty.” 1A Secured Transactions under the Uniform Commercial Code § 16.04 [1] at 1698 (1973). The authors cite section 9-104 (j) for this proposition. The notion that the assignment of a lease or of rents thereunder as collateral might be considered a security interest in personal property controlled by Article 9 is dismissed as “unduly fearful.” The authors state that “[t]he clear intent of section 9-104(j) * * * would be completely nullified” by such an interpretation.

These views of the authorities in no way bind this Court nor are they determinative of the intent of the legislators who enacted Article 9 into law. Nonetheless, the composite picture is suggestive of what the experts expected to be the effect of section 9-104(j). The legislators could not have been wholly unmindful of the views of authorities in the areas affected by the Code. Had the legislators intended a different effect for the language, they might well have given some indication of this. That they did not is surely some evidence that the intended scope of section 9-104(j) was not in sharp contrast to what was generally believed to be its ambit by the leaders in the field. Therefore, a broad reading of section 9-104 (j) which would exclude the present transaction from Article 9 is consistent with the views of the authorities and is not controverted by an indication from the legislators that these views are mistakenly held.

One final consideration buttresses the conclusion that the lease when used as collateral should be exempted from Article 9. The universal practice of Pennsylvania lenders in these circumstances is to ignore any application of the Code to leases received as collateral. A bank often takes an assignment of a lease or the rents due under a lease as security for a loan. C. Funk, Banks and the Uniform Commercial Code 61 (2d ed. 1964). Collateral of very substantial value is involved in such loans, which are granted regularly and repeatedly in the world of finance. Parties to these loans “are apt to think for good reasons that they are outside the scope of Article 9.” Hawkland, 77 Com.L.J. 79, 84 (1972).

While a uniform trade practice does not constitute proof that the legal consequences of the practice are what those in the field take them to be, neither can it be assumed that a legislature which passed the Code and which has considered and passed amendments to it on several occasions would let stand practices or beliefs which it disapproved. In fact, the amendments passed by the Legislature have tended in the other direction, restricting the application of Article 9 when transactions touch real property. (See discussion swpra.)

Where language is susceptible of two reasonable meanings, a court, in the commercial field, should choose that interpretation which comports with current universal practice in the business world.

It is argued that by dovetailing the two sections to achieve a wider reach for section 9-104 (j) and a resultant narrower scope to section 9-102, sufficient heed is not given to the admonition that the Code be “liberally construed and applied to promote its underlying purposes and policies.” 12A Pa.Stat.Ann. § 1-102 (1970). Although the conclusion reached today eliminates from Article 9 a class of secured transactions, it nevertheless would not appear to conflict with the self-proclaimed purposes of the Code, which are generally to “simplify [and] clarify” commercial law, to “permit the continued expansion” of commercial life and to “make uniform” commercial law throughout the United States. Section 1-102(2).

Admittedly, a principal function of Article 9 is to achieve maximum benefit for creditors from the notice-filing provisions. The goal of the filing system is to make known to the public whatever outstanding security interests exist in the property of debtors. Once a transaction falls within the Code, this legislative intent must be given full force in any determination of how the Code applies in a situation. The notice requirements are at the core of Article 9. In re Middle Atlantic Stud Welding Co., 503 F.2d 1133 (3d Cir. 1974).

In ascertaining whether including or excluding a transaction for Article 9 conforms to the legislative intent, however, we must weigh the interest in public notice against the other purposes of the Code, such as uniformity and the promotion of commercial law, and interpret the statute in the light of current commercial and banking practice. On balance, this Court concludes that the drafters who wrote Article 9 and the legislators who enacted it into law intended section 9-104(j) to be interpreted sufficiently broadly to exclude the assignment of a lease and rents thereunder from the operation of Article 9. The burden of those who would propound a different view is to persuade the State Legislature. We should not usurp the legislative function.

The decision of the district court will be reversed, and the case will be remanded for entry of an order consistent with this opinion.

      . 12A Pa.Stat.Ann. § 9-101 et seq. (1970).

      . The Comments have not been officially enacted into law by the Pennsylvania Legislature and thus are not of binding effect. We note, however, that the Pennsylvania Supreme Court gives substantial weight to the Comments as evidencing the intended application of the Code. Philadelphia Title Insurance Co. v. Fidelity-Philadelphia Trust Co., 419 Pa. 78, 212 A.2d 222 (1965); In Re Royal Electrotype Corp., 485 F.2d 394 (3d Cir. 1973).

      . Two situations relating to the present case are specifically addressed by Article 9: In one case the provisions of Article 9 control, in the other case the transaction is excluded from coverage. First, had a borrower, such as Bristol, mortgaged its real property to a bank as collateral for a loan, rather than assigning a lease it held as landlord, the Code, under section 9-104(j), explicitly excludes such transaction from its provisions.
      On the other hand, where a borrower holds a promissory note in conjunction with a mortgage of real property and then assigns the note as collateral for a loan by a bank, the provisions of Article 9 govern the transaction. The latter situation is the case which the Code includes in section 9-102, Comment 4. Appellant Girard appears to question even this latter application of the Code. But see P. Ooogan, W. Hogan & D. Vagts, 1A Secured Transactions Under the Uniform Commercial Code § 23.11 (1973) ; Warren, Coverage of the Secured Transactions Division of the California Commercial Code, 13 U.C.L.A.L.Rev. 250 (1966).

      . We assume, arguendo, that a lease in Pennsylvania is personalty. M. Stern, Trickett on The Law of Landlord and Tenant in Pennsylvania 2 (rev. 3d ed. 1972). Case law support for this proposition is scant. See Wilford v. Dickey, 196 Pa.Super. 468, 174 A.2d 98 (1961). The characterization of mortgages has been more fully developed; mortgages generally have been held to be personalty in Pennsylvania. Gallagher v. Rogan, 322 Pa. 315, 185 A. 707 (1936); McGlathery’s Estate, 311 Pa. 351, 166 A. 886 (1933); Equitable Trust Co. v. Schwebel, 40 F.Supp. 112 (E.D.Pa.1941).

