Paragon Jewel Coal Company, Inc. v. Commissioner of Internal Revenue

PETITIONER:Paragon Jewel Coal Company, Inc.
RESPONDENT:Commissioner of Internal Revenue
LOCATION:Criminal District Court, Parish of New Orleans

DECIDED BY: Warren Court (1962-1965)
LOWER COURT: United States Court of Appeals for the Fourth Circuit

CITATION: 380 US 624 (1965)
ARGUED: Mar 08, 1965
DECIDED: Apr 28, 1965

Facts of the case


Audio Transcription for Oral Argument – March 08, 1965 in Paragon Jewel Coal Company, Inc. v. Commissioner of Internal Revenue

Earl Warren:

Number 134, Paragon Jewel Coal Company Incorporated, Petitioner, versus Commissioner of Internal Revenue and Number 320 — 237 Commission of Internal Revenue versus Robert Lee Merritt et al.

Colonel Wiener.

Frederick Bernays Wiener:

Mr. Chief Justice, may it please the Court.

The question in these consolidated cases is whether a lessee of coal lands must share its depletion allowance with the persons it hired to mine the coal but who themselves never own the coal while it is was unmined in the ground or own the coal after it had been extracted.

Tax Court decided this question in favor of the petitioner Paragon Jewel and against the respondent contractors, the respondents in 237.

The Court of Appeals reversed.

We brought supp certiorari on the grounds of conflict with Parsons against Smith in the 359th United States and the Commissioner who fiscally is a stakeholder agreed with us and still agrees with us and as Your Honors will doubtless discern in the course of the argument, they agree with us completely in result and only somewhat — disagree only somewhat in emphasis.

I shall take up first the facts found by the Tax Court concerning the agreement, the arrangements between petitioner Paragon Jewel, the lessee, and its contractors.

I will then discuss the statute because after all we are dealing here with a deduction that is accorded as a matter of legislative grace and yet the court below dealt with that deduction without discussing the statute without holding the statute and without even citing the statute.

And then I will take up the common law of depletion the decisions here to show that the entire emphasis in Your Honors’ decisions has been that depletion is an allowance to the owner for the exhaustion of his capital investment of his capital assets and that therefore it isn’t available to one who never had any capital investment in the minimum.

Let me first deal with the facts found by the Tax Court.

Petitioner Paragon Jewel was the assignee or the sub-lessee of numerous coal leases in the hills of the Commonwealth of Virginia.

It is assumed all the obligations of the original lessee under those leases.

It paid all the royalties, it paid all the property taxes.

It never assigned or sublet any of its leases and it never surrendered any capital interest in the coal in place.

I pause to say that the expression mineral in place, coal in place, oil in place seems somehow confusing to some of the lawyers with whom I have discussed it.

I may refer to it as the coal in the ground.

I don’t see that that’s a word of art at all, that’s perfectly quite.

Now, Paragon made contracts with various individual miners to mine this coal.

These contractors assume no obligations under the leases.

They paid no property taxes on the mineral on any mineral interest.

They paid no royalties under the leases.

They paid nothing for the coal.

They got no title to the coal either in the ground or after it was mined and the great many of them on the stand expressly disclaimed any capital investment in the unmined coals.

They got nothing by purchase or lease.

They were not entitled to sell to anyone — to any outsider the coal that they mine for Paragon.

They had to deliver every bit of coal they mine to Paragon at its tipple and in return they got the personal covenant of Paragon to be paid for their mining operations at a fixed price per ton.

Tom C. Clark:

Any negotiation on this depletion item?

Frederick Bernays Wiener:

There was none.

No, it’s plain that depletion is a conflict which I’ll come to in a minute on whether it was terminable.

Frederick Bernays Wiener:

There was no negotiation about depletion.

Actually, the depletion issue didn’t arrive even in the bureau and even in the Tax Court after these contracts remained.

The price fixed by Paragon varied prospectively so that the contractors would know when how much they would get for the next ton of coal they mine.

It was not changed in the course of mining and not changed retrospectively and the Tax Court found that Paragon could and did change this price at will.

