HAND, Circuit Judge (after stating the facts as above).
Taken formally there seems to us no doubt that the payments made after May 1, 1917, were not firm income. We reserve for the moment the question whether we must go behind the form. Cannon had by the original articles the right to demand of the firm 60 per cent. gross of the commissions coming from the "Cannon Group." This he surrendered, and got in its stead nothing but the firm's promise not to collect any payments under its contracts with the 3 named mills. We do not forget that he was also given freedom to deal with the mills as he chose, but the permission was of no moment, since the firm could neither bestow nor withhold it. This contract did indeed leave the firm's contracts with the mills untouched; as between itself and the mills, the firm was still bound to act as commission agent, and entitled to collect its commissions. There was no release, no novation, no accord.
This, however, makes no difference in the result, because the firm had agreed with Cannon not to collect under its contracts with the mills and could not lawfully do so. It is difficult to see how Cannon had any remedy at law upon a breach of his contract with the firm. The mills' payments were not from his pocket and involved him in no loss. If so, he could have enforced the promise specifically by injunction. The most that can be said to the contrary is that the firm's collection of its commissions might in fact have prevented Cannon from making any contracts with
However, we find it unnecessary to decide that question. Even if he had not the power, it would have been a wrong had the firm collected the payments. We are concerned only with whether the payments actually made were paid under the firm's contracts, and there is no doubt that they were not. There is no suggestion that the firm violated its contract with Cannon, and no reason to assume that it did. On the contrary, the payments proved that it had not. While these were made by checks to the firm's order, the accompanying letters directed the distribution of the proceeds, and became conditions upon the firm's title if they cashed the checks. The money in its hands was in equity the property of the distributees, who could have held the firm accountable for its diversion. Whether or not the whole transaction was no more than a device through which the law will look, it was loyally carried out by all sides, and the payments were clearly not made under those contracts between the firm and the mills, which the firm had bound itself not to enforce. So we should hold, and in any case the question is not open after verdict.
Therefore, it makes not the slightest difference whether Cannon's contracts with the mills were authorized, or whether they had a valid consideration; the firm being already bound under its contracts with the mills to perform the duties of a commission agent. The payments may have been purely voluntary, and the result would be the same; they were not firm income, and could not lawfully be such, unless Cannon chose to release the firm. They are relevant at all, only as characterizing the payments and furnishing added proof, if any be needed, that the payments were not made under the firm's contracts. Therefore we do not find it important to consider some of the questions mooted in the argument. Taken formally, we have no doubt that the payments were not firm income.
A more difficult question is whether the whole arrangement was not a device to distribute firm profits to Cannon as partner by an elimination of the firm. Is the case like those in which the courts have held that guaranteed dividends paid direct to shareholders of a lessor company are payments to the company? Rensselaer & S. R. Co. v. Irwin, 249 F. 726, 161 C. C. A. 636; Blalock v. Georgia R. & E. Co., 246 F. 387, 158 C. C. A. 451; West End St. R. Co. v. Malley, 246 F. 625, 158 C. C. A. 581; Houston, etc., Co. v. U. S., 250 F. 1, 162 C. C. A. 278. Those cases regard a distribution to the constituent members (the shareholders) of the corporate entity as equivalent to a payment to the entity itself, and a distribution by it. We have no disposition to question their authority, nor do we mean to suggest that partnership transactions might not take on a similar character. To take the present case, one might suppose that the partners were to divide between them all the firm contracts with the several mills, and each was to make a contract with the firm not to collect any of the commissions due upon any of them. Acting upon such contracts, each might persuade the mills to pay him the commissions upon the contracts assigned to him, leaving the firm as the worker, while the partners, the drones, sucked the honey. It may well be that such an arrangement would be regarded as merely a device for sharing the profits, and that the commissions would remain firm income under the tax laws. For the purposes of argument we will assume that this is so.
In ascertaining whether this was in fact what was done we must look at the situation before May 1, 1917. Certainly the contract of that date was intended to do no more than commute the former payments of 60 per cent. gross of the commissions from the "Cannon Group" into payments made direct to Cannon or his nominees. The argument cannot therefore apply, if the earlier payments were not, properly speaking, profits at all, but a discharge of firm obligations. Although he cannot sue for its recovery, owing to the repugnance of our law to regard a partnership as an entity, a partner may lend money to his firm, and, in the settlement of the firm accounts, he can compel its repayment, with interest, not as a share of his profits, but as the discharge of a genuine loan. Henderson v. Ries, 108 F. 709, 714, 47 C. C. A. 625; Rodgers v. Clement, 162 N.Y. 422, 56 N. E. 901, 76 Am. St. Rep. 342; Winchester v. Glazier, 152 Mass. 316, 25 N. E. 728, 9 L. R. A. 424. The same rule must, of course, be true if the partner does not lend money, but transfers property of any sort in consideration of the firm's promise to repay him in money. Moreover, it must be immaterial whether the payment is single or serial, whether it is calculated upon the earnings of the property or is fixed in advance. Had Cannon required the firm to pay a series of fixed payments during the continuance of the articles, we
Now it appears to be quite true that this part of the transaction embodied in the articles can appear only by inference, all the parties being dead. The question after verdict, however, is whether there was any adequate basis for the finding that the payments were reserved as consideration for the transfer of the business of the "Cannon Group," or whether they must be regarded as a part of Cannon's division of the profits. It seems to us that the facts justify and make almost certain the first conclusion. The 13 mills in question were Cannon's especial property; he controlled their management, was an owner of their shares, in many instances their president, and could turn their business as he would. When we find that he declined to allow the firm as such to divide as profits more than 40 per cent. of the gross returns from their business, it seems to us that only one conclusion is possible, which is that he did not mean to give the firm his whole business, or, what is the same thing, that he meant to require it to pay him 60 per cent. as a consideration for doing the business at all.
Besides, to call the agreement a preferential share in the firm profits appears to us altogether to ignore the form of the articles, which were executed at a time that forbids any suspicion that they were a cover to escape taxation. While in fact the probability was exceedingly remote, nevertheless they constituted a charge upon the firm which might have consumed not only all its profits, but have actually eaten into its capital. We see no reason to suppose that, if that had happened, the firm could have refused payment; the undertaking is absolute, and has no relation whatever to profits. In any event it is quite wrong to speak of it as a preferential share in the profits, even if it should not be pressed to the extreme that we have suggested. It had no relation to profits, and was determined by the transactions of the firm with the group, regardless of how successful the general business might be. It was a charge upon that business, and indeed we need not even hold that it was created as consideration for the transfer of Cannon's good will.
It is argued in reply that, if so, the payments were never firm income at all, and that either as a deduction for debts paid or as a diminution of income received they ought not to have been included in the returns before May 1, 1917. Perhaps that is so, but at most it shows no more than that the firm has been less astute to protect itself than it might have been. Nobody estops himself into paying taxes by failing in the past to assert his full rights.
Therefore we do not regard the agreement of May 1, 1917, as changing into a new form an earlier division of profits, and the case does not fall within the hypothetical instance which we put. So far as we can see, it was no more than a change in the character of payments which never had been income, and which were not therefore taxable. That it was done for the purpose of evading taxation is at best immaterial.