author: RONEY, Circuit Judge:

text:
    KRIVO INDUSTRIAL SUPPLY COMPANY and Morgan Precision Parts, Inc., et al., Plaintiffs-Appellants, v. NATIONAL DISTILLERS AND CHEMICAL CORPORATION, Defendant-Appellee.
    No. 72-1710.
    United States Court of Appeals, Fifth Circuit.
    Aug. 7, 1973.

      Samuel G. McKerall, James L. Shores, Birmingham, Ala., Lewis & Burns, Robert E. Lewis, Hawkins, Rhea, Keener & Cusimano, Gadsden, Ala., for plaintiffs-appellants.
    Reid B. Barnes, Robert McDavid Smith, Birmingham, Ala., for defendant-appellee.
    Before GEWIN, GODBOLD and RONEY, Circuit Judges.
   RONEY, Circuit Judge:

Plaintiffs, ten creditors of a now reorganized corporation, individually sued National Distillers and Chemical Corp., the major creditor of that corporation, on their debts. Finding that the cases all involved common questions of law and fact, the District Court consolidated them for trial on the single issue of liability. The issue of damages was severed and was reserved for subsequent proceedings. The alleged liability of National Distillers was predicated upon the rule that, when one corporation controls and dominates another corporation to the extent that the second corporation becomes the “mere instrumentality” of the first, the dominant corporation becomes liable for those debts of the subservient corporation attributable to an abuse of that control. After hearing plaintiffs’ evidence, the District Court granted a directed verdict in favor of National Distillers. We affirm, finding that the evidence was insufficient to establish a jury question as to the presence of the requisite degree of control.

I. The Law

In this diversity suit, federal law provides the procedural standard against which we must judge the propriety of the directed verdict, and Alabama law provides the substantive legal context within which we must scrutinize the evidence.

Directed Verdicts

The standard for reviewing a directed verdict is set out in Boeing Co. v. Shipman, 411 F.2d 365 (5th Cir. 1969):

On motions for directed verdict and for judgment notwithstanding the verdict the Court should consider all of the evidence — not just that evidence which supports the non-mover’s case —but in the light and with all reasonable inferences most favorable to the party opposed to the motion. If the facts and inferences point so strongly and overwhelmingly in favor of one party that the Court believes that reasonable men could not arrive at a contrary verdict, granting of the motions is proper. On the other hand, if there is substantial evidence opposed to the motions, that is, evidence of such quality and weight that reasonable and fair- . minded men in the exercise of impartial judgment might reach differing conclusions, the motions should be denied, and the case submitted to the jury. A mere scintilla of evidence is insufficient to present a question for the jury. The motions for directed verdict and judgment n.o.v. should not be decided by which side has the better of the case, nor should they be granted only when there is a complete absence of probative facts to support a jury verdict. There must be a conflict in substantial evidence to create a jury question. However, it is the function of the jury as the traditional. finder of the facts, and not the Court, to weigh conflicting evidence and inferences, and determine the credibility of witnesses.

411 F.2d at 374-375.

On appeal, then, the party against whom a verdict was directed must demonstrate the existence of a conflict in substantial evidence. He must show that, at trial, he introduced sufficient evidence so that reasonable men, weighing all the evidence, might reach different conclusions. Backer v. Coursey, 472 F.2d 887 (5th Cir. 1973); Jones v. Concrete Ready-Mix, Inc., 464 F.2d 1323 (5th Cir. 1972); Trawick v. Manhattan Life Ins. Co., 447 F.2d 1293 (5th Cir. 1971).

The “Instrumentality” Doctrine

We note at the outset that the case before us involves only the question of National Distillers’ liability under the “instrumentality” theory. It involves no question of fraud, deceit, or misrepresentation. Nor does it involve charges that National Distillers received large amounts of security for small debt and made excessive, overreaching profits through foreclosure. Hence, we must examine the evidence exclusively within the framework of the narrow rule of corporation law known as the “instrumentality” doctrine.

Basic to the theory of corporation law is the concept that a corporation is a separate entity, a legal being having an existence separate and distinct from that of its owners. This attribute of the separate corporate personality enables the corporation’s stockholders to limit their personal liability to the extent of their investment. But the corporate device cannot in all cases insulate the owners from personal liability. Hence, courts do not hesitate to ignore the corporate form in those cases where the corporate device has been misused by its owners. The corporate form, however, is not lightly disregarded, since limited liability is one of the principal purposes for which the law has created the corporation.

One of the most difficult applications of the rule permitting the corporate form to be disregarded arises when one corporation is sought to be held liable for the debts of another corporation. A corporation may become liable for the debts of another corporation in two ways. First, expressly or impliedly, it may assume responsibility for those debts by indicating to the creditors of the other corporation that it stands behind those debts as a guarantor. In this situation, one separate and distinct corporation becomes responsible for the debts of another separate and distinct corporate entity. The corporate form of each remains intact and liability is not predicated upon disregarding the corporate form of the debtor. Second, a corporation may be held liable for the debts of another corporation when it misuses that corporation by treating it, and by using.it, as a mere business conduit for the purposes of the dominant corporation. See generally 1 W. Fletcher, Cyclopedia of the Law of Private Corporations § 43 (perm. ed. rev. 1963). The rationale for holding the dominant corporation liable for the subservient corporation’s debts is that, since the dominant corporation has misused the subservient corporation’s corporate form by using it for the dominant corporation’s own purposes, the debts of the subservient corporation are in reality the obligations of the dominant corporation. In these cases, “the courts will look through the forms to the realities of the relation between the companies as if the corporate agency did not exist and will deal with them as the justice of the case may require.” United States v. Reading Co., 253 U.S. 26, 63, 40 S.Ct. 425, 434, 64 L.Ed. 760 (1920); cf. Chicago, Milwaukee & St. Paul Ry. Co. v. Minneapolis Civic & Commerce Ass’n, 247 U.S. 490, 38 S.Ct. 553, 62 L.Ed. 1229 (1918). Here, then, the corporate form of the subservient corporation is disregarded so as to affix liability where it justly belongs. Plaintiffs’ claim in this case is based on this second theory of liability.

In formulating a basis for predicating liability of a dominant corporation for the acts or omissions of another corporation, courts have developed various legal theories and descriptive terms to explain and to describe the relationship between a dominant and a subservient corporation. For example, under the “identity” theory the separate corporate identities are disregarded and both corporations are treated as one corporation. See United States v. Lehigh Valley R.R. Co., 220 U.S. 257, 31 S.Ct. 387, 55 L.Ed. 458 (1911). Alternatively, a subservient corporation may be labeled the instrument, agent, adjunct, branch, dummy, department, or tool of the dominant corporation. See, e. g., Constitution Publishing Co. v. Dale, 164 F.2d 210 (5th Cir. 1947); Birmingham Realty Co. v. Crossett, 210 Ala. 650, 98 So. 895 (Ala.1923). “Instrumentality” is perhaps the term most frequently employed to describe the relationship between a dominant corporation and its subservient corporation, and Alabama law follows this characterization. In Forest Hill Corp. v. Latter & Blum, Inc., 249 Ala. 23, 29 So.2d 298 (Ala.1947), the Alabama Supreme Court stated:

The notion of separate corporate existence will not be recognized where a corporation is so organized and controlled and its business conducted in such a manner as to make it merely an instrumentality of another, and in such circumstances the fiction may not be prosecuted to permit the corporation to evade its just responsibilities.

29 So.2d at 302. See also Brown v. Standard Casket Mfg. Co., 234 Ala. 512, 175 So. 358 (1937); Birmingham Realty Co. v. Crossett, supra.

Nevertheless, the mere incantation of the term “instrumentality” will not substitute for rigorous, tough-minded analysis. Professor Ballantine once described this aspect of the law of corporations as a “legal quagmire,” Ballantine, Separate Entity of Parent and Subsidiary Corporations, 14 Cal.L.Rev. 12, 15 (1925), and Justice Cardozo observed that these cases tend to be “enveloped in the mists of metaphor.” Berkey v. Third Avenue Ry. Co., 244 N.Y. 84, 155 N.E. 58, 61 (1926). Moreover, the very term “instrumentality” is a poor one because all corporations are in one sense “instru-mentalities” of their stockholders. See May Dept. Stores Co. v. Union Electric Light & Power Co., 341 Mo. 299, 107 S. W.2d 41 (1937).

To counteract the dangers of a legal analysis based upon ambiguous metaphors and to avoid the trap of mere definitionalism, the case law has developed a more concrete test to guide the application of the “instrumentality” doctrine. Although the Alabama courts have yet to delineate a more precise test, the parties in the case at bar agree, and we agree, that two elements are essential for liability under the “instrumentality” doctrine. First, the dominant corporation must have controlled the subservient corporation, and second, the dominant corporation must have proximately caused plaintiff harm through misuse of this control. See Berger v. Columbia Broadcasting System, Inc., 453 F.2d 991 (5th Cir.), cert. denied, 409 U. S. 848, 93 S.Ct. 54, 34 L.Ed.2d 89 (1972) (applying New York law); see also National Bond Finance Co. v. General Motors Corp., 238 F.Supp. 248 (W.D.Mo. 1964) , aff’d, 341 F.2d 1022 (8th Cir. 1965) ; Huski-Bilt, Inc. v. First-Citizens Bank & Trust Co., 271 N.C. 662, 157 S.E.2d 352 (1967).