It found also that the contractors were not obligated to mine any specific amount of coal and that they were not specifically given the right to mine any particular area to exhaustion.

They couldn’t be, because it was impossible to determine in advance what areas would be mined.

For one thing, any contractor could quit and the good many of them did.

For another the mining operations would uncover rolls and faults in the seams so that it was never possible to say at the beginning of the operation, you shall have this track describing it either by means and bounds or by natural monuments, it just wasn’t and Paragon had an engineer to coordinate the mining of the several contractors so that they would work together, so that they extract all the mineable coal which Paragon under its leases was bound to do and so they wouldn’t blow up each other’s tunnels.

Now as determination, the Tax Court said that they couldn’t say that the contract was terminable but by the same token they couldn’t say it was non-terminable and they found that nothing was said about terminability at the time the contracts were made.

We think that last finding is plainly wrong because a year-and-a-half before any of these petitions for review were in the Tax Court, one of the respondents in 237 in two separate sworn documents filed with the Internal Revenue Service on behalf of all the partners in two partnerships constituting all of these respondents set under oath, the contracts specified the right of termination by either party at any time but the question never arose between the partnership in Paragon.

We say that in view of these ante motam litem admissions binding all the respondents that particular finding of the Tax Court is clearly erroneous.

We don’t have to rest on that.

Even without that correction, even taking the findings of the Tax Court as they now stand we say that on the facts that they found it is perfectly clear that there never was any transfer of capital interest in the unmined coal by Paragon Jewel to any of these contractors.

Mr. Wiener —

Frederick Bernays Wiener:

Yes Your Honor.

(Inaudible) the reading of this record that somewhat the respondent say the capital to the miners (Inaudible)?

Frederick Bernays Wiener:

Yes Your Honor, and if I can persuade Your Honor to pay me $300,000 for the Brooklyn Bridge that doesn’t pass title to you and these people had no capital to settle.

They may have —


Frederick Bernays Wiener:

Yes sir.


Frederick Bernays Wiener:

Oh, there’s no question that was terminable at will in the first place a lot of these miners quit.

The record is perfectly clear on that and as a matter of state law, if a contractor is terminable at the will of one party, it’s terminable at the will of both and if it weren’t — if the miners could quit but Paragon couldn’t terminate them it would lack mutuality.

How do you purport people then who were making investments?

Frederick Bernays Wiener:

They didn’t make it — they made an investment, yes, but not in coal.

And if — again, if I can soft talk, Your Honor, into buying the Brooklyn Bridge, that wouldn’t convey title and that’s what this was.

I don’t know what they represented that they had to sell.

They might sold them machinery.

They might have said, “Look I put in all this wood and all this timber and that costs me a lot of time and money and blood and sweat and if you want to take my place you got to pay me something for it.”

Well, that doesn’t mean they had any interest, capital interest in the unmined coal which by taking money from a successor miner.

Frederick Bernays Wiener:

They could then say to Paragon, “See I own the coal.

I was able to sell it to the next fellow.”

These miners didn’t own the coal in the ground.

They admitted that.

They never made that claim.

They didn’t know that afterwards, after it was mined because they weren’t free to dispose of it and the entire facts, the facts are completely consistent with the capital investment in this coal being in the lessee only and none of it being in the contractors and none of it ever having been transferred and therefore they are not entitled to depletion and the Tax Court so held following Parsons against Smith where these same arguments were made.

Now, the court below found a sharing of “economic interest”.

Now for that, we go back to the opinion in Palmer against Bender in 287 United States but those words weren’t used alone.

What Mr. Justice Stone, as he then was, said an economic interest representing a capital investment in the mineral in place.

In other words, we don’t care about legal title.

We don’t care about the niceties of conveyances if there is an ownership interest and economic interest representing a capital investment in the mineral in place but here, the economic interest is in the enterprise, the economic interest of the contractors is in their machinery, it may be in their labor but they’ve never made an investment in the coal in place.

