Major, Senior Circuit Judge, and Schnackenberg and Cummings, Circuit Judges. Schnackenberg, Circuit Judge (dissenting).
MAJOR, Senior Circuit Judge.
This litigation had its genesis in an employment agreement entered into on April 22, 1957, between Jack I. LeVant (petitioner) and the S.M. Edison Chemical Company (Edison), by which petitioner claims, among other things, that he was granted an option to purchase up to 20% of Edison, which option was exercisable for a two-year period commencing January 1, 1958. Edison was a sole proprietorship until October 1959, when it transferred its assets to a newly created corporation, Edison, Inc., in exchange for 345, or all of the outstanding, shares of the common stock of that corporation.
During petitioner's employment by Edison, a number of companies displayed interest in acquiring Edison, Inc., including Colgate Palmolive Company (Colgate). The latter, in 1959, agreed to purchase Edison, Inc. for $1,500,000. The agreement provided that the purchase price was to be paid in the form of Colgate stock, valued for purposes of the exchange at $38.50 per share. The acquisition of Edison, Inc. by Colgate was consummated on January 15, 1960, at which time Colgate exchanged its common shares for the interest of Edison and the claimed interest of petitioner in Edison, Inc. Colgate received all of the outstanding shares of the latter. Edison agreed, under circumstances subsequently discussed, that petitioner by reason of the employment agreement of April 22, 1957, had a 20% interest in Edison, Inc. Accordingly, petitioner received in Colgate shares 20% of $1,500,000, as the result of the exchange with Colgate. Because of petitioner's obligation to pay Edison $50,000 at the time he exercised his alleged option, he actually received a net of only $250,000 in Colgate stock (6494 shares), at a pegged price of $38.50 per share.
Petitioner represented to Colgate that the shares of stock issued to him were to be acquired for investment and not for distribution. This representation was required by Colgate because the shares, while admitted for listing on the New York Stock Exchange, had not been registered with the Securities and Exchange Commission for public sale, as required by the Securities Act of 1933, if they were going to be sold to the public. The investment representation required by Colgate was to protect it from liability under the Securities Act. The shares which the taxpayer thus acquired were termed "investment letter stock," and although the stock certificates were not stamped in such a manner as to prevent assignment, petitioner was advised by representatives of Colgate that he could not sell the shares at the time and that he should not attempt to do so without first consulting counsel. Petitioner did not sell any of the Colgate stock in less than three years from the time he acquired it. After the acquisition by Colgate of all of the stock in Edison, Inc., petitioner became president of Edison, Inc., and a vice president of Colgate.
Petitioner did not report any income in 1956 or 1957 by reason of the alleged grant of an option to purchase 20% of the business of Edison. For the taxable year 1960, he reported as long term capital gain the amount of $236,828.13 from the sale of a capital asset termed "Option to acquire 20% interest in S. M. Edison Chemical Company," at a gross sales price of $251,573.75.
The Commissioner determined that the amount of $236,828.13 received by petitioner in 1960 was not a long term capital gain but was ordinary income. In doing so, he valued the 6494 shares of Colgate stock at $39 1/16 per share, less expenses in the amount of $16,843.75, for a taxable gain of $236,828.13.
The Tax Court sustained the determination of the Commissioner, except it found that the fair market value of the 6494 shares of Colgate stock received by petitioner on January 15, 1960, was $34 3/8 per share. It found a deficiency in income tax for that year in the amount of $96,928.86. It is from this decision of the Tax Court that Jack I. LeVant and May LeVant are here on petition for review. (The latter is petitioner's wife, and joined as a party only because joint returns were filed.)
Petitioner on brief states the contested issues:
"1. Whether the Tax Court correctly concluded that the option LeVant received on April 22, 1957, which was exercisable on and after January 1, 1958, did not represent income to LeVant on either of those days because under Respondent's regulations 1.421-6 the option did not have a 'readily ascertainable fair market value'. Are these regulations of Respondent valid for the purpose of determining the value of an employee's option to which Section 421 of the Internal Revenue Code does not apply?
"2. Whether the Tax Court was correct in determining that the exchange of LeVant's option for Colgate's shares was a taxable transaction under the Internal Revenue Code.
"3. Whether the Tax Court correctly determined the fair market value on January 15, 1960, of the Colgate shares received by LeVant."
Petitioner devotes much effort in support of his contention that the Commissioner's regulations 1.421-6 are invalid in requiring a "readily ascertainable fair market value" of petitioner's alleged option at the time received on April 22, 1957, or January 1, 1958. This argument generally is to the effect that these regulations require a higher degree of proof as to value than is applied in other circumstances. The Commissioner makes no effort to defend these regulations because the Tax Court, while discussing them, based its decision on case law.
In our judgment, the case was tried on the false premise that petitioner was granted or acquired an assignable option on April 22, 1957. Petitioner's contention that he did necessarily encompasses the further contention that it was freely assignable by him. In our view, as we shall subsequently show, he acquired no option but, assuming that he did, it was personal to him and non-assignable.
This conclusion requires consideration of the employment agreement entered into between petitioner and Edison on April 22, 1957. As a prelude thereto, it appears pertinent to state briefly the relationship existing between the parties at the time of the execution of the agreement and prior thereto.
In 1956, petitioner attempted unsuccessfully to buy Edison, which was engaged in the manufacture and sale of pharmaceutical products. He agreed to work for Edison on a trial basis as a consultant for some three months, primarily to determine if the Edison products could be sold profitably on the consumer market. During the three-month period petitioner received a monthly salary of $1,500 and an expense account of $750. Without reciting the details, it is sufficient to note that petitioner from his experience was encouraged and felt that the sale of Edison products could be greatly increased. He decided that he would like to have a share in the business and, on December 26, 1956, he submitted to Edison a written memorandum on the terms he would expect for his continued employment. In the written proposal, referred to as "Proposal of Employment," petitioner offered to work as a director of sales and merchandising for a two-year period; to devote his full time, talent and efforts in the best interest of the company, at a monthly salary of $1,500, plus an expense advance of $750, plus a bonus of 2% of annual net sales of Edison in excess of $300,000. He also suggested an option for a period of five years to purchase up to a 20% interest in Edison.
Edison did not agree to the proposal, and petitioner deemed their relationship terminated. Shortly thereafter, Edison, evidently much impressed with the services which petitioner had rendered, decided that he was needed in the business and in a conversation agreed to give him an option to buy into the business. Petitioner continued to work for Edison without a signed written agreement.
With this background and under these circumstances, Edison on April 22, 1957 wrote petitioner as follows:
Herewith follows the terms of our agreement covering your employment with the S. M. Edison ...