In considering the first element, that of control, the courts have struggled to delineate the kind of control necessary to establish liability under the “instrumentality” rule. Two problem areas have persistently tx’oubled the process of ascertaining the extent of control. First, to what extent is stock ownership critical, and second, how much weight should be given to the existence of a cx’editor-debtor relationship in those cases where the debtor corporation is alleged to be the “instrumentality” of its creditor ?

As to the effect of stock ownership, an examination of the case law in this area indicates that the fact that the allegedly dominant corporation held an ownership interest in another, allegedly subservient, corporation does not, per se, resolve the question of control. For example, in Owl Fumigating Corp. v. California Cyanide Co., 24 F.2d 718 (D.Del. 1928), aff’d, 30 F.2d 812 (3d Cir. 1929), the allegedly dominant corporation owned all of the stock of another corporation. The District Court, in rejecting an attempt to establish liability on the part of the defendant by disregarding the corporate form of the allegedly subservient corporation, found that defendant had done nothing beyond the authority legally vested in it as a creditor and a stockholder.

On the other hand, the fact that the allegedly dominant corporation held no stock ownership interest in the allegedly subservient corporation has not precluded application of the “instrumentality” rule where actual and total control has been otherwise established.

For example, in Baltimore & Ohio Tel. Co. v. Interstate Tel. Co., 54 F. 50 (4th Cir. 1893), the defendant did in fact own all of the stock of the debtor corporation, but the Fourth Circuit recognized that broader principles, especially the actual exercise of direction, management, and control over the debtor cox;poration, governed its decision. Liability flowed from control, whether that control arose out of the defendant creditor’s actions as “sole beneficial owner of all [of the debtor corporation’s] stock, or as creditor who had made large advances . . . .” 54 F. at 54.

In Henderson v. Rounds & Porter Lumber Co., 99 F.Supp. 376 (W.D.Ark. 1951), the defendant contended that liability was precluded since it did not own a majority of the capital stock of the subservient corporation. Rejecting that view, the District Court stated: “the real basis of liability is actual control and manipulation of [the subservient corporation], whether that control and manipulation be exercised by virtue of stock ownership or otherwise.” 99 F. Supp. at 383-384.

In Portsmouth Cotton Oil Refining Corp. v. Fourth National Bank, 280 F. 879 (M.D.Ala.), aff’d, 284 F. 718 (5th Cir. 1922), the defendant bank owned no stock in the debtor corporation, but the two entities had interlocking directorates and common shareholders. Affirming a verdict that disregarded the corporate form of the debtor corporation in order to affix liability to the defendant bank, this Court refused to be bound by the paper technicalities of the relationship, and stated:

The important question is whether the defendant bank managed, operated, and controlled the [debtor], and the fact that the latter had a valid corporate existence was wholly immaterial.

284 F. at 719.

As with stock ownership, a creditor-debtor relationship also does not per se constitute control under the “instrumentality” theory. The general rule is that the mere loan of money by one corporation to another does not automatically make the lender liable for the acts and omissions of the borrower. See Peterson v. Chicago, Rock Island & Pacific Ry. Co., 205 U.S. 364, 27 S.Ct. 513, 51 L.Ed. 841 (1907); Henderson v. Rounds & Porter Lumber Co., supra. The logic of this rule is apparent, for otherwise no lender would be willing to extend credit. The risks and liabilities would simply be too great. Nevertheless, lenders are not automatically exempt from liability under the “instrumentality” rule. If a lender becomes so involved with its debtor that it is in fact actively managing the debtor’s affairs, then the quantum of control necessary to support liability under the “instrumentality” theory may be achieved.

An examination of “instrumentality” cases involving creditor-debtor relationships demonstrates that courts require a strong showing that the creditor assumed actual, participatory, total control of the debtor. Merely taking an active part in the management of the debtor corporation does not automatically constitute control, as used in the “instrumentality” doctrine, by the creditor corporation.

The broad scope permitted creditors to institute various restrictions on the activities of their debtors is exemplified by Chicago Mill & Lumber Co. v. Boatmen’s Bank, 234 F. 41 (8th Cir. 1916). In Chicago Mill & Lumber Co., a bank lent large sums of money to a mill and land company. To protect its investment, the bank had its assistant cashier elected president of the debtor company. The manager of the company testified that he took his directions from either the president of the bank or the assistant cashier who headed the company. After the company went into bankruptcy, a creditor sued the bank on the theory that the bankrupt company had been merely a department of the bank and that the bank’s arrangements for monitoring the activities of its debtor entitled the plaintiff to a jury determination of whether or not the company was in fact controlled by the bank.

Affirming the District Court’s directed verdict in favor of the bank on the issue, the Eighth Circuit accorded great importance to the fact that “the bank was a large creditor, and as such largely interested in the prosperity of the company, and most naturally should desire to keep an oversight over its doings.” 234 F. at 46. Referring to various statements attributed to bank personnel indicating that the bank owned the company or was conducting the company’s business in the bank’s behalf, the Court stated:

Comprehensively speaking, they are all easily and naturally referable to a legitimate and customary practice of keeping an oversight by a creditor over the business, management, and operations of a debtor of doubtful solvency. All the facts of this case and all the reasonable inferences deducible from them would not, in our opinion, have warranted a jury in finding . that the [bank] was carrying on the business of the [company] as a part of its own ....

Id. See also American Southern Trust Co. v. McKee, 173 Ark. 147, 293 S.W. 50 (1927) (contract by which creditor banks made further advances to debtor bank, sent their agent to protect their interests by looking after collateral, loans, and collections, and required debt- or to keep cash deposits with them, cannot be construed as authority to take over debtor bank, or to control or manage it).

Not all “instrumentality” cases that involve creditor-debtor pressures result in findings of no liability. But in the cases resulting in “instrumentality” liability for the creditor, the facts have unmistakably shown that the subservient corporation was being used to further the purposes of the dominant corporation and that the subservient corporation in reality had no separate, independent existence of its own.

This absence of an independent corporate purpose is most apparent in those cases in which the dominant corporation, to further its own corporate purposes, either organized or acquired the subservient corporation.

For example, in Centmont Corp. v. Marsch, 68 F.2d 460 (1st Cir. 1933), cert. denied, 291 U.S. 680, 54 S.Ct. 530, 78 L.Ed. 1068 (1934), a railway company organized another corporation to build an addition to the railway company’s line. Affirming the District Court’s conclusion that the corporation was a mere instrumentality of the railway company, the First Circuit found the evidence overwhelming that the subservient corporation had been established and had been operated solely for the purposes of the dominant railway company.

In American National Bank v. National Wall-Paper Co., 77 F. 85 (8th Cir. 1896), the Eighth Circuit affirmed the jury verdict in favor of a plaintiff who had sued a bank on the debt of a corporation organized by the bank. Again, liability under the “instrumentality” rule was predicated largely upon the absence of a separate corporate purpose of the subservient corporation:

One reading the testimony in the case cannot wink so hard as not to see that the [subservient corporation] was a creation of the bank for its own purposes, that the business conducted in the name of this new creation was the bank’s business, and that the bank was the recipient of the proceeds of the business, and was fully advised of all that was going on, including the purchase of the goods from the plaintiff.

77 F. at 91.

In Henderson v. Rounds & Porter Lumber Co., supra, the dominant corporation was held liable for the debts of its bankrupt subservient corporation because the evidence was clear that the bankrupt corporation had been formed to further the corporate purposes of the dominant corporation and had been controlled and manipulated to the extent that it had no separate corporate existence of its own. See also In re Otsego Waxed Paper Co., 14 F.Supp. 15 (W.D. Mich.1935) (dominant corporation operated subservient corporation as a division) ; Portsmouth Cotton Oil Refining Corp. v. Fourth National Bank, supra (bank organized subservient corporation for the sole purpose of handling property owned by the bank).

In summary, then the control required for liability under the “instrumentality” rule amounts to total domination of the subservient corporation, to the extent that the subservient corporation manifests no separate corporate interests of its own and functions solely to achieve the purposes of the dominant corporation. As Professor Fletcher states:

The control necessary to invoke what is sometimes called the “instrumentality rule” is not mere majority or complete stock control but such domination of finances, policies and practices that the controlled corporation has, so to speak, no separate mind, will or existence of its own and is but a business conduit for its principal.

1 W. Fletcher, supra, § 43 at 204-205. No lesser standard is applied in “instrumentality” cases involving a creditor-debtor relationship. As the Court said in In re Kentucky Wagon Mfg. Co., 3 F.Supp. 958, 963 (W.D.Ky.1932), aff’d, 71 F.2d 802 (6th Cir.), cert. denied, Laurent v. Stites, 293 U.S. 612, 55 S.Ct. 142, 79 L.Ed. 701 (1934), “[i]t is to be noted that it is not ‘controlling influence’ that is essential. It is actual control of the action of the subordinate corporation.”