      . 1956 Recommendations of the Editorial Board of the Uniform Commercial Code 257-58; Report No. 1 of the Permanent Editorial Board of the Uniform Commercial Code, in 1962 Uniform Commercial Code Official Text with Comment.

      . Act of April 6, 1953, P.L. 3 § 9-102.

      . Act of Oct. 2, 1959, P.L. 1023 § 9.

      . “Instrument” is defined for purposes of Article 9 as “a negotiable instrument, or a security or any other writing which evidences a right to the payment of money and is not itself a security agreement or lease. ...” 12A Pa.Stat.Ann. § 9-105 (g) (1970) (cross references deleted).

      . Generally the opinions of these authorities are predicated on what is purported to be the “intent of the clear and explicit language” of § 9-104(j). Little, if any, attempt has been made to explain why this interpretation, giving a broad reading to § 9-104 (j) and a narrow reading to § 9-102(3), is warranted.

      . This statement is found under the subsection “Loans Secured by Other Types of Personal Property.” Banks & the Uniform Commercial Code, 60, 61 (2d Ed. 1964).

      . However, out of an abundance of caution, the authors recommend clarification of the language by revision. Section 23.11 [6] at 2401. Accord, Coogan, Kripke & Weiss, The Outer Fringes of Article 9: Subordination Agreements, Security Interests in Money and Deposits, Negative Pledge Clauses and Participation Agreements, 79 Harv.L.Rev. 229, 268 (1965).

        See also Warren, Coverage of the Secured Transactions Division of the California Commercial Code, 13 U.C.L.A.L.Rev. 250 (1966). Professor Hawkland also has noted the confusion inadvertently generated by the language of §§ 9-102 and 9-104. The Proposed Amendments to Article 9 of the U.C.C. — Part IV: The Scope of Article 9, 77 Com.L.J. 79 (1972). Convinced that no one in the lending field intended the pledge of a realty lease to fall within Article 9, Professor Hawkland proposes further amendments to the Code to clarify the matter.

      . It was suggested at oral argument without contradiction that lenders believe they are excluded because “literally hundreds of opinion letters” from attorneys have so informed the banking community.

      . AVere this Court to interpret the statute so as to require compliance with Article 9 whenever a lease is utilized as collateral, the status of all such leases presently held as collateral would be called into question. Unresolved issues would generate additional litigation. Under the Code, filing would likely be required to perfect the security interest against attack from lien creditors. 12A Pa. Stat.Ann. §§ 9-301, 9-302(1) (e), 9-304 (1970). Undertaking at this time to file all outstanding security interests in leases would be time-consuming and expensive for the secured parties. Assuming, arguendo, that such ruling applied retroactively, the interest of a lender in a lease would be subordinated to any competing claim perfected before the date of filing. 12A Pa.Stat.Ann. § 9-312(5) (a) (1970).
      Also, if this Court were to infer the state legislative intent incorrectly, it would appear to create far less dislocation and interim confusion for the state to correct the present holding than to correct a contrary result. The chaos in business affairs precipitated by a result different from that reached here today would seem ill-advised absent stronger indications that such a result was intended by the Legislature.

      . Cases from other jurisdictions have been examined in an attempt to achieve a uniform rule, or to benefit from whatever light has been shed on this issue elsewhere. However, no clear or uniform result emerges. Two appellate state courts have held that leaseholds are excluded from Article 9 by reason of section 9-104(j). In Hilst v. Bennett, 485 P.2d 880 (Colo.1971), a leasehold which a judgment creditor attempted to attach was found outside the scope of Article 9, but the factual discussion does not make clear whether the judgment debtor is the lessor or lessee of the leasehold. In Ingraham v. Ingraham, 527 P.2d 254, 14 U.C.C.Rptr. 1043 (Kan.1974), a security interest in an oil and gas leasehold was held not governed by the Code. In addition, the Attorney General of Maryland has issued an opinion which takes the official position that a secured transaction such as that before us is not controlled by Article 9. 2 U.C.C. Rptr. 44, 108, Feb. 20, 1964, May 20, 1964.
      Coming to a contrary conclusion are two decisions from intermediate state courts, both dealing not with leases but with land-trust agreements. In Levine v. Pascal, 94 Ill.App.2d 43, 236 N.E.2d 425 (1968), a land-trust agreement was used as collateral for a loan. A subsequent judgment creditor of the debtor sought to reach the land trust. The court held that as jjersonal property the trust was subject to the Code and, as it was not perfected by filing, it could be reached by a judgment creditor. In Riebe v. Budget Financial Corp., 264 Cal.App.2d 576, 70 Cal.Rptr. 654 (1968), it was the lender who urged that the Code covered the transaction. A broker of notes secured by deeds of trust was successful in arguing that because the notes were personal property covered by the Code, the lender was exempt from the state usury laws, which did not apply to Code transactions. Since it was the notes rather than the trust deed which were used as collateral, Riebe appears directly within Comment 4 to section 9-102. The result in Riebe is thus not contrary to the conclusion reached here.

      . 12A Pa.Stat.Ann. §§ 9-101, 9-104, and Comments thereto (1970). P. Coogan, AV. Hogan & D. Vagts, 1 Secured Transactions Under the Uniform Commercial Code 461 (1973).


author: BREITENSTEIN, Circuit Judge.

text:
    UNITED STATES of America, Plaintiff, v. WYOMING NATIONAL BANK OF CASPER, Defendant-Appellee, H. A. True, Jr., Impleaded-Defendant-Appellee, Riverton Auction and Livestock Co., Impleaded-Defendant-Appellant.
    No. 74-1117.
    United States Court of Appeals, Tenth Circuit.
    Argued Sept. 11, 1974.
    Decided Nov. 4, 1974.

      No appeal by, or appearance for, the United States.
    Harold E. Meier, Lander, Wyo. (Meier & Gist, Lander, Wyo., on the brief), for impleaded-defendant-appellant Riverton Auction and Livestock Co.