Now, let me go to the statute as I have said — and as any revenuer can always make any tax lawyer squirm every deduction is an act of legislative grace.

Well then, we look to the legislation and yet in this case, the court below was able to deal with this legislated deduction without even citing the statute much less quoting it or discussing.

Alright, let’s go to the basic provision which is 613 (a) and I will read only short passages.

The allowance for —

William J. Brennan, Jr.:

Where are you reading from, Mr. Weiner?

Frederick Bernays Wiener:

I’m reading from page 2a the appendix —

William J. Brennan, Jr.:

Thank you.

Frederick Bernays Wiener:

— the Paragon Jewel’s brief.

Section 613 (a) beginning of the third line.

The allowance for depletion under Section 611, 611 is the basic grant of that deduction, shall be the percentage specified in subsection B of the gross income from the property, so that it’s a percentage of gross income from the property.

Now we go over to page at the top of page 4a which is Section 614 (a), property means each separate interests owned by the taxpayer in each mineral deposit in each separate track or parcel of land and I ask what mineral depo — what interest was owned by these contractors in each mineral deposit in each separate track of this aggregation of leases the Paragon Jewel had assembled, the answer is none.

Now, there are additional reasons, statutory reasons that lead to the same result.

For many years, there has been a provision in the tax statute going back to at least 1918 page 1a, in the case of a lease the deduction under this section shall be equitably apportioned between the lessor and lessee.

Substantially similar language has been on the books for 45 years.

But by reason of legislation passed after the tax years considered in Parsons against Smith, there is no longer any apportionment in the case of coal.

The coal lessor gets capital gains treatments on his royalties and therefore no longer shares in the depletion deduction which therefore belongs indivisibly to the lessee and I ask where is the statutory warrant for making the lessee share that depletion now with the people he simply hires to mine the coal.

And finally, there are further sections also dating since — from 1951 but sharpened only last year, which show that Congress understood very well the difference between an economic interest in the mineral and a right to cut or mine the mineral.

Page 4a, 631 (b), the last three lines this is the timber subsection.

The term ‘owner’ means, any person who owns an interest in such timber including a sublessor and a holder of a contract to cut timber and a holder of a contract to cut timber.

Frederick Bernays Wiener:

But in the next section over on the next page 631 (c), the word ‘owner’ means any person who owns an economic interest in coal in place including a sublessor and Congress doesn’t go on to say and the holder of a contract to mine coal and that section was amended only last year in 1964 to include with the lessor of coal, the lessor of domestic iron ore and Congress didn’t change that language, so that is perfect it is just as clear as it can possibly be from statutory language that the holder of a contract to mine coal is not one of those to whom Congress has extended the depletion deduction.

Arthur J. Goldberg:

Do you believe this would be so whether this contract is agreed or concurred on the field of coal they were brought to?

Frederick Bernays Wiener:

I think so yes, because the — and — in our view, the terms of the contract are important only as they show or fail to show a transfer of capital interest.

Beyond that in Mr. Justice Holmes’ phrase, the spider’s webs inadequate to control the dominant fact.

I deprecate the kind of cases that say, well if you pay him a fixed price he doesn’t get any depletion but if you let him have a percentage of the market price he does and that sort of thing.

In other words, if I have a contract to cut Your Honors’ loan in perpetuity just for the rest of my life, every summer, that doesn’t give me any capital interest in Your Honors’ front loan in the real estate and that’s what this is.

Now, I am confirmed —

Potter Stewart:

That isn’t exactly what this is —

Frederick Bernays Wiener:

Well —

Potter Stewart:

— even by analogy —

Frederick Bernays Wiener:

Well —

Potter Stewart:

— because you’re not depleting anything when you’d take a —

Frederick Bernays Wiener:

Yes, but —

Potter Stewart:

— the loan, you’re simply maintaining it.

Frederick Bernays Wiener:

But when you’re cutting like — when you’re mining coal, you are not — the contractor is depleting the asset of the person who owns the coal.

Now, in Parsons v. Smith where this thing was going into a great length, the key in paragraphs, the key passage is at page 220 of 359 U.S. and in the key sentences there and I’ll read them briefly omitting the citation the word ‘owner’ is used no less than three times.