In addition to actual and total control of the subservient corporation, the “instrumentality” rule also requires that fraud or injustice proximately result from a misuse of this control by the dominant corporation. Berger v. Columbia Broadcasting System, Inc., supra-, see National Bond Finance Co. v. General Motors Corp., supra. Alabama emphatically rejects actual fraud as a necessary predicate for disregarding the corporate form, holding instead that courts may decline to recognize corporate existence whenever recognition of the corporate form would extend the principle of incorporation “beyond its legitimate purposes and [would] produce injustices or inequitable consequences.” Forest Hill Corp. v. Latter & Blum, Inc., supra, at 302.

This is the better rule, for the theory of liability under the “instrumentality” doctrine does not rest upon intent to defraud. It is an equitable doctrine that places the burden of the loss upon the party who should be responsible. The basic theory of the “instrumentality” doctrine is that the debts of the subservient corporation are in reality the obligations of the dominant corporation.

II. The Factual Background

Because the facts are critical in cases under the “instrumentality” rule, we detail the events and transactions tending to illuminate the relationship between the defendant National Distillers and Brad’s Machine Products, Inc., for whose debts the plaintiff creditors seek to hold National Distillers responsible.

Brad’s Machine Products, Inc., was a California corporation that began its existence as a machine shop in Stanton, California. Employing approximately 25 persons, Brad’s was owned by John C. Bradford and his wife Nola. In addition to the machine business, Bradford’s investments included a championship quarter horse, racing boats, airplanes, an Arizona bar, an Alabama motel, Florida orange groves, and oil wells. In addition, Bradford, a country and western singer, formed a motion picture company, Brad’s Productions, Inc., through which he produced a film that featured him as a singer. All of these investment activities were funded by his income from the machine shop.

The record shows that Bradford was an able and inventive machinist and that the California operation had been profitable. In 1966, Bradford saw potential profit in the munitions industry, so he employed Arnold Seitman to guide his entry into the Government contracting system. Seitman had previously supervised government contracting for a company in Gadsden, Alabama, and he soon obtained for Brad’s a 2.7 million dollar contract for the production of M-125 fuses, the principal component of which was brass.

Bradford’s skills as a machinist enabled him to develop a very efficient and unique system for manufacturing the fuse bodies. Instead of making them from a cored forging, Bradford machined them directly from brass rods two inches in diameter and eighteen feet long. This new technique was said to have revolutionized the manufacture of that particular fuse body.

In the latter months of 1966, Brad’s moved its entire operation from California to Gadsden, attracted by the availability of unskilled labor, lower wages, and cheaper plant acquisition costs. Brad’s operated in Gadsden, regularly employing about five hundred persons, until financial problems forced it to close in 1970.

For a brief time, Brad’s appeared to prosper. Bradford’s wide-ranging investments, however, soon became a severe financial drain on the Brad’s operation. One subsidiary, a Gadsden box plant that made wooden boxes for shells, alone lost over one million dollars. By the end of 1968, Brad’s was headed for financial distress.

The M-125 booster fuse assembly was the major product manufactured by Brad’s, accounted for ninety percent of its gross sales, and required substantial quantities of brass rods. In the beginning Brad’s had purchased its brass requirements from three sources: Revere Brass Company, Mueller Brass Company, and Bridgeport Brass Company. Brad’s principal source of supply was Bridgeport, and- Brad’s was one of Bridgeport’s larger customers. Bridgeport is a division of the defendant, National Distillers and Chemical Corporation.

In early 1969, Bridgeport was shipping approximately $400,000-1500,000 worth of brass rod to Brad’s every month. In March, 1969, Brad’s owed Bridgeport approximately $1,000,000 and Bridgeport, at the request of Brad’s, agreed to convert this arrearage to a promissory note. On March 28, 1969, Bridgeport accepted Brad’s note, secured by (1) the personal guaranties of John C. Bradford, Chairman of the Board and sole stockholder of Brad’s, and his wife and (2) a mortgage on real property owned by J-N Industries, Inc., a subsidiary of Brad’s located in Tucson, Arizona. The note was payable at the rate of $40,000 per month, plus interest on the unpaid balance, and it contained a “balloon agreement” under which the final payment in March of 1970 would equal the unpaid balance. Another provision stated that the note was to be extended to March 1, 1971, if, prior to April 1, 1970, Brad’s entered into another contract with the Government for the manufacture and sale of fuse bodies, with the same cash flow and the same economic benefits to Brad’s as under the then-current contract.

In connection with the agreement for deferred payment, Brad’s and Bridgeport entered into a “financing and loan agreement.” Under this agreement, Bridgeport agreed to continue to supply Brad’s with brass rod, so long as Brad’s paid for current brass shipments within fifteen or sixteen days (with a ten day grace period). Despite this condition, by the end of July, 1969, Bridgeport permitted Brad’s to build up an additional $630,000 in brass rod accounts payable.

On August 1, 1969, Bradford, Brad’s President E. J. Huntsman, and Brad’s Comptroller Roy Compton, went to New York to confer with representatives of National Distillers, including Assistant General Counsel and Secretary John F. Salisbury. The representatives of Brad’s stated that its current financial situation precluded continued operation unless it received additional assistance, including working capital. They blamed the unsuccessful attempts to diversify Brad’s as the reason for the company’s financial straits. Moreover, they needed immediate assistance because the Government had threatened to cancel the current fuse contract if the financial condition of Brad’s continued to worsen. Bradford offered to put up all the assets he and the company had in exchange for the additional funds and for National Distillers’ intervention with the Government on behalf of Brad’s.

At the close of the August 1, 1969, meeting, National Distillers and Brad’s reached an oral agreement in line with Bradford’s requests. National Distillers was to (1) provide internal financial management assistance to help Brad’s eliminate costly waste, (2) lend Brad’s another $600,000 in cash, (3) defer payment on the $630,000 accounts receivable, (4) help Brad’s and Bradford liquidate unprofitable holdings to provide more capital for Brad’s, and (5) intervene with the Government to prevent cancellation of the current fuse body contract. Brad’s and Bradford personally were to assign to National Distillers as collateral the various interests accumulated during the attempted diversification.

Salisbury immediately telephoned a Government official in Birmingham, Alabama, whose job included monitoring for the Defense Contract Administration Service the financial ability of Brad’s to perform its Government contracts, and assured him of National Distillers’ intent to aid Brad’s. On August 4, 1969, Brad’s executed notes for the $600,000 in cash and for the $630,000 in unpaid accounts receivable, with National Distillers taking a real estate mortgage on the Gadsden plant and premises and a security agreement covering the plant’s furniture and fixtures. Brad’s and Bradford also assigned to National Distillers certain shares of capital stock of other corporations, several oil and gas leases, and all of the capital stock of Brad’s Productions, Inc. These assets were to be sold and the proceeds were to be returned to the operating capital of Brad’s. To help the financial management at Brad’s, Leon Rudd, one of National Distillers’ “Internal Auditors” was sent to Gadsden to oversee its finances and to establish control procedures for managing cash and investments. ' Finally, Salisbury assigned one of his assistants to help him and Brad’s dispose of the assets assigned to National Distillers and other assets not so assigned. Under the terms of several agreements, both formal and informal, National Distillers agreed that any income or proceeds from these unassigned assets would be used for certain designated purposes in aid of Brad’s other creditors and then either would revert to Brad’s or to Bradford or would belong to National Distillers outright.

Rudd remained with Brad’s for fifteen months, during which National Distillers loaned Brad’s an additional $169,000 in cash and deferred another $667,131.28 in accounts payable by Brad’s to Bridgeport. Despite these transfusions, Brad’s ceased its operations in December, 1970. These suits resulted from debts left unpaid by Brad’s.

III. The Decision

After a comprehensive review of the testimony and exhibits presented by the plaintiffs in the District Court, and viewing the evidence in the light most favorable to the plaintiffs, we conclude that the evidence was not “of such quality and weight that reasonable and fair-minded men in the exercise of impartial judgment might reach different conclusions,” Boeing v. Shipman, supra, 411 F.2d at 374, on the issue of control. Keeping in mind that the kind of control prerequisite to liability under the “instrumentality” rule is actual, operative, total control of the subservient corporation, the evidence here was wholly insufficient to support a jury decision that Brad’s had “no separate mind, will or existence of its own and [was] but a business conduit” for National Distillers. The evidence is overwhelming that Brad’s maintained a separate, independent corporate existence at all times. Hence, the motion for a directed verdict in favor of defendants was properly granted.

In cases involving the “instrumentality” rule, we must take a broad approach to the question of control, examining all of the plaintiffs’ evidence to ascertain if the allegedly subservient corporation in fact had no separate corporate purposes or existence. In the case before us, plaintiffs presented evidence of (1) National Distillers’ ownership of majority control of Brad’s, (2) National Distillers’ view of its relationship to Brad’s, (3) the scope of National Distillers’ control over Brad’s, and (4) the alleged exploitation of Brad’s supposedly wrought through abuses of that control.

1. Although stock ownership is not per se determinative of the issue of control, see Baltimore & Ohio Tel. Co. v. Interstate Tel. Co., supra; Henderson v. Rounds & Porter Lumber Co., supra; Portsmouth Cotton Oil Refining Corp. v. Fourth National Bank, supra, it is a factor to be considered in assessing the relationship between two companies sought to be linked under the “instrumentality” rule.