      William E. Barton, Casper, Wyo. (Claude W. Martin and Brown, Drew, Apostólos, Barton & Massey, Casper Wyo., on the brief), for defendant-ap-pellee Wyoming National Bank of Cas-per.
    Houston G. Williams, Casper Wyo., (Frank D. Neville and Wehrli & Williams, Casper, Wyo., on the brief), for impleaded-defendant-appellee H. A. True, Jr.
    Before BREITENSTEIN, SETH and McWilliams, circuit judges.
   BREITENSTEIN, Circuit Judge.

This controversy relates to the respective rights of creditors of a defunct packing company. The action was brought by the United States to enforce a tax levy. Jurisdiction lies under 28 U.S.C. §§ 1340 and 1345; see also 26 U.S.C. § 7402. The district court gave judgment for two secured creditors and against both the United States and the unpaid seller of certain cattle. The United States has not appealed. Our concern is with the claims asserted by the seller against the secured creditors. We affirm.

Appellees Wyoming National Bank of Casper and H. A. True were secured creditors of Wyoming Beef Packers, Inc. Appellant Riverton Auction and Livestock Co. on November 24, 1970, sold cattle to Packers. Packers took immediate possession of the cattle and they became part of its inventory. In payment for the cattle Packers gave River-ton two checks totalling $10,155.38. Bank refused to pay one check because of insufficient funds and the other because of an insufficient endorsement. On December 6 an audit disclosed that Packers was in default under its loan and security agreement with Bank. On the next day Packers turned all of its assets over to Bank. Riverton has never been paid for the cattle.

The United States sued Bank to enforce a tax levy against property of Packers held by Bank. Bank impleaded True and Riverton. Riverton filed a cross-claim against Bank and True. True filed a cross-claim against River-ton. Trial was to the court which made findings that are not here contested. Bank was adjudged a first, and True a second, secured creditor with rights superior to the United States. Riverton was relegated to the position of a general creditor.

On the day of trial, but before it began, Riverton moved under Rule 41, F.R.Civ.P., to dismiss its cross-claims against Bank and True, and moved under Rule 21, F.R.Civ.P., to be dropped as a party. The motions were opposed by the other parties and were denied by the court. Riverton claims that under Wyoming law it has a superior right to recover the unpaid purchase money, and desires to have that issue decided in state court.

The motions are interrelated and may well be considered together. River-ton was a proper party to the suit. In an action to enforce a tax lien “[a]ll persons having liens upon or claiming any interest in the property involved in such action shall be made parties thereto.” 26 U.S.C. § 7403(b). Riverton and True each claimed an interest in the property which Bank held and which the United States asserted was subject to its levy. Joinder was feasible and proper under Rule 19 because without River-ton and True in the suit Bank would be subjected to the “substantial risk of incurring double, multiple, or otherwise inconsistent obligations.”

Rule 41(c) provides that voluntary dismissal by a cross-claimant of a cross-claim is impermissible after a responsive pleading has been filed. Because responsive pleadings to Riverton’s cross-claim had been filed, dismissal could be had only by court order, Rule 41(a)(2), reviewable for abuse of discretion. Shaffer v. Evans, 10 Cir., 263 F.2d 134, 135. The grant of the motion to dismiss would not have taken River-ton out of the case because it was both an impleaded defendant and a cross-defendant.

Rule 21 permits a party to be dropped on motion. Here again the motion is addressed to the discretion of the court. 7 Fed.Pract. & Proc. § 1688, p. 342; see also Standard Industries, Inc. v. Mobil Oil Corporation, 10 Cir., 475 F.2d 220, 232, cert. denied, 414 U.S. 829, 94 S.Ct. 61, 38 L.Ed.2d 63. The court did not abuse its discretion in denying either the Rule 41 or the Rule 21 motion. Riverton was a proper party whose presence was needed to protect the rights of all parties and to accomplish the expeditious determination of the litigation. Ibid.

We turn to the merits. River-ton argues that the Packers and Stockyards Act, 7 U.S.C. § 181 et seq., and particularly regulations of the Secretary of Agriculture promulgated thereunder and appearing as 9 CFR §§ 201.43 (b) and 201.99, control. Reliance is placed on In re Samuels & Co., Inc., 5 Cir., 483 F.2d 557. That decision was reversed sub nom., Mahon v. Stowers, 416 U.S. 100, 94 S.Ct. 1626, 40 L.Ed.2d 79. Among other things, the Supreme Court said that the interests of cattle sellers “like that of similarly situated sellers, would depend for protection upon their taking of appropriate steps under the commercial law of the various States in which they did business.” 416 U.S. at 112, 94 S.Ct. at 1632, 40 L.Ed.2d at 88. The Court went on to say that a course of conduct mandated by the Act or regulations might “be relevant or even dispositive under state law.” 416 U.S. at 114, 94 S.Ct. at 1633, 40 L.Ed.2d at 89. In the case at bar we find nothing in the Act, or in the mentioned regulations, which is relevant to or dis-positive of the state law issues.

This brings us to Wyoming law. Riverton argues that federal courts are bound by a pertinent Wyoming decision. In a state court suit involving Bank, Packers, and an unpaid seller, the seller prevailed over secured creditors. The Wyoming Supreme Court affirmed on the basis of an equally divided court. Wyoming National Bank of Casper v. Greenwald, Wyo., 506 P.2d 434. Two justices voted to reverse on the ground that summary judgment was improper because evidence should have been received as to Bank’s good faith and two voted to affirm on the ground that it was apparent as a matter of law that Bank was not a good faith purchaser.

The record before us establishes Bank’s good faith both in the receipt of its security interest and in its refusal to honor Packers’ checks payable to Riverton. The decision of the Wyoming Supreme Court is not pertinent. The proceedings of the state district court are not reported and are not before us. We have no way of knowing the facts before that court or the rationale of its decision. In Wyoming a district court decision does not have precedential value and is persuasive only to the extent of its underlying logic. State Board of Equalization v. Courtesy Motors, Inc., Wyo., 362 P.2d 134, 135. A federal court need not follow state decisions which are not precedents in the state itself. King v. Order of United Commercial Travelers of America, 333 U.S. 153, 160-161, 68 S.Ct. 488, 92 L.Ed. 608. Absent a controlling Wyoming decision, we must apply that state’s law as we see it.