The purpose of the deduction for depletion is plain and has been many times declared by this Court.

It is permitted in recognition of the fact that the mineral deposits are wasting assets and is intended as compensation to the owner for the part used up in production.

The depletion exclusion is designed to permit a recoupment of the owner’s capital investment, the owner’s capital investment in the mineral so that when the minerals are exhausted, the owner’s capital is unimpaired.

In short — and this is the conclusion of the paragraph, the purpose of the depletion deduction is to permit the owner of a capital interest in mineral in place to make a tax brief recovery of that depleting mineral asset.

And as far back as Thomas against Perkins in the 301 United States, the Court said ownership is essential, in the Bankline case in the 303rd United States, Chief Justice Hughes said the phrase ‘economic interest’ is not to be taken as embracing a mere economic advantage derived from production through a contractual relation to the owner by one who has no capital investment in the mineral deposit, skipping, respondent had no capital investment in the mineral deposit which suffered depletion and is not entitled to the statutory allowance.

Now, that language was taken over into the regulations and it’s there pretty much in haec verba and it’s there without substantial change today on the next to last page — two next to last pages of the brief.

An economic interest is possessed in every case in which the taxpayer has it acquired by investment any interest in mineral in place.

A person who has no capital investment in the mineral deposit does not possess an economic interest merely because through a contractual relation he possess a mere economic or pecuniary advantage derived from production and agreement between the owner of an economic interest and another entitling the latter to compensation for extraction or cutting does not convey a depletable economic interest.

Needless to say this regulation was not mentioned by the court below.

Instead of which, the court below and the contractors here seek to find an economic interest by dropping the vital qualification representing a capital investment in the mineral in place and say because they have an economic interest in the enterprise and because they invested in things other than the coal and because they own things other than the coal which they can deduct under other provisions, they have somehow presto change-o made a capital investment.

We say that is a fiction, this Court said it was a fiction, this Court dealt with the — this precise question in Parsons against Smith.

This Court rejected the fiction, this Court said you must find a surrender, a transfer of the capital interest and since that transfer, since that surrender is absolutely lacking here except on a wholly fictitious basis we say with the Commissioner that the court below disregarded Parsons against Smith and that its judgment must therefore be reversed.

Earl Warren:

Mr. Heymann.

Philip B. Heymann:

Mr. Chief Justice, may it please the Court.

Philip B. Heymann:

The government comes out in favor of the mineral lessee, Paragon in this case, and opposed to the depletion claims of Merritt, the contract miners.

We believe that that conclusion is dictated by the purpose of depletion allowance.

Depletion is the deduction that Congress allows taxpayers so that they can recover the value of a mineral deposit in the ground.

It differs from all other tax relationships and that it turns on value, not cost but it’s recover the value to —

William O. Douglas:

That wasn’t true when you’re at southwest exploration being heard.

Philip B. Heymann:

What wasn’t true, Your Honor?

William O. Douglas:

What you just said, to recover the value — your owner to recover the value of minerals in place.

Philip B. Heymann:

Justice Douglas, that depends on how you define owner and I will get to that very shortly.

Okay, the simplest way of explaining what depletion is, is to look to its immediate predecessor discovery depletion.

Ideally what we would do is we would value the value of a mine, the mineral deposit in the ground.

Let’s say that $60,000.

We would determine how many units would come out of that mine but say 100,000 units, and then we would divide one into the other and we would conclude that you got 60 cents tax-free recovery every unit you sell.

If you have a mine worth $60,000 coal mine, if we can — if we could figure out you’re going to go 100,000 tons of coal out of the mine, we would allow — we would figure that the coal was worth 60 cents a ton in the mine and when you sold it for $6 a ton, we would allow you a tax-free recovery of 60 cents a ton.

This very system discovery depletion was used for many years it was — it has now been completely replaced by percentage depletion simply as a matter of administrative convenience.