Plaintiffs attempted to prove that the stock ownership of Brad’s had been transferred from John C. Bradford to National Distillers. Plaintiffs introduced (1) letters indicating that National Distillers intended to enter into an agreement with Bradford to assign the stock to National Distillers, (2) a memorandum dated August 13, 1969, and written by National Distillers’ credit manager, Zimmerman, indicating that the stock transfer was “in process,” and (3) a guaranty executed by National Distillers promising to repay a loan made to Brad’s, that referred to National Distillers as “a mortgage holder” of the Brad’s stock. Significantly, no one testified that the Brad’s stock was ever actually assigned. On the other hand, National Distillers’ Salisbury testified that, despite his earlier intent to take the stock, the transfer was never consummated because he feared endangering National Distillers’ mortgage interest. Salisbury also testified that the reference to National Distillers as “a mortgage holder” of the Brad’s stock was made at a time when National Distillers still intended to effect the transfer. Moreover, Seitman, who returned to Brad’s in September of 1969, who became its president and a director in February, 1970, and who certainly would have known whether the stock was transferred, testified unequivocably that no transfer ever was effected. Hence, plaintiffs failed to create an issue of fact on this point.

2. According to plaintiffs, the evidence shows that National Distillers believed that it had the power to control Bradford and his corporation and acted accordingly. A careful examination of this evidence, however, makes clear that National Distillers considered control of Brad’s to be, at most, only partly shared between National Distillers and Brad’s.

First, a letter from National Distillers’ Salisbury to the general manager of the movie company, Brad’s Productions, Inc., stated: “As I am sure you are aware, National Distillers and Chemical Corporation has taken an active role in the management and control of Brad’s Machine Products, Inc., and various other undertakings of John C. Bradford.” This letter, however, is not inconsistent with National Distillers’ argument, which we conclude is correct, that the evidence shows that Brad’s voluntarily shared control with National Distillers. The letter does not say that National Distillers had taken control of Brad’s; rather, it states only that National Distillers had “taken an active role in the management and control of Brad’s.”

Second, according to Compton’s testimony, National Distillers’ credit manager, Zimmerman, told him that National Distillers “had the power, authority to fire Bradford and run him off.” But the evidential importance of this statement is clarified by Compton’s preceding testimony: “he (Zimmerman) said that Mr. Bradford should be fired and control taken away from him, and the plant be run properly.” This language indicates that, although an employee of National Distillers may have felt that they should have taken control of Brad’s away from John Bradford, they had not done so. Moreover, Compton testified that he did not believe that National Distillers would fire Bradford.

Third, plaintiffs quote Seitman’s testimony that states that Salisbury at one time threatened to “fire” both Seitman and Bradford and run the Brad’s operation itself. A complete reading of Seit-man’s testimony indicates that he believed that National Distillers’ so-called power or authority to “fire” lay in its “control of the purse strings.” Seitman testified that National Distillers could not “have told Brad’s who its officers were to be,” and he then stated that he understood Salisbury to mean that National Distillers would cease extending credit to Brad’s if certain contracts were not fulfilled. Thus, it is plain that National Distillers could have “fired” Brad’s personnel only by cutting off credit or loans, thereby putting Brad’s out of business. The record contains no evidence showing that National Distillers conceived that it could have directed or implemented the replacement and selection of management personnel, absent credit control.

3. As to the scope of National Distillers’ alleged control, the evidence shows only that National Distillers’ activities were narrowly restricted to safeguarding its interests as a major creditor of Brad’s, that National Distillers participated in the corporate decision-making at Brad’s only to a limited degree, and that at no time did National Distillers assume actual, participatory, total control of Brad’s.

The thrust of plaintiffs’ contention here is that Leon Rudd, who was sent to the Gadsden plant by National Distillers in August, 1969, and who remained until late November, 1970, actively dominated the Brad’s decision-making apparatus during his stay.

A reading of the testimony, especially that of the Brad’s comptroller Compton, compels a conclusion that Rudd’s activities were much more circumscribed than appellants argue. Rudd, an internal auditor employed by National Distillers, was transferred to Brad’s in response to John Bradford’s request for assistance in establishing a system of internal controls. Rudd was not thrust upon Brad’s unwanted or unneeded.

Because many of the financial problems at Brad’s had been precipitated by improvident investments and uncontrolled spending, Rudd immediately moved to put himself in the position of monitoring Brad’s cash outlays. , According to Compton’s testimony, Rudd suggested, and they all “readily agreed,” that no purchase orders be sent out without his prior approval. Also, Rudd’s signature was made mandatory on all checks from the Brad’s accounts. From these “controls,” plaintiffs would extrapolate the theory that National Distillers, through Rudd, was in charge of Brad’s. Such a conclusion is untenable.

First, the evidence showed that, in fact, Rudd’s prior approval of purchase requisitions was not always necessary for purchases. At the trial, several of plaintiffs’ purchase orders, put in evidence for other purposes, were shown to have been made up and sent out without Rudd’s approval.

Second, assuming that Rudd in fact enjoyed such an all-powerful veto over purchases, this power was never exercised where Brad’s proper business purposes were involved-. Rather, Rudd voiced his displeasure only when expenditures were contemplated that were unrelated to the Brad’s machine shop operation.

Third, Rudd’s powers were essentially negative in character. The testimony showed that his function was to monitor the finances and to help Compton fend off aggressive, unhappy creditors. A1-. though plaintiffs contend that Rudd “participated in the management” of Brad’s, the evidence shows that he did so only in a limited sense. Only those decisions having an immediate effect on Brad’s financial position were subject to Rudd’s primary attention. He attended management meetings solely in that capacity. The record contains no evidence that he was ever substantially involved in personnel or production decisions. Rudd left the delicate task of renegotiating Government contracts to Compton. (After a Government contract had been completed, Government officials often reviewed the profits of the contracting firm, seeking the return of “excess profits.”)

Fourth, Rudd’s position as a required signatory on all checks drawn against the Brad’s general account provides little support for plaintiffs’ theory. Besides Rudd’s signature, the checks also required one other signer from Brad’s. Hence, Rudd again had but a veto power.

Plaintiffs argue that Rudd, using his power as a required signatory, expanded his powers into management (1) by negotiating and consummating settlements of disputed claims and (2) by designating the order in which creditors were to be paid. Once again, Compton’s uncon-tradieted testimony illuminates the extent of Rudd’s “control.” Because Brad’s had always been short of working capital, the practice had developed of writing checks to creditors as soon as a particular bill came due and then retaining the checks until there was money in the Brad’s account to pay the checks. As could be expected, irate creditors often called upon Compton to pay up. When Rudd arrived, he and Compton worked together handling creditors. Compton testified that theirs was a cooperative effort but that, since Rudd was more skilled in dealing with creditors, he had the final decision as to which creditors were paid. The factors they considered included (1) the amount of money in the account, (2) the importance of the creditor to the continued operation of the plant, (3) the age of the bill, and (4) the urgency or fervor of a particular creditor’s demand. In addition, Rudd often spoke with these creditors, attempting to forestall or to settle their demands.

Rudd’s activities while at Brad’s simply do not amount to active domination of the corporation. His job was to provide internal financial management assistance and all that he did was in keeping with this mission. Although he kept a fairly tight rein on disbursements, the evidence shows that his role was that of providing a centralized control over purchases and disbursements. His job was two-fold: (1) to eliminate costly duplication, e. g., multiple orders of the same supply, and (2) to eliminate all disbursements not directly and immediately related to the machine shop business. These controls were strong, and Rudd was not afraid to exercise his power, but we cannot conclude from the evidence before us that his activities could justify a jury verdict that found control. Rudd limited the scope of his position to overseeing the finances of Brad’s. Neither he nor anyone else from National Distillers or from Bridgeport Brass had much, if any, influence, let alone control, over other key areas of managerial decision-making at Brad’s.

In addition to Rudd’s activities, plaintiffs argue that other National Distillers personnel exercised control over Brad’s outside investments and production.

First, they contend that Salisbury and an assistant made the final decisions as to which assets of the “mini-conglomerate” to retain and which to liquidate. Compton testified that these efforts stemmed from Bradford’s earlier request for management assistance from National Distillers and that all the proceeds were returned to Brad’s to provide working capital. Although National Distillers’ personnel apparently did make the final decision on the disposition of these assets, in many cases this power may be traced to the transaction in which they were assigned to National Distillers for precisely such a disposition.

Second, Compton also testified that a vice president of Bridgeport, A1 Jones, visited Brad’s on a weekly basis for five or six months, offering his advice and assistance wherever the production personnel at Bi’ad’s might need it. Nowhere in the record is it indicated that Jones ever exercised any control over the production process. To the contrary, his function was that of a consultant, checking data and offering his analysis. Compton specifically testified that neither Rudd nor Jones was concerned with production quantity.

These activities of both Rudd and the other are not sufficient to establish the degree of control requisite to “instrumentality” rule liability. The evidence shows that, at most, National Distillers shared managerial responsibility for some but not all aspects of the Brad’s operation. That is not enough.