The issues require consideration of the Wyoming version of the Uniform Commercial Code. See Wyo.Stat., 1973 Cum.Supp. Chap. 22, §§ 34-1-101 to 34-10-105. The trial court’s finding of good faith on the part of Bank is not attacked on this appeal. When Packers took possession of the cattle, it had the power to transfer good title to Bank, a good faith purchaser for value, see § 34-2-403(1). A purchaser is one who takes by purchase. § 34-1-201(33). Purchase includes taking by mortgage, pledge, lien or any other voluntary transaction creating an interest in property. § 34-1-201(32). A person gives value for rights if he acquires them as security for, or in partial satisfaction of, a pre-existing claim. § 34-1-201(44) (b). The transfer occurred when Packers took possession of the cattle because Bank’s security interest then attached. See § 34-9-204; First National Bank of Elkhart County v. Smoker, Ind.App., 286 N.E.2d 203, 209. The only title interest which Riverton could retain was a security interest. See § 34-2-401(1).

The trial court found that when Packers took possession of the cattle they became part of its inventory. Riv-erton does not attack the validity of the security agreements held by Bank and True. The inventoried cattle, and the proceeds therefrom, were subject to those agreements. See § 34-9-306. Riverton does not claim a security interest for itself. Rather, it argues that UCC must be liberally construed, see § 34-1-102(1), and in the absence of specific provisions resort must be had to principles of law and equity. . It says that as a defrauded seller its rights are superior to those of Bank and True. The difficulty is that § 34-2-702(2) provides that on a credit sale to an insolvent buyer, seller has 10 days to make written demand for reclamation and: “Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay.” This eliminates any common-law claim by a defrauded seller. Riverton made no demand for reclamation within the 10-day period provided by § 34-2-702(2).

Riverton relies on § 34-2-507 (2), which provides that: “Where payment is due and demanded on the delivery to the buyer of goods * * * his right as against the seller to retain or dispose of them is conditional upon his making the payment due.” The provision applies between seller and buyer. We are concerned with the respective rights of seller and holders of security interests.

Although Riverton does not now assert a security interest, it should be noted that Riverton made no effort to comply with the provisions of § 34-9-312(3) and (4) relating to the respective priorities of a purchase money security interest and a conflicting security interest.

Riverton did not take advantage of the rights which it had under Wyoming law and must now yield to the superior rights of Bank and True. The United States District Judge for Wyoming so held. In the absence of a controlling state decision, his determination of the law of that state is most persuasive. Julander v. Ford Motor Co., 10 Cir., 488 F.2d 839, 844.

Affirmed.


author: PHILLIPS, Chief Judge.

text:
    HARDING HOSPITAL, INC., Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
    No. 73-1661.
    United States Court of Appeals, Sixth Circuit.
    Nov. 13, 1974.

      Herbert R. Brown, Vorys, Sater, Seymour & Pease, Richard R. Stedman, Byron E. Ford, Columbus, Ohio, for plaintiff-appellant.
    William W. Milligan, U. S. Atty., Columbus, Ohio, Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Thomas R. Jones, Donald R. Anderson, Elmer Kelsey, Murray S. Horwitz, Tax Div., Dept, of Justice, Washington, D. C., for defendant-appellee.
    Before PHILLIPS, Chief Judge, and EDWARDS and PECK, Circuit Judges.
   PHILLIPS, Chief Judge.

The sole issue presented in this appeal is whether Harding Hospital, Inc. (the Hospital) qualified under § 501(c)(3) of the Internal Revenue Code of 1954 as an organization exempt from federal income taxes during the years 1966, 1967 and 1968. The District Court determined, inter alia, that the Hospital was not operated exclusively for charitable purposes and denied the exemption. We affirm.

I.

Reference is made to the opinion of the District Court for a comprehensive statement of the facts. 358 F.Supp. 805, 806-810 (S.D.Ohio 1973).

The Hospital commenced this civil tax refund suit to recover $141,730 from the United States. That sum represented the aggregate amount of income taxes which the Hospital paid for the three years in question.

The Hospital, a nationally recognized psychiatric institution, treats mental and nervous diseases. It utilizes a method of treatment known as milieu therapy in which a patient’s total environment is controlled on an around the clock basis and structured toward rehabilitation.

The Hospital was originally a corporation for profit. In December 1961, its articles of incorporation were amended to adopt its present name and to qualify under Ohio law as a corporation not for profit. In the reorganization, the shareholders of the predecessor corporation exchanged their stock which was valued at approximately $3,800 per share for notes having a face value of $3,000 per share and bearing interest at the annual rate of four per cent.

The reorganization was carried out along guidelines established through conferences with officials of the Exempt Organizations Branch of the Internal Revenue Service (IRS). In 1962 the IRS issued a tentative ruling that the Hospital was exempt from paying federal income taxes under § 501(c)(3) of the Code. In a letter dated December 1, 1965, the IRS indicated that it proposed to revoke the tentative exemption ruling issued in 1962. On November 14, 1968, the District Director of the IRS issued a determination letter revoking the tentative ruling of 1962. The Hospital was declared not to be exempt and thus was required to file federal income tax returns. Since the Hospital had relied on the 1962 ruling, the IRS determined that the revocation of the 1962 ruling would not be applied prior to January 1, 1966.

Before amending its articles of incorporation, the Hospital had a contract with a medical partnership composed of seven doctors. This medical partnership performed all the psychiatric treatment on ninety to ninety-five per cent of the patients admitted to the Hospital. Immediately after the Hospital’s change in status in 1962, the medical partnership was incorporated as the Harding-Eyans Medical Associates, Inc. (the Associates).