Congress now says in the case of coal that it arbitrarily assumes that 10% of the sale — sales price of a ton of coal after it has been washed and cleaned and graded represents the value in the ground.

The ton of coal sells for $6, Congress figures 60 cents as the value in the ground and they’re going to give that back to the taxpayer tax-free.

You’re going to allow them to recover that out of your sales tax-free.

The very nature of depletion and here Justice Douglas, I’m getting to your question dictates that the deduction goes to the owner of valuable rights in mineral in the ground.

Now, I don’t want to be too free in saying where I agree and where I disagree with Colonel Wiener because I’m not 100% sure that I’m certain.

What I do know is that the government doesn’t care whether its property rights in the ground or contract rights for one thing.

Many of the early cases involved are contract right to receive retain by the owner of lands who leased the coal and under state law the lease was equivalent to a sale of all the coal.

They retained a right to a royalty of certain number, actually they’re oil case a certain number of dollars a barrel that was held to be a depletable interest.

The government has moreover for many years allowed a purchase of such an interest.

The taxpayer comes along and pays $200,000 for a royalty interest of $4 a ton in coal or $4 a barrel in oil.

He will obtain and running to exhaustion, he will obtain a depletable interest.

We say he has bought in to the value of the mineral deposit in the ground and we don’t care whether he gets legal title under property law or not.

Now, in southwest exploration, the Court held that these men were necess — that the uplands landowners were necessary to the mineral — into the mining, but if — I just take one step — I just take step one step back, the one case this Court hasn’t decided is whether you can buy a net profits interest in a mining business, whether you can buy an interest, whether you can spend $200,000 and get a right to a quarter of the profits from a coal mining or an oil production business.

If you take a royalty, if you take $4 a ton, at least the government isn’t firm on this.

If you take a $4 a ton or if you take 1/8 of the oil out of the ground, this can be bought and sold and you get a depletable interest, whether that would happen with net profits nobody knows.

Southwest explorations are net profits case.

Philip B. Heymann:

The government came into this Court and argued that we believe that a person can spend $200,000 and buy net profits interest in a mineral business and he should be entitled to the depletion because he’s —


Philip B. Heymann:

Your Honor, the difficult case that lurks behind here and I would like to say that we come out pretty clearly and squarely on Paragon.

Now, I really never got to my argument yet.

The difficult case that lurks behind here is the one that you’re moving towards.

I’m sure Colonel Wiener would not agree with me.

I think the government would say that if a man came and promised to mine 5000 tons of coal in exchange for 1/8 royalty interest in the coal field, he would get a depletable interest.

It doesn’t have to be cash.

Now, that’s the difficult case that lurks behind and my explanation will be that that is the —

Potter Stewart:

Well, that was depletable interest because you’d have — because you would have the 1/8 royalty not because he promised to mine 5000 tons of coal.

Philip B. Heymann:

Exactly right, Justice Stewart.

It’s possible though to promise.

The difficulty is that it is at least conceivable.

We haven’t seen the depletion case yet but it’s conceivable that in exchange for promise of services, you would take out an economic interest in a mineral.

Potter Stewart:

You would have a depletable interest I suppose if you were given an 1/8 of royalty.

Philip B. Heymann:


Potter Stewart:

How would you acquire it that would give him a depletable interest?

Philip B. Heymann:


And that’s why the notion of capital investment that Mr. Merrell emphasizes so much in his brief is to us largely a question, largely a read hearing.

We don’t care how much you spend.

You can be given a depletable interest and you get a depletable interest.

We care what you take out of a transaction and not what you put into a transaction.

Well, I had said that the very nature of depletion drives you back to owner and I have said that by owner we mean owner of legally enforceable rights to share in the value of the mineral deposit.

They can be contract rights, they can bee property rights, they can be purchased, they can be given, you have to have legally enforceable rights.

Our first position in this case and the only one we argued in our brief is that there in the case of contract miner —

Potter Stewart:

Have you been issued — that’s in the southwest?

Philip B. Heymann:

We don’t — yes, Your Honor unless you have any questions.

We don’t have any problem with southeast — southwest exploration.