4. Finally, plaintiffs contend that control was shown indirectly by proving abuses of the Brad’s corporation by National Distillers that could have been accomplished only with the requisite control.

First, plaintiffs complain that Rudd did not exercise his supposed veto enough. They point to Rudd-approved disbursements for a new house for Bradford, for a Mercedes automobile for the Bradford family, and for racing boats. Plaintiffs argue that these examples represent the abuse of power and control by National Distillers. In view of Rudd’s limited functions at Brad’s, the only fair inference that can be drawn from this configuration of “abuses of control” is that, in fact, Rudd had very little control over John Bradford.

Second, plaintiffs contend that National Distillers forced Brad’s into disadvantageous brass transactions. According to plaintiffs, “freed of [National Distillers’] control, Brad’s could have sold a substantial portion of its scrap for a higher price than it received from Bridgeport, and purchased a substantial portion of its rod at a lower price than it paid to Bridgeport.”

Two brass contracts are involved. Purchase Order 4314 and Purchase Order 8600. According to P.O. 4314, dated September 30, 1968, Brad’s agreed to purchase from Bridgeport fifteen and one-half million pounds of half-hard free cutting brass rod at $.4184 per pound. Additionally, Bridgeport agreed to repurchase brass scrap at $.2575 and $.2675 per pound, based upon a 50% return of scrap. P.O. 4314 was agreed to, and the prices fixed, nearly a year before the August 1, 1969, meeting between the representatives of Brad’s and National Distillers and more than six months before the first note was executed, so no question of control arises as to its terms. P.O. 4314 remained in effect throughout the remainder of 1968, all of 1969, and until March 31,1970.

P.O. 8600 is the second purchase order. Dated March 17, 1970, it calls for 2.8 million pounds of brass rod at $.4834 per hundredweight with scrap to be repurchased at $.3225 and $.3325 per pound.

Brass Scrap — Plaintiffs’ argument as to the scrap is this:' Although P.O. 4314 required Brad’s to resell 50% of the brass as scrap to Bridgeport, it is undisputed that Brad’s returned 70% of the brass as scrap, 20% more than was contractually required. Moreover, plaintiffs produced evidence tending to show that Brad’s could have resold this extra scrap at a higher price than they received from Bridgeport. From these facts, plaintiffs deduce' transactions "that were unfavorable to Brad’s. That deduction is unwarranted.

First, the timing of these transactions must be considered. According to Seit-man, “the bulk” of the brass scrap was returned to Bridgeport before the August 1, 1969, meeting, well before the August 6, 1969, date established in the pretrial order as the beginning of the alleged domination.

Second, Seitman testified that the scrap was returned to Bridgeport voluntarily and in Brad’s trucks. Most importantly, Salisbury testified, and no contradictory testimony appears in the record, that Seitman had stated that the extra return was “inadvertent.” Up until October of 1969, when Seitman stopped the shipment of the extra 20%, apparently no one at Brad’s realized that the scrap returns exceeded contractual requirements. Nor is there any record evidence tending to show that Bridgeport realized that it was repurchasing more scrap than was contractually bound to repurchase.

Third, after Seitman stopped shipping the extra 20%, he met with the Bridgeport and the National Distillers representatives and negotiated an adjustment. Under this adjustment agreement, Brad’s would be credited at $.38 per pound for all scrap returned in November and December, 1969. This credit amounted to $117,000, which Brad’s received. Although Seitman testified that he was “not particularly satisfied” with these results, the record is clear that Bridgeport and Brad’s negotiated a settlement which benefited both parties. Brad’s had no contractual right to be paid a higher price for the excess scrap, yet Bridgeport adjusted the scrap prices when confronted with the unfairness of the situation.

Fourth, the very nature of the fluctuating brass scrap market indicates that it was not necessarily disadvantageous to Brad’s to return all of its scrap to Bridgeport. Although higher prices may have been available at times during the few months in question, employing Bridgeport as a guaranteed purchaser could be worth the price differential. As Salisbury testified, “you have got to have a home for your scrap, otherwise you will start to accumulate scrap without credit or sale, and it is so uneconomical.”

Brass Rod — Plaintiffs argue two separate points dealing with the brass rod transactions between Brad’s and Bridgeport :

As to the first contention, that Brad’s purchased brass rod from Bridgeport at a higher price than was required elsewhere, plaintiffs introduced a quotation from Scoville Manufacturing Company, dated February, 1970, offering a much smaller quantity of brass at a lower price than the quantity and price finally agreed to between Brad’s and Bridgeport in March, 1970. The Scoville quotation was not in reality a viable alternative source of supply. The Scoville quotation contained this requirement: “This quotation is subject to credit approval.” Seitman had underlined this sentence in the original and, in May, 1970, had sent it to National Distillers with the accompanying comment “I have underlined what could have been the problem area.” Testifying at the trial, Seitman explained that what he meant was that, as of February, 1970, Brad’s could not have shown a good credit report.

As to plaintiffs’ second contention, that Brad’s failed to exploit fully its contractual rights under the first purchase order, P.O. 4314, the evidence did not establish a substantial conflict on that point. To understand plaintiffs’ contention, a brief chronological analysis of the transactions involved is necessary. P.O. 4314, dated September 30, 1968, ordered fifteen and one-half million pounds of brass rod at $.4184 per pound. P.O. 4314 carried this notation: “Government contract No. DAAA09-69-C-0147.” On January 12, 1970, Brad’s advised Bridgeport that the contract then in production would require only 314,508 pounds more of brass rod and that Brad’s was therefore initiating a change order to reduce the original order from fifteen and one-half million pounds to 13,250,250 pounds. P.O. 8600, dated March 17, 1970, ordered 2.8 million pounds of brass rod at $.4834 per pound. P.O. 8600 carried a notation different from that of P.O. 4314: “Government contract #DAAA09-70-C-0198.” Thus, P.O. 8600 was for an entirely different Government contract.

The thrust of plaintiffs’ contention is this: why didn’t Brad’s just “carry over” the more than two million pounds of excess brass rod from P.O. 4314 to the second Government contract? Since P.O. 4314 priced brass rod at a lower price, substantial savings would have resulted from such a “carry over.”

There is no evidence that such a “transfer” could have been effected. Defendant’s evidence indicated that these purchase orders were keyed to specific Government contracts and represented the estimated quantity of brass needed for those particular contracts. Plaintiffs failed to show that Brad’s had a contractual right to the full amount of the brass rod ordered in P.O. 4314 if the particular Government contract with which it was associated was not completed.

Additionally, the time sequence shows that the option of “carrying over” from P.O. 4314 to P.O. 8600 was not available to Brad’s. Although P.O. 8600 is dated March 17, 1970, the specific Government contract to which it related was open for bids in the fall of 1969. Hence, Seitman contacted Bridgeport in September, 1969, and was given a quote, the price ultimately found in P.O. 8600. Brad’s winning bid, therefore, was based in part on the price quoted by Bridgeport on September 10, 1969. Since operations under the new Government contract did not start immediately, Seitman had no reason to issue a formal purchase order for the brass rod until March, 1970. Thus, by the January, 1970, quantity change in P. O. 4314, Brad’s and Bridgeport had already entered into a new, separate contract for brass rod, based on a rise in the brass market, for the new Government contract. P.O. 8600 merely implemented the commitment made six months earlier.

After considering the plaintiffs’ evidence in the most favorable light, it is plain that Brad’s never became an “instrumentality” of National Distillers. Although National Distillers’ position as a major creditor undoubtedly vested it with the capacity to exert great pressure and influence, we agree with the District Court that such a power is inherent in any creditor-debtor relationship and that the existence and exercise of such a power, alone, does not constitute control for the purposes of the “instrumentality” rule. See, e. g., Chicago Mill & Lumber Co. v. Boatmen’s Bank, supra. Plaintiffs had to show the exercise of that control in the actual operation of the debtor corporation. Accordingly, because plaintiffs failed to produce substantial evidence of such actual operative total control, we affirm the directed verdict granted by the District Court.

Because we hold that plaintiffs failed to establish the requisite degree of control, we do not reach the question of whether the case should have been tried before a judge or before a jury.

Costs will be taxed to appellants.

Affirmed.


source: Caselaw Access Project

author: J. JOSEPH SMITH, Circuit Judge:

license: Public Domain

text:
    W. T. GRANT COMPANY, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant,
    No. 770, Docket 72-2213.
    United States Court of Appeals, Second Circuit.
    Argued May 10, 1973.
    Decided Aug. 22, 1973.

      Jane M. Edmisten, Atty., Tax Div., Dept, of Justice (Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks and Paul M. Ginsburg, Attys., Tax Div., Dept, of Justice, Washington, D. C., of counsel), for appellant.
    A. Chauncey Newlin, New York City (White & Case, David Sachs, New York City, of counsel), for appellee.
    Before SMITH, MULLIGAN and TIMBERS, Circuit Judges.
   J. JOSEPH SMITH, Circuit Judge:

The Commissioner of Internal Revenue appeals from a decision of the Tax Court, Charles R. Simpson, Judge, reviewed by the court, reported at 58 T.C. 290 (1972), holding that taxpayer’s sales under its Coupon Book Installment Plan qualify for installment method treatment under § 453 of the Internal Revenue Code of 1954. We find that the sales do not qualify under the Code and the regulations 3 and reverse.