Starting in 1962, and for the years in question, the Hospital entered into contracts with the Associates whereby the Associates provided medical supervision in the Hospital, teaching and supervision in the residency and other training programs, and medical service to the Hospital’s indigent patients without a charge or at a reduced rate. For these services, the Hospital paid the Associates an annual amount of $25,000. This amount was raised to $35,000 as of July 1, 1968. Further, the agreement provided that the Associates were to pay the Hospital $1,000 per month as rental for facilities, equipment and business office services. This rental was increased to $35,000 per year as of January 1, 1965. It subsequently was lowered to $15,000 per year as of July 1, 1968, at the same time that the amount which the Hospital paid the Associates for medical supervision was increased from $25,000 to $35,000.

Since 1963, individuals not connected with the Associates have constituted a majority of the Board of Trustees of the Hospital. During the years in question, the Board consisted of nine members, only two of whom had any connection with the Associates of the Hospital prior to the 1961 reorganization.

The Harding-Evans Foundation (the Foundation) was set up in 1959 and is an entity separate from the Hospital and the Associates. The Foundation is a tax exempt organization, the principal activity of which is to provide a residency program in the field of psychiatry for the physicians. The Foundation collects charitable funds and expends them on the residency training program at the Hospital.

II.

Since the early days of federal income tax law, corporations organized and operated exclusively for charitable, religious, educational and certain other purposes have been accorded exemption from the tax. Act of Oct. 3, 1913, c. 16, § II, G, 38 Stat. 172. The exemption is conferred in recognition of the benefit which the public derives from the activities of such organizations. See, e.g., Trinidad v. Sagrada Orden, 263 U.S. 578, 581, 44 S.Ct. 204, 68 L.Ed. 458 (1924); St. Louis Union Trust Co. v. United States, 374 F.2d 427, 432 (8th Cir. 1967).

“[T]he Government is compensated for the loss of revenue [caused by the exemption] by its relief from financial burden which would otherwise have tó be met by appropriations from public funds, and by the benefits resulting from the promotion of the general welfare.” H.Rep.No.1860, 75th Cong., 3d Sess., p. 19 (1939-1 Cum. Bull. (Part 2) 728, 742).

An exemption is an exception to the norm of taxation. An organization which seeks to obtain tax exempt status, therefore, bears a heavy burden to prove that it satisfies all the requirements of the exemption statute. The Supreme Court repeatedly has said that exemptions from taxation are not granted by implication. See, e.g., Mescalero Apache Tribe v. Jones, 411 U.S. 145, 156, 93 S.Ct. 1267, 36 L.Ed.2d 114 (1973), and authorities therein cited. The Tax Court has stated consistently that “[a] statute creating an exemption must be strictly construed and any doubt must be resolved in favor of the taxing power.” American Automobile Association v. Commissioner, 19 T.C. 1146, 1158 (1953); Associated Industries of Cleveland v. Commissioner, 7 T.C. 1449, 1464 (1946).

Section 501(a) of the Code provides that the following organizations, which are listed in § 501(c)(3), are exempt from federal income taxation:

“Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation, and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of any candidate for public office.”

In the context of the present case, this section essentially imposes three requirements for exemption: 1) the corporation must be organized and operated exclusively for charitable purposes; 2) no part of its net earnings may inure to the benefit of a private individual or shareholder; and 3) it cannot engage in certain lobbying and political activities. The Government stipulated that the Hospital did not offend the third requirement for exemption.

The requirements in § 501(c) (3) are stated in the conjunctive. A taxpayer’s failure to satisfy any one of them therefore causes a loss of the tax exemption. Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633 (8th Cir. 1963), cert. denied, 376 U.S. 969, 84 S.Ct. 1135, 12 L.Ed.2d 84 (1964). Consequently, the Hospital must satisfy both the first and second requirements listed above in order to qualify for exemption from income taxation during the years in question.

The term “exclusively”, as used in § 501(c)(3), means that an organization is not exempt if it has any substantial noncharitable purpose. Better Business Bureau v. United States, 326 U.S. 279, 283, 66 S.Ct. 112, 90 L.Ed. 67 (1945); Seasongood v. Commissioner, 227 F.2d 907, 910 (6th Cir. 1955). This view is supported by Treas.Reg. § 1.-501(c)(3)-l(c)(2) which states:

“An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. * •>:• * »

and by Treas.Reg. § 1.501(c) (3)-l(d) (1) (ii) which provides as follows:

“An organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.”

The term “charitable” is used in § 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as limited by the separate enumeration in § 501(c)(3) of other tax exempt purposes which may fall within the broad outlines of “charity” as developed by judicial decisions. Treas.Reg. § 1.501(c) (3)-l(d) (2).

The phrase “net earnings”, as used in § 501(c)(3), may include “more than the term net profits as shown by the books of the organization or than the difference between the gross receipts and disbursements in dollars.” Northwestern Municipal Ass’n v. United States, 99 F.2d 460, 463 (8th Cir. 1938). Earnings may inure to an individual in ways other than through the distribution of dividends. 6 Mertens, Law of Income Taxation, § 34.13, at 63 (1968 ed.).

“[I]f a particular individual or limited number of individuals reap commercial benefits from the operation of the instrumentality, though they do not do so by direct acquisition or payment over to them of its earnings, the earnings may nevertheless ‘inure’ to their ‘benefit’ within the intendment of such phrasing so as to destroy the exempt status.” Id. at 63-64.

See, e.g., Chattanooga Automobile Club v. Commissioner, 182 F.2d 551 (6th Cir. 1950), in which this court, speaking through Judge Martin, determined that the benefits of an automobile club, such as emergency road service, free tourist information and an insurance policy, inured to the benefit of private individuals. In that case, two automobile clubs affiliated with the American Automobile Association were denied tax exemptions.