We would think the decision were correct on a broader ground and we think it’s on and we think it’s very clearly correct on a narrow ground.

Now, we urge the broader ground that that case is an alternative.

Philip B. Heymann:

We think there is plainly depletable interest in the Huntington upland owners in that case.

In the case of contract miners, we think that there are two minimum conditions and as I’ll go on to say we don’t think these are sufficient.

They’re just necessary.

They’re minimum conditions to getting the depletable interest.

One is that the contract miners’ rights must not be terminable at the will of the mineral lessee.

Merritt’s rights must not be terminable at the will of Paragon.

A man doesn’t have any legally enforceable rights to share in the value of a mineral asset if he can be cut off at the will of someone else who then takes over his rights.

I don’t think that requires any belaboring.

The second condition which we think is equally clear is that a man has no legally enforceable rights to share in the value of a mineral deposit in the grounds if he has — if he’s obligated to sell it to another man at a price set by that other man.

Now, if I own a diamond mine and I give Mr. Smith a right to withdraw all the diamonds he wishes and merely limit him to selling to me at a price set by me, he has obtained no valuable right, no legally enforceable rights to share in the value of the diamonds.

I’m going to set my — I at least have a right.

I should be careful how I say that.

I at least have a right to set my price at the value of the services.

Now, one thing is if I’m an enlightened businessman, I’m going to pay them more than the value of the services.

I’m going to try to keep them happy.

I’m not going to want turnover and I may be enlightened enough that I’m going to let him share in good times and cut him back in bad times.

Justice Goldberg asked about the investment in this case.

He asked about the $30,000 investment that one miner made in a relationship with another miner in a situation where we put where we — I’m about to argue.

We think that the price can be set completely by Paragon as a matter of legally enforceable rights.

I’d like to respond in terms of an agency case I learned in law school.

I think it involved the Dwain agency, advertising agency, where a young associate went off and left with a major client.

I don’t — damages were astronomical, hundreds of thousands of dollars.

The client could leave that will.

He haven’t taken anything except goodwill, except the favorable relationship.

Now, these miners know that Paragon is going to treat them well.

They know that paragon isn’t going to throw them off for no good reason and is going to maintain a fairly steady price.

I think that’s what they paid for.

At this point, I have turned the facts of this case as to whether there is terminability at the will of Paragon and as to whether Paragon has the right to set the price anywhere they want.

Potter Stewart:

You say that if either one of those retains, then there can’t be any goodwill.

Philip B. Heymann:

Either one —

Potter Stewart:

Not both.

Philip B. Heymann:

Either one proves as a logical matter that there’s no legally enforceable right to share in the value of the deposit.

You may be sharing in some way as a matter of a gift or purchase of goodwill by Paragon but no legally enforceable right to share it.

I’d like to skip over terminability saying mainly that the evidence is quite lacking on this.

No one seems to have discussed very much or there’s no reliable evidence as to whether Paragon could terminate at will.

On this basis, the Tax Court held that they would not find terminability.

They would not find the right to mind exhaustion when no one had said anything about it, especially in the light of the statute of frauds which seems to me to be directly and intended to deal with oral contract such as this I would have thought that was a sound result.

The Fourth Circuit respondent that you don’t allow a man to make sizeable investments or sizeable at least in his terms and then cut him off at will, no court would allow that.I think there’s a lot of sense in that.

However, I think the answer is that if a man makes sizeable investments under a contract with no specific discussion of a duration of the contract, you pay them quantum meruit.

You pay him what his investment was worth.

You don’t give him a right to stay on indefinitely.

But nobody contemplates giving him two years or five years or ten years because the only term of court can infer is contract at will or indefinite.

(Inaudible) you say however that you anticipate on both parties that the contract miner (Inaudible).

Philip B. Heymann:

Your Honor, again what I’m distinguishing between is a legally enforceable right and a general expectation of the parties.

These contracts — when you look at these contracts and when you look at what went on here, you can start right off by saying we have — we’re dealing between people with unequal economic power.