The facts are found in the Tax Court opinion and may be summarized as follows.

Grant’s provides its customers with three basic credit plans: (a) Special Purchase Installment Plan, a traditional single item installment plan; (b) 30-day Option Plan, a typical revolving credit plan; and (c) the Coupon Book Installment Plan, the plan at issue. Under the Special Purchase Installment Plan the customer enters into a retail credit agreement for individual purchases, and agrees to pay equal monthly installments over a fixed period of time. A service charge is included as part of the selling price. For the term of the contract, Grant’s retains a security interest in the item purchased.

The 30-Day Option Plan allows a customer, through use of a credit card, to charge to his account sales during the billing month which he may pay fully within thirty days without a service charge, or may elect to pay at least 10 per cent of the balance in the account each month. With this election the customer incurs a service charge calculated each month on the outstanding balance in the account. No security interest is retained in the merchandise.

Under the Coupon Book Installment Plan customers deemed good credit risks are given the opportunity to purchase coupon books whose coupons may be redeemed for merchandise in any Grant’s store. The books vary in value for $10 to $100 and contain coupons of various denominations. The books may be paid for in full or over a period of time pursuant to a retail credit agreement in which the customer agrees to pay a certain time price differential in addition to prescribed monthly payments. In the tax years in question the period was a minimum of four months, a maximum of eighteen months. During this period the coupons may be redeemed at any time and in any amount. Return of the coupons or merchandise, or payment in full of the outstanding balance of the obligation results in a reduction in the amount due, as well as a proportionate reduction in the time price differential.

Grant’s accounts for the special purchase plan sales and coupon books redemption in an identical manner. Sales under the coupon plan are deemed to occur when the coupons are redeemed, not when the coupon books are initially sold. The retail credit agreement, however, does indicate that the book is the item sold on which credit is extended. Grant’s does not keep records of coupon redemption for each customer account. Thus there is no means of correlating the sales of merchandise items to the installment payments.

The Tax Court found that the coupon book was an installment sale, a “sales arrangement whereby the selling price is collected in periodical installments” and “the selling of consumer goods on credit under conditional sales contracts that provided for regular periodic payments after an initial down payment.” The court resorted to the “common understanding of installment sale” as was done in Consolidated Dry Goods Co. v. United States, 180 F.Supp. 878 (D. Mass.1960). In Consolidated, Dry Goods, however, this was resorted to solely for lack of either a statutory or regulatory definition of installment sale. Regulatory definitions were quickly drawn up in response to Consolidated Dry Goods.

Congress in 1964 first adopted, but soon repealed a statutory definition, preferring to rely on the regulation. See 1964 U.S.Code Cong. & Admin.News p. 3320, S.Rep. No. 1242, 88th Cong., 2d Sess. Any determination, therefore, of Grant’s qualifying for § 453 treatment must be made in the context of the regulations. § 1.453-2(b)(1), (2).

Traditional installment sales, as characterized in § 453(1)(a) are covered by Treas.Reg. § 1.453-2(b) (1). Normally under these plans a separate contract is executed for each sale of personal property, and a security interest is retained in the property. Typical of such sales is the conditional sales contract. Sales falling within the second definition, § 1.-453-2(b)(2) include — contingent on certain proof — revolving credit plans, cycle budget accounts, flexible budget accounts, and other similar plans or arrangements for the sale of personal property under which the customer agrees to pay each billing month a part of the outstanding balance of his account.

Installment reporting was enacted as a relief provision to allow a merchant first to actually realize profits arising from deferred payment transactions before requiring that a tax be paid on the gain. Prendergast v. Commissioner, 22 BTA 1259, 1262 (1931). To qualify for the benefits of installment reporting the taxpayer has the obligation of showing that he is one of the intended beneficiaries of § 453, that in fact gain realized on his sales will be received in installments.

The primary distinction between § 1.453-2(b) (1) and § 1.453-2(b) (2) sales on installment plans focuses on this obligation of the taxpayer. Where there is a separate contract for each sale in which the parties contract for installment payments for the purchase of a particular item, the Commissioner will accept the provision for periodic payments as establishing such payments. Where, however, the parties’ contract covers a number of sales no specific intent is demonstrated as to any particular purchase; it is not unlikely then that while installment payments may be made on a great number of the sales, some will be paid in single payments. As intent cannot be demonstrated specifically proof of actual multiple payments is required. See S.Rep. No. 1242, supra, at 3320-3322; Emory, The Installment Method of Reporting Income: Its Election, Use and Effect, 53 Cornell L.Rev. 181,262-63 (1968).

The Congress, in the Revenue Act of 1964, as noted above, initially adopted the position suggested by the Tax Court here, and provided a statutory definition of installment sale so as to extend § 453 “to income received under any plan which provides for the payment by the purchaser for personal property sold to him in a series of periodic installments of an agreed part or installment of the debt due the seller.” Exception was made for sales essentially made as an ordinary charge account. See 1964 U.S. Code Cong. & Admin.News at pp. 1771-1772. Within the same year, however, the statutory definition was repealed, the Congress concluding “that it would have been better to have left the Treasury Department with the opportunity to determine by regulation the extent to which sales under revolving credit type plans are to be treated as sales under installment plans.” S.Rep. No. 1242, supra, U.S.Code Cong. & Admin.News at p. 3322.

In the context of the regulation’s definitions the similarities between the Special Purchase Installment Plan and the Coupon Book Installment Plan relied on by the Tax Court and appellee are of little significance. While the company uses the same accounting procedures for both plans, the basic distinction still exists — contract and accounts under the special purchase plan apply to a single sale item and thus reflect an intent as to the specific purchase and clearly correlate payments to individual sales while there is no correlation of payment and' purchase under the coupon book plan.

Underlying the court’s decision in the case at bar was the assumption that when a customer purchases a coupon book he is doing so in order to acquire an aggregate purchase of merchandise and to pay for it in installments. It discounted the possibility of small individual purchases that would be covered by the monthly payments, or delayed re-demptions, finding it unreasonable to believe that customers would incur an added finance charge without taking advantage of the extension of credit. Yet while it is true that overall the records of the company indicate that a great number of the coupons are redeemed quickly and frequently in a period of one month, there is evidence that a significant number are not immediately redeemed.

The evidence suggests the possibility that redemptions could be covered by single or prior payments. The proof procedures provided in § 1.453-2(d) were designed to cover this situation — sales where a large number are expected to be paid and are paid in installments, but may also be and are in some cases paid in full. The intent of Congress is clear; § 453 is to be extended to revolving credit plans, such as Grant’s subject however to the regulation and proof requirements deemed warranted by the Commissioner. At least some and possibly a substantial number of the purchases in the last month of the tax year are covered by a single month’s payment and were not intended to be the basis for tax deferral.

Grant’s chose the merchandising coupons method to avoid the expense and inefficiency of a separate credit contract for each small purchase; in doing so it lost the protection of the traditional installment sales presumption of periodic payment.

“A dealer who desires to compute income by the installment method shall maintain accounting records in such a manner as to enable an accurate computation to be made by such a method in accordance with the provisions of this section. . . . ” Treas.Reg. § 1.453-2(c)(1). Grant’s might either have used separate contracts or kept customer accounts of redemptions. It did neither and therefore cannot prove that it is eligible for § 453 relief. Tax deferral should not have been granted.

Reversed and remanded.

      . Internal Revenue Code of 1954 (26 U.S.C.) :

        “Sec. 453. Installment method.

      (a) [as amended by Sec. 3(a), Act of August 31, 1964, P.L. 88-539, 78 Stat. 746] Dealers in Personal Property.-
      (1) In general. — Under regulations prescribed by the Secretary or his delegate, a person who regularly' sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit, realized or to be realized when payment is completed, bears to the . total contract price.”

      . Treasury Regulations on Income Tax (1954 Code) (26 C.F.R.) :
      “§ 1.453-1 Installment method of reporting income.

      (a) In general. (1) Section 453 permits dealers in personal property, that is, persons who regularly sell or otherwise dispose of personal property on the installment plan, to elect to return the income from the sale or other disposition thereof on the installment method. To the extent provided in paragraph (d) of § 1.453-2, sales under a revolving credit type plan will be treated as sales on the installment plan and the income from the sales so treated may be returned on the installment method. A dealer who makes sales of personal property under both a revolving credit plan and a traditional installment plan may elect to report only sales under the traditional installment plan on the installment method; or he may elect to report only sales under the revolving credit plan on the installment method; or he may elect to report both sales under the revolving credit plan and the traditional installment plan on the installment method. A traditional installment plan usually has the following characteristics:
      (i) The execution of a separate installment contract for each sale of personal property, and
      (ii) The retention by the dealer of some type of security interest in such property. (2) The installment method may also be applied with certain limitations (see paragraph (c) of this section) to the sale or other disposition of real property and the casual sale or other casual disposition of certain personal property.
      § 1.453-2. Special rules applicable to dealers in personal property.