The Commissioner’s standards relative to when a hospital is exempt under § 501(c)(3) are set forth in Rev.Rul. 56-185, 1956-1 Cum.Bull. 202, which provides in pertinent part:

“In order for a hospital to establish that it is exempt as a public charitable organization within the contemplation of section 501(c)(3), it must, among other things, show that it meets the following general requirements :
“1. It must be organized as a nonprofit charitable organization for the purpose of operating a hospital for the care of the sick. A nonprofit hospital chartered only in general terms as a charitable corporation can meet the test as being organized exclusively for charitable purposes. See Commissioner v. Battle Creek, Inc., 126 F.2d 405.
“2. It must be operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay. It is normal for hospitals to charge those able to pay for services rendered in order to meet the operating expenses of the institution, without denying medical care or treatment to others unable to pay. The fact that its charity record is relatively low is not conclusive that a hospital is not operated for charitable purposes to the full extent of its financial ability. It may furnish services at reduced rates which are below cost, and thereby render charity in that manner. It may also set aside earnings which it uses for improvements and additions to hospital facilities. It must not, however, refuse to accept patients in need of hospital care who cannot pay for such services. Furthermore, if it operates with the expectation of full payment from all those to whom it renders services, it does not dispense charity merely because some of its patients fail to pay for the services rendered.
“3. It must not restrict the use of its facilities to a particular group of physicians and surgeons, such as a medical partnership or association, to the exclusion of all other qualified doctors. Such limitation on the use of hospital facilities is inconsistent with the public service concept inherent in section 501(c) (3) and the prohibition against the inurement of benefits to private shareholders or individuals. It is recognized, however, that in the operation of a hospital there must of necessity be some discretionary authority in the management to approve the qualifications of those applying for the use of the medical facilities. The size and nature of facilities may also make it necessary to impose limitations on the extent to which they may be made available to all reputable and competent physicians in the area.
“4. Its net earnings must not inure directly or indirectly to the benefit of any private shareholder or individual. This includes the use by or benefit to its members of its earnings by way of a distribution of profits, the payment of excessive rents or excessive salaries, or the use of its facilities to serve their private interests. If provision is made in the bylaws for dividends, exemption will not be allowed even though no dividends have been declared. Exemption will not be defeated, however, merely because the shareholders or members might possibly at some future date share in the assets upon dissolution in the absence of a case of mala fides where there appears to be a plan on the part of the shareholder or individual to acquire assets on the dissolution of the corporation.
“A community hospital of the type supported partly by contributions from the general public and/or public grants from a city, county, or state, normally meets the requirements of section 501(c)(3) as a public charitable organization. It is formed for the purpose of furnishing hospital facilities to all persons in the community at the lowest possible cost and necessarily accepts patients who are unable to pay for hospital facilities in order to retain the support of the community. A nominal charity record for a given period of time, in the absence of charitable demands of the community, will not affect its right to continued exemption. On the other hand, a hospital formed by one or more physicians in a community who may own the capital stock thereof or rent the hospital facilities to a corporation which they control requires careful study to determine whether it is being operated in part to serve their interest, directly or indirectly. See I.T. 2421, C.B. VII-2, 150 (1928).”

The Commissioner modified Rev.Rul. 56-185, especially the second numbered paragraph thereof, in Rev.Rul. 69-545, 1969-2 Cum.Bull. 117. There the Com: missioner held that Hospital A as described therein qualified as a tax exempt charitable hospital even though it did not provide free or reduced rate services to indigents other than emergency care. Rev.Rul. 69-545 provides in part:

“In the general law of charity, the promotion of health is considered to be a charitable purpose. Restatement (Second), Trusts, sec. 368 and sec. 372; IV Scott on Trusts (3rd ed. 1967), sec. 368 and sec. 372. A nonprofit organization whose purpose and activity are providing hospital care is promoting health and may, therefore, qualify as organized and operated in furtherance of a charitable purpose. If it meets the other requirements of section 501(c)(3) of the Code, it will qualify for exemption from Federal income tax under section 501(a).
“Since the purpose and activity of Hospital A, apart from its related educational and research activities and purposes, are providing hospital care on a nonprofit basis for members of its community, it is organized and operated in furtherance of a purpose considered ‘charitable’ in the generally accepted legal sense of that term. The promotion of health, like the relief of poverty and the advancement of education and religion, is one of the purposes in the general law of charity that is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community, provided that the class is not so small that its relief is not of benefit to the community. Restatement (Second), Trusts, sec. 368, comment (b) and sec. 372, comments (b) and (c); IV Scott on Trusts (3rd ed. 1967), sec. 368 and sec. 372.2. By operating an emergency room open to all persons and by providing hospital care for all those persons in the community able to pay the cost thereof either directly or through third party reimbursement, Hospital A is promoting the health of a class of persons that is broad enough to benefit the community.
“The fact that Hospital A operates at an annual surplus of receipts over disbursements does not preclude its exemption. By using its surplus funds to improve the quality of patient care, expand its facilities, and advance its medical training, education, and research programs, the hospital is operating in furtherance of its exempt purposes.
“Furthermore, Hospital A is operated to serve a public rather than a private interest. Control of the hospital rests with its board of trustees, which is composed of independent civic leaders. The hospital maintains an open medical staff, with privileges available to all qualified physicians. Members of its active medical staff have the privilege of leasing available space in its medical building. (See Rev.Rul. 69-464, page 132, this Bulletin.) It operates an active and generally accessible emergency room. These factors indicate that the use and control of Hospital A are for the benefit of the public and that no part of the income of the organization is inuring to the benefit of any private individual nor is any private interest being served.
“Accordingly, it is held that Hospital A is exempt from Federal income tax under section 501(c)(3) of the Code.
«- * -x- -x -x- *
“Revenue Ruling 56-185, C.B. 1956-1, 202, sets forth requirements for exemption of hospitals under section 501(c)(3) more restrictive than those contained in this Revenue Ruling with respect to caring for patients without charge or at rates below cost. In addition, the fourth requirement of Revenue Ruling 56-185 is ambiguous in that it can be read as implying that the possibility of “shareholders” or “members” sharing in the assets of a hospital upon its dissolution will not preclude exemption of the hospital as a charity described in section 501(c)(3) of the Code. Section 1.-501(c) (3)-l(b) (4) of the regulations promulgated subsequent to Revenue Ruling 56-185 makes it clear, however, that an absolute dedication of assets to charity is a precondition to exemption under section 501(c)(3) of the Code.
“Revenue Ruling 56-185 is hereby modified to remove therefrom the requirements relating to caring for patients without charge or at rates below cost. Furthermore, requirement four has been modified by section 1.-501(c) (3)-l(b) (4) of the regulations.”