      :¡: íjt í]! í|t
      (b) Definition of sale on the installment plan. The term “sale on the installment plan” means—
      (1) A sale of personal property by the taxpayer under any plan for the sale or other disposition of personal property, which plan, by its terms and conditions, contemplates that each sale under the plan will be paid for in two or more payments, or
      (2) A sale of personal property by the taxpayer under any plan for the sale or other disposition of personal property—
      (i) Which plan, by its terms and conditions, contemplates that such sale will be paid for in two or more payments, and
      (ii) Which sale is in fact paid for in. two or more payments. Normally, a sale under a traditional installment plan (as described in paragraph (a) (1) of § 1.453-1) meets the requirements of subparagraph (1) of this paragraph. See paragraph (d) of this section for the application of the requirements of subparagraph (2) of this paragraph to sales under revolving credit plans.”

      . For instance in a $50.00 book, coupons range from $2.00 to 500 in value.

      . Grant’s relies in part on a letter from the Treasury indicating that it was not an open-ended credit plan for the purposes of the Truth in Lending Act.
      This does not settle the issue for § 453 purposes. The purpose of the Truth in Lending Act is to assure that the consumer debtor is aware fully of the costs of his credit. Where the cost is predetermined and spelled out in advance the special disclosures required for open-ended accounts are not needed. Whether payments under a credit plan are made on a revolving credit plan under § 453 goes to an entirely different issue — whether in fact payments on a debt account covering the purchase of a number of items covers the purchase price of particular purchases, or represents only partial payment of the price of each item, justifying tax deferral.

      . Treas.Reg. § 1.453-2 (d)(3).

      . Traditionally a conditional sales contract retained a security interest in the property because the usual sale was of hard goods which would have some resale value on repossession. Generally items bought on a revolving credit plan would not be subject to this kind of security interest because such soft goods would have relatively little resale value after repossession. Raum, The Tax Aspects of Revolving Credit: Application of the Installment Method of Reporting Income, 19 Institute of Federal Taxation 1225, 1226 (1961). In some states retention of such an interest is prohibited for revolving credit including merchandising coupons. See, e. g., N.Y. Personal Property Law §§ 401, 402A (McKinney’s Consol. Laws, c. 41, 1962), as amended (McKinney Supp.1972).

      . In both 1964 and 1965, issued coupons exceeded redeemed coupons in six months of each year, ranging from $140,000 to $1,960,000 in 1964 and $3,000 to $3,000,000 in 1965.

      . The regulations were deemed at the time of the 1964 Revenue Act to cover at least 80% of all revolving credit plans.

      . The possibility of single payments to avoid incurring a credit charge under revolving credit plans apparently is one basis for the Commissioner’s insistence on some proof provision under § 453.

      . The government contends that under Grant’s accounting methods, if installment tax treatment is allowed, a substantial amount received over the years for coupons mislaid, lost or destroyed will never be reached for taxation. We express no opinion on the substantiality of this claim on the record before us.


author: JOHN W. PECK, Circuit Judge.

text:
    AMERICAN HOME PRODUCTS CORP., Plaintiff-Appellant-Cross-Appellee, v. LOCKWOOD MANUFACTURING CO., Defendant-Appellee-Cross-Appellant.
    Nos. 72-2202, 72-2203.
    United States Court of Appeals, Sixth Circuit.
    Argued June 12, 1973.
    Decided Aug 28, 1973.

      George P. McAndrews, Chicago, 111., for appellant; Timothy J. Malloy, Moli-nare, Allegretti, Newitt & Witcoff, Chicago, 111., and Thomas Y. Allman, Taft, Stettinius & Hollister, Cincinnati, Ohio, on brief.
    Richard H. Evans, Cincinnati, Ohio, for appellee; Truman A. Herron, John D. Poffenberger, Wood, Herron & Evans, Cincinnati, Ohio, on brief.
    Before EDWARDS, PECK and LIVELY, Circuit Judges.
   JOHN W. PECK, Circuit Judge.

This is an appeal and a cross-appeal from a judgment of the District Court which found that the two patents in suit were valid and infringed, but that the plaintiff was guilty of laches and therefore could not prosecute the suit. The plaintiff appealed from the finding of laches, and the defendant has cross-appealed from the findings of validity and infringement.

The predominant patent is a process patent (#2,687,994) which concerns a method of darkening tin by oxidizing it. The second is a product patent (#2,724,526) for a baking pan having a steel base, an overlaying layer of iron-tin alloy, a further layer of metallic tin, and a surface layer of olive-green oxide. The second is a derivative of the first in that the pan is the end result of the process. These patents are fully discussed in two opinions of the Seventh Circuit, Ekco Products v. Chicago Metallic Mfg. Co., 321 F.2d 550 (7th Cir. 1963), cert. denied, 375 U.S. 970, 84 S.Ct. 490, 11 L.Ed.2d 418 (1964), and 347 F.2d 453 (7th Cir. 1965), and in the opinion of the District Court, 173 U.S. P.Q. 486 (S.D.Ohio 1972), and the technical details need not be repeated here.

I

LACHES

The record discloses that there are only three major manufacturers of commercial baking pans in the United States. The largest is Ekco, a subsidiary of the named plaintiff, American Home Products; the second is Lockwood, the defendant; the third, and smallest of the three, is Chicago Metallic Mfg. Co., against whom Ekco brought an infringement suit in 1958 for infringement of the same patents which are the subject of this suit.

In March of 1950, Ekco applied for the ’994 patent, which issued in 1954; in April of 1950, Ekeo applied for the ’526 patent, which issued in 1955. Ekeo began to market baking pans manufactured by the patented (pending) process in 1950. In the fall of 1951, Lockwood began to market an identical line of pans. In September of 1956, after both patents had issued, Ekco notified Lockwood and Chicago Metallic that Ekco felt that they were infringing Ekco’s patents. Both Lockwood and Chicago Metallic denied that they were infringing, and both declined an offer to sign licensing agreements.

Following this reply from Lockwood, Ekco replied to Lockwood with a two paragraph letter, a document critical to this case, which read in its entirety:

“We have received your letter of June 11th, 1957 regarding our proposed license agreement relating to the process of forming a heat absorptive oxide coating on tin plated bake pans.
Since your letter raises a legal question, I have referred this matter to our attorneys and have asked them for their opinion regarding the position you have taken.”

There was no further correspondence or other communication between Ekco and Lockwood concerning these patents until the filing of this suit in 1967. During this ten year interval, however, Ekco was not idle.

In May of 1958, Ekco commenced patent infringement litigation against Chicago Metallic in the Federal District Court in Chicago (N.D.Ill.) for infringement of the dominant '994 and the derivative ’526 patent (and for infringement of two other derivative patents not relevant to this case). In March of 1962, the Chicago District Court held that the Ekco patents were invalid. In August of 1963, the Seventh Circuit reversed this judgment, holding that the ’994 patent was valid, 211 F.2d 550 (7th Cir. 1963), cert. denied, 375 U.S. 970, 84 S.Ct. 490, 11 L.Ed.2d 418 (1964); the parties are not in agreement as to the holding of this case concerning the ’526 patent.

Upon remand, the District Court found that the '526 patent was valid and infringed (damages as to the ’994 patent had been settled). On June 17, 1964, the Seventh Circuit reversed this judgment of the District Court and held that the defendant in that case was not infringing patent '526 relating to the tin plate baking pan because it had a thicker alloy layer than described in the patent claims, 347 F.2d 453 (7th Cir. 1964). Upon remand, accountings were made and on September 19, 1966, the parties settled the case and the District Court entered a final order terminating all proceedings in the Chicago Metallic case. Eight months later, on May 23, 1967, Ekco brought this action against Lockwood in the District Court for the Southern District of Ohio. As noted above, the District Court found that the patents were valid and infringed, but dismissed the complaint upon a finding of laches.

The parties do not dispute that the doctrine of laches is applicable to patent cases in which the plaintiff has “acquiesced for a long term of years in the infringement of the exclusive, right conferred by the patent, or [has] delayed, without legal excuse, the prosecution of those who have openly violated it.” Woodmanse & Hewitt Mfg. Co. v. Williams, 68 F. 489, 493 (6th Cir. 1895) quoting Kittle v. Hall, 29 F. 508, 511 (S.D.N.Y. 1887); see also General Electric Co. v. Sciaky Bros., 304 F.2d 724 (6th Cir. 1962).

Generally, laches requires that there be, in the light of all the existing circumstances, an unreasonable delay resulting in prejudice to the other party. Sobosle v. United States Steel Corp., 359 F.2d 7, 12 (3rd Cir. 1966). Ekco, however relies upon the generally accepted principle that delay in suing an infringer is not legal delay in a laches sense when the party asserting the patent is engaged in other litigation against other infringers. U. S. Mitis Co. v. Detroit Steel & Spring Co., 122 F. 863, 866 (6th Cir. 1903); Jenn-Air Corp. v. Penn Ventilator Co., 464 F.2d 48, 50 (3rd Cir. 1972). This exception takes into account the fact that patent litigation is often unusually complex, lengthy and expensive. It is an equitable doctrine, and must be considered as one factor which would, in appropriate circumstances, negate a defense of laches. Therefore, we must assess the various factors which might tend to negate a claim of unreasonable delay and must consider all of the factors which contributed to this admittedly unique situation.

First of all, we reject Ekco’s suggestion that the existence of other litigation automatically excuses any delay in bringing suit against a second alleged infringer. We do not find that the cases support so rigid an application of this equitable doctrine. For example, in Remington Rand v. Acme Card System, 29 F.Supp. 192 (S.D.Ohio 1937), the earlier litigation had been terminated favorably to the patent owner only four weeks before the second suit was brought. Nevertheless, the patent owner was precluded from maintaining the second suit by the doctrine of laches because the plaintiff had lulled the defendant into a sense of security and induced it to make expenditures which otherwise would have been unnecessary. The court rejected the plaintiff’s argument that other litigation automatically excused the delay in bringing the action against the defendant. 29 F.Supp. at 200.

Also, in Anchor Stove & Range Co. v. Montgomery Ward & Co., 114 F.2d 893 (7th Cir. 1940), the Court refused to permit the action to be prosecuted even though the plaintiff was engaged in other litigation during the period of alleged delay principally because the defendant in the present suit may have had no knowledge of the prior action. Similarly, in Baker Mfg. Co. v. Whitewater Mfg. Co., 430 F.2d 1008 (7th Cir. 1970), upon which the District Court relied heavily, the Seventh Circuit rejected the “other litigation” defense to the laches doctrine because the patent owner had not found time during the five years prior to the instigation of the second litigation to notify the defendant that it was going to press its claim of infringement. 430 F.2d at 1015.

In this respect, the admonition of the District Court is precisely pertinent:

“The fact is there was no agreement [to delay a suit against Lockwood pending the determination of validity in the Chicago Metallic litigation]. If there had been, these corporate entities and their counsel were fully capable of writing an appropriate one-page letter. No other explanation is advanced by the delaying plaintiff.” 173 U.S.P.Q. at 497.

This is not to imply that the other litigation rule is applicable only by agreement between the parties; clearly it is not. See: 2 Pat.L.Pers. § B.3 [2] at 10-11 (1972). But if Ekco had intended to press its claim after the Chicago litigation, it surely would have (or should have) found time to send Lockwood a simple letter to that effect.

This notification is important, partly because it puts the accused infringer on notice that a suit will be filed against him on this issue, and partly because it permits him to bring a declaratory judgment action if the delay in waiting for a judicial determination would be a burden upon his proposed operation.

Although the “other litigation” exception does permit a patent owner to sue multiple infringers consecutively, we are unable to find any authority for the proposition that the existence of “other litigation” is a complete bar to the assertion of a laches defense. Although multiple litgation need not be maintained against multiple infringers, we see no reason why a patent owner need not at least assert to the other infringers its intention to bring a subsequent action at the termination of the presently pending action.

The competing equities were set out by the Third Circuit in Westco-Chippe-wa Pump Co. v. Delaware Electric & Supply Co., 64 F.2d 185 (3rd Cir. 1933):

“It is rather hard and seemingly unjust that any one should be allowed to infringe a valid patent and deprive its owner of royalty to which the patent entitles him. On the other hand, it does not seem equitable for a person with full knowledge to sleep on his rights for seven years and thus lead another to think that he is safe in following his counsel’s advice that he may manufacture a proposed device with impunity, and then, when he has made large investments and built up a good business, punish him and innocent investors for doing what might have been prevented by timely action on the part of the patentee.” 64 F.2d at 186.

In addition to Ekco’s failure to assert its intentions to Lockwood in 1958, there is the additional failure of Ekco to bring suit against Lockwood after the first opinion of the Seventh Circuit in 1963. The interpretation of the “other litigation” doctrine most favorable to Ekco would only excuse Ekco’s inaction up to 1964. There is no excuse for the delay in bringing suit after the first opinion of the Seventh Circuit. That decision found unequivocally that the ’994 patent, the dominant patent, was valid and infringed, and although the case was remanded for further proceedings, no judgment could have been rendered inconsistent with this holding, and Ekco knew that it would prevail in this litigation. This became an absolute certainty when the Supreme Court denied the appellee’s petition for certiorari on January 6, 1964, Chicago Metallic Mfg. Co. v. Ekco Prod. Co., 375 U.S. 970, 84 S.Ct. 490, 11 L.Ed. 2d 418.

Ekco points out that Lockwood was aware of the Chicago Metallic litigation, and it is not unreasonable to presume, in an industry dominated by only three companies, that any one company would be aware of important patent litigation between the other two. However, the knowledge of the other litigation is not the important factor; the point is that Ekco never asserted to Lockwood that it intended to file similar litigation against it at the conclusion of the Chicago litigation. Had such notice been made by Ekco at any time during the pendency of that litigation, until 1963, the company would have been informed of the threat of litigation on this process and this particular product, and the company could have taken steps to mitigate any losses which might result, from an adverse result in such a suit.

The damage resulting to Lockwood by the failure of Ekco to inform it of the threat of litigation is most clearly demonstrated by an interim transaction. On February 25, 1965, all of the assets of the Lockwood Company were sold to new owners. As a part of this transaction, the sellers were requested by the purchasers to list all pending and threatened law suits against the company. Although various unrelated matters were listed, including one involving Ekco, no mention of this patent dispute was made. This failure to include this dispute in the list of threatened litigation indicates the reliance which Lockwood had placed upon Ekco’s failure to assert this cause of action against it, even in the most informal manner. In reliance upon this silence, the purchasers of the Lockwood Company were deprived of the opportunity to consider the effect which this litigation might have upon the company, and, unaware of any claim against the company, built up the business by expanding the operations of the company using the contested product and process. See Anchor Stove & Range Co. v. Montgomery Ward & Co., supra, at 895.

As an issue of fact, a finding of laches cannot be disturbed unless it has been shown to be clearly erroneous, General Electric v. Sciaky Bros., supra; Rule 52(a) F.R.Civ.P., and as a question addressed to the discretion of the District Court, it will not be disturbed unless an abuse of discretion has been shown. City of Erlanger v. Berkemeyer, 207 F.2d 832 (6th Cir. 1953); Baker v. Whitewater, supra, at 1009; Gillons v. Shell, 86 F.2d 600, 611 (9th Cir. 1936). After a careful consideration of the record before this Court, we conclude that the appellant has not met this burden, and accordingly, the judgment of the District Court on the issue of laches is affirmed.

II

VALIDITY

On cross-appeal, Lockwood contends that both patents in suit are invalid for obviousness. The technical details of the patents are set out in the opinions of the Seventh Circuit and in the opinion of the District Court. Suffice it to note that, as detailed in these prior opinions, the patented process is a two step process: first, the pan is anodized to form an oxide coating on the tin that is dark or blue-black in color; the second step involves heating the pan to an elevated temperature from about 190° C to 230° C to convert the oxide to green oxide of tin.

Initially we observe that the normal statutory presumption of validity accorded to a patent (35 U.S.C. § 282) is greatly enhanced when it has been held valid in a prior decision. A prior adjudication of validity should be followed “unless the court is convinced of a very palpable error in law or fact.” Cold Metal Process Co. v. Republic Steel Corp., 233 F.2d 828, 837 (6th Cir.), cert. denied, 352 U.S. 891, 77 S.Ct. 128, 1 L. Ed.2d 86 (1956), quoting Penfield v. C & A Potts & Co., 126 F. 475, 478 (6th Cir. 1903).

Lockwood’s position, however, is that the prior decisions of the Seventh Circuit should be reconsidered in light of new evidence which was not presented to that Court in the Chicago Metallic litigation. Lockwood contends that the Seventh Circuit did not consider the argument that the patent is obvious because the second step of the patent process is an inevitable result of heating the pan, which would occur in ordinary baking. Lockwood argues that the heating incidental to baking causes the color change because the claimed temperature range covers the temperatures used in ordinary baking, and that therefore the patents should be held invalid because the results flow naturally or inevitably from the teachings of the prior art.

We agree with the District Court that the evidence presented did not support this argument. The temperature specified in the patent is just below the melting point of the tin. The evidence showed that pans take many hours to convert the green oxide of tin when bread dough is in them because the heat of vaporization of the water in the dough causes the surface temperature of the ' pan to drop too low for rapid conversion; before this conversion could be completed the thick black oxide would flake off and the pans would corrode. After hearing the testimony of the inventor (Russell) and of experts in the field, and after hearing the testimony of Lockwood’s technical experts, the District Court made the following finding:

“This record demonstrates, however, that what the inventor Russell did — simple as it was — defied the ex- ' pert research, not only of those possessing ‘ordinary skill’ but of those who could be described as the most skilled. Even after the result (i. e., product of what he had done) was in the hands of Chicago Metallic, Lockwood, U. S. Steel, The Batelle Memorial Institute, etc. — so, each of them had the benefit of knowing what their objective was — it took Chicago Metallic months and Lockwood more than a year to solve what was concededly a definite ‘advance.’ That is hardly obvious.” 173 U.S.P.Q. at 490.

We conclude, after an examination of the record before this Court, and after a careful consideration of the prior decisions of the Seventh Circuit, that the District Court’s finding that the additional evidence presented by Lockwood was insufficient to overcome the enhanced presumption of validity which accompanies this patent.

The judgment of the District Court is affirmed.