III.

Applying the above principles to the present case, we proceed to determine if the District Court was correct in holding that the Hospital “was operated almost exclusively for the benefit of the members of the . . . Associates and was not operated exclusively for charitable purposes.” 358 F.Supp. at 814. We bear in mind the admonition contained in Rev.Rul. 56-185:

“[A] hospital formed by one or more physicians in a community who may own the capital stock thereof or rent the hospital facilities to a corporation which they control requires careful study to determine whether it is being operated in part to serve their interest, directly or indirectly.” (Emphasis added.)

On its facts we consider this to be a much closer case than the decisions cited as precedent by the District Court. Maynard Hospital, Inc. v. Commissioner, 52 T.C. 1006 (1969); Sonora Community Hospital v. Commissioner, 46 T.C. 519 (1966), aff’d, 397 F.2d 814 (9th Cir. 1968); Lorain Avenue Clinic v. Commissioner, 31 T.C. 141 (1958). The 1961 reorganization was conducted pursuant to the advice of officials of the Exempt Organizations Branch of the IRS. The doctor-shareholders of the predecessor corporation indicated some degree of charitable intent in exchanging their stock appraised at approximately $3,800 per share for notes with a face value of $3,000. Further, the notes bore interest at a rate of four percent per annum, which was below the going rate. Control of the Board of Trustees of the hospital was taken out of the hands of the shareholders of the predecessor corporation. For the years in question, the Hospital had an independent board, unlike the hospitals in Maynard Hospital and Sonora Community Hospital.

Likewise, some educational, training and community-oriented programs were conducted at the Hospital, e.g., training program for psychiatric residents, training program for nurses and social workers, day care treatment program enabling patients to carry on jobs, halfway house for patients not sufficiently mentally ill to stay in the Hospital, family care program to place patients in a home situation. There is no indication that such programs existed in the hospitals in Maynard Hospital, Sonora Community Hospital or Lorain Avenue Clinic. The record demonstrates to our satisfaction, however, that these programs of the Hospital were either conducted by the Foundation, the tax exemption of which is not questioned, or were provided by the Hospital as a part of its regular program of care (not even in part on a planned free or below cost basis).

With respect to the provision of free • or below cost care, the Hospital relies on Rev.Rul. 69-545 in which the Commissioner held that a hospital qualified for exemption even though it did not provide free or reduced rate services to indigents other than emergency care. This regulation was ruled to be valid by a two-to-one decision in Eastern Kentucky Welfare Rights Organization v. Simon, 506 F.2d 1278 (D.C.Cir. 1974), rev’g 370 F.Supp. 325 (D.D.C. 1973). Judge J. Skelly Wright dissented, expressing the view that Rev.Rul. 69-545 is invalid.

We find it unnecessary in the present case to pass judgment on the validity of Rev.Rul. 69-545. The issue was neither briefed nor argued before us. Further, the combination of factors set forth in § IV of this opinion requires denial of the tax exemption even if Rev.Rul. 69-545 should be determined to be valid.

With respect to those educational and training programs conducted at the Hospital by the Foundation, we conclude that the Hospital’s participation in these programs is not sufficient to merit its tax exemption. The Hospital was established to provide psychiatric medical care. The Foundation was incorporated separately to conduct these educational and training programs. We have no basis whatsoever for holding clearly erroneous the following finding of the District Court:

“These programs . . . are not paid for by the Hospital but are directly and completely funded by the . Foundation which is an exempt organization .... of course, the Hospital receives the benefit of having the participating residents perform medical duties at the Hospital.” 358 F.Supp. at 812.

Since the Hospital does not fund these programs and in fact receives an incidental benefit from them a fortiori it cannot obtain a tax exemption on the basis of them.

Not only is this case considerably different than the precedents relied on by the District Court, but there are two Government contentions here which we feel compelled to reject. The Government contends that if the Associates did not have the Hospital’s facilities available they would no longer be able to practice milieu therapy. This contention is incorrect from both a factual and legal standpoint. There is convincing evidence in the record from several sources that the well qualified psychiatrists who practiced at the Hospital could be employed at another psychiatric institution if they so desired. Further, we know of no authority for the legal argument that because a hospital is needed by doctors to practice their specialty the hospital cannot claim a tax exemption. Acceptance of such a proposition might eliminate tax exemptions for a substantial number of hospitals in that nearly all medical specialists require a hospital in which to practice, e. g., surgeons and heart transplant specialists require highly specialized hospital facilities.

Equally misfounded is the Government’s contention that we should penalize the Hospital with loss of its tax exemption because the Associates’ milieu therapy type of treatment acts as a de facto limitation on the staff of the Hospital. See the third requirement of Rev.Rul. 56-185. To adopt such a proposition might effectively read out of the law the ability of any specialized hospital, e. g., milieu therapy psychiatric institution, cancer research hospital, skin treatment clinic, to acquire tax exempt status. To our knowledge, neither Congress nor the Commissioner has ever manifested such an intent, and it is not mandated by the third requirement of Rev.Rul. 56-185.

These two Government contentions, if upheld, might have a stifling effect on the creation of charitable hospitals which serve a special medical purpose. Such contentions disserve one of the congressional purposes behind § 501, i. e., to promote the creation of charitable institutions which provide health care.

IV.

Although there are factual differences between this case and the three cases relied on by the District Court, those differences are not dispositive. We find it impossible to conclude either that the Hospital was organized and operated exclusively for charitable purposes or that no part of its net earnings inured to the benefit of a private individual. Based on the five factors set forth below, we hold that the Hospital was not entitled to tax exemption under § 501(c)(3) during the years in question. We do not single out any one or combination of these factors as the consideration crucial to our holding. We conclude only that all these factors, as they occurred in the aggregate in this case, require denying the appellant Hospital the tax exemption for the years in question.

1) There is insufficient evidence that the appellant Hospital for the years in question “held itself out to the public even in a limited way as a charitable institution.” Sonora Community Hospital, supra, 46 T.C. at 526. Insofar as the record reveals, the only significant charitable donations which the Hospital received during the years in question, if any, were contributions of Hospital notes held by the Associates.

2) The Hospital did not have a specific plan or policy for the treatment of charity patients during the years in question. Rather, as its Medical Director admitted, practically all patients presented themselves as paying patients and only when their funds were exhausted did the Hospital treat them on a charitable basis.

We are cognizant of the statistics which reveal that the ratio of uncompensated services to total revenue at the Hospital ranged from 4.25 per cent to 7.78 per cent for the years in question. These figures admittedly are higher than those for some other area hospitals and those hospitals for which exemptions have been denied. Maynard Hospital, supra, 52 T.C. at 1026 (Charity work constituted less than one per cent of total expenses); Sonora Community Hospital, supra, 46 T.C. at 524, 526 (Charity work was less than one per cent of paid care); Lorain Avenue Clinic, supra, 31 T.C. at 146, 161. (No records were produced to show the amount of free care, if any.)

The appellant Hospital cannot be considered in the' same class as the hospitals which were granted exemptions in Intercity Hospital Ass’n v. Squire, 56 F.Supp. 472 (W.D.Wash.1944) and Davis Hospital, Inc., 11 P-H Tax Ct. Mem. 344 (1945). In Intercity Hospital, the hospital had “an extremely liberal rule concerning admittance of patients without funds .... no questions whatever were asked and no statement required of financial standing nor ability to pay immediately or prospectively.” 56 F.Supp. at 473-474. In Davis Hospital, “large numbers of poor and indigent persons . . . [were admitted to the hospital although they] were financially unable to pay the cost or reasonable value of the necessary medical, surgical, nursing and hospitalization services.” 11 P-H Tax Ct. Mem. at 346. Both of these institutions, unlike the appellant Hospital, had definite plans or policies for the admission of charity patients.

The Hospital refers to two other psychiatric institutions, the Shepherd-Pratte Hospital in Towson, Maryland, and the Menninger Clinic in Topeka, Kansas, as being tax exempt and having lower ratios of uncompensated services to total revenue than the appellant Hospital. The Hospital neglects to state that the Shepherd-Pratte Hospital operates a community health center and the Menninger Clinic operates a ghetto clinic, both of which provide medical services to indigents regardless of their ability to pay. Each of these programs constitutes a specific plan or policy on the part of these two institutions for the treatment of charity patients.

3) Since the doctors who were members of the Associates treated between ninety and ninety-five per cent of the patients admitted to the Hospital, they derived substantial benefit from the existence and operation of the Hospital. This was the primary source of the doctors’ professional income. Although the Hospital did not pay over any of its net earnings to the Associates, except for the annual sum for supervision, this virtual monopoly by the Associates of the patients permitted benefits to inure to the Associates within the intendment of the statute. Sonora Community Hospital, supra, 46 T.C. at 526; 6 Mertens, Law of Federal Income Taxation, § 34.-13, at 63-64 (1968 ed.).

4) Associates also benefitted from the agreement with the Hospital whereby the Associates paid $35,000 annually as rental for office space, equipment, and business office services. See the fourth requirement of Rev.Rul. 56-185. The $35,000 amount was reduced to $15,000 as of July 1, 1968. According to Rev. Rui. 56-185, leasing office space in a hospital to doctors at a fair rental value does not per se detract from the charitable character of the Hospital’s status, although it raises a question as to the need, for further investigation. Leasing of office space to individual staff members contributes importantly to hospital functions by increasing efficiency, encouraging fuller utilization of facilities, and improving the quality of medical care. Rev.Rul. 69-464, 1969-2 Cum. Bull. 132.

The Hospital introduced the testimony of an appraiser who indicated, in sum, that the $35,000 figure was a fair rental for the office space. That essentially meant that the Associates were not adequately compensating the Hospital for the use of the equipment and business office services (including secretarial assistance). Further, when the annual rental was reduced to $15,000, the Associates were not adequately compensating the Hospital for office space alone.

5) The Associates also received a private benefit from the agreement whereby the Hospital paid an annual sum of either $25,000 or $35,000 to the Associates for hospital supervision. Although the doctors who were members of the Associates did not receive any fees from the pharmacy or laboratory, as the doctors did in Maynard Hospital, supra, and Sonora Community Hospital, supra, respectively, the doctors in the instant case did receive some compensation (a portion of the annual sum) for supervision of the pharmacy and laboratory. The other portion of the annual sum was attributed to nursing supervision and general supervision of the Hospital.

The Hospital contends that by paying this sum it was spared the cost of employing a salaried Medical Doctor, which expenditure both the Shepherd-Pratte Hospital and the Menninger Clinic had. Assuming this claim to be factually accurate in all respects, it does not in our opinion negate our conclusion that the Associates received a private benefit from the agreement between it and the Hospital analogous to the benefits conferred in Maynard Hospital and Sonora Community Hospital.

On the basis of these five factors, the judgment of the District Court is affirmed.

No costs are taxed. Each party will bear its own costs on this appeal.

      . The record reveals that the doctors who were members of the Associates were well qualified, apparently unlike the doctors who founded the hospital in Sonora Community Hospital, supra, because they were “virtually tossed out of” another hospital. However, we cannot decide an issue of tax exemption on the basis of the doctors’ qualifications or whether the hospital involved is nationally known. The same standards for tax exemption apply to those hospitals as they do to hospitals of only local import and with less than outstanding medical staffs.

      . In § III hereof we refrained from reaching a conclusion as to the validity of Rev.Rul. 69-545. We also leave open the question of whether the sole provision of an emergency room open to all constitutes a specific plan or policy for tlie treatment of charity patients.