These are contracts entered into with nothing said and with high hopes and oftentimes little legal support for their high hopes.

Everybody did expect to stay on, they didn’t expect to be turned off and Paragon expected to keep them on.

Paragon didn’t expect to steal their investment down.

I’m just saying —


Philip B. Heymann:

That Paragon has never thrown one of these fellows off, though some have quit.

But let me get the price which is the heart of the government’s case.

The heart of the government’s case is that Paragon retain the legal right to set the price that they would pay for mine coal, for coal mines either at will or at the very most at the fair market value of the service of the miners.

Now, the basic facts of — I should begin by saying that the Tax Court — I should refer you to the two court opinions on this issue which we regard as crucial.

In the record at page 22 — oh 222, is the Tax Court opinion near the bottom of the page.

The Tax Court says, I would say about an inch-and-a-half up, there’s no evidence that the amount paid by Paragon was directly related either to the price it was getting for the coal or to the sales price of a particular contractors coal and the amount was apparently changeable at the will of Paragon and we take this to be a finding that Paragon could post what prices it wished.

What to make of the Fourth Circuit’s opinion is —


Philip B. Heymann:



Philip B. Heymann:

Your Honor, reading the record you’ll find over and over again miners saying that they didn’t know what Paragon was being paid.

Now, Mr. Merrell has an explanation that may have some validity to it.

He says these miners knew that the basic field price of bituminous coal that they didn’t really know what Paragon is being paid.

I was going to get to reading you a passage on 91 if you would like to skip around in the record to indicate what we regard the transaction to be, basically a transaction between economic unequals, people with unequal economic power.

This is a miner talking.

“Did the price that you receive for your coal vary during the period?”

“Yes sir, up and down.”

Would go up and down — excuse me Mr. Merrell is cross examining him.

“Yes, and that was generally in accordance with changes in market price for coal was it not?”

“I don’t know.

In other words, I guess it was.

They would come and tell us we have to cut you or they would raise you market picked up I imagine.”

“When they came and told you they had to cut you didn’t you ask why?”

“I don’t know as I did.”

“Being in the coal fields, you usually know when it was up and down.

You usually knew.

Weren’t you concerned that the fact you were getting cut?”

“Was I, why sure, anybody would be concerned but not much you can do about it, I don’t think.”

Now that’s our picture what was going on in price in the coal fields.

By the way, I don’t want to dispute in any way that Paragon apparently when it arranged the price terms with these miners said to them right up to that, we’re going to pay you $4, we reserve the right to change the price and the price will go up if things — if conditions are good and will good down if conditions are bad.

We just interpret the latter — the very last statement they’ll go up and down as mainly — as merely reassurance general talk.

The reservation of right to change price it seems to us to be legally binding.

Potter Stewart:

Who’s going to tell us what the Court of Appeals said on this issue?

Philip B. Heymann:

The Court of Appeals statement in page 255, basically, it’s in their concluding paragraph.

The operators had a continuing right to produce the coal, that’s their finding of non-terminability that we would dispute if we thought it was necessary.

And to be paid therefore at a price which was closely related to the market price.

Now, personally I read that as saying they had a right to produce the coal and to be paid at a price which was in fact closely related to the market price.

It is possible to read it as saying they had a right to have their price stay in touch with the market price.

We think that when a mineral lessee retains the right — make specific his right to change the price and no standard is set by which the changes will be measured, you’d have to find that he has the right to change the price as he wishes.

At least at the very most he’s obligated to pay the fair market value of services.

Philip B. Heymann:

I was going to say that that was confirmed by three facts.

One that the miners didn’t seem to generally know the prices Paragon was paid.

I wanted to quote from the testimony that I read to Justice Goldberg.

And the three of the Jewel brief, there is an amicus brief in this case by Jewel Ridge Coal Company which shows a very good job of tracing its reply brief in particular.

It does a very good job of tracing what happens to prices of coal and prices paid to miners.

They point out that on two of the nine occasions with no drop in price of coal that’s perceptible at all, the miners take a 25-cent cut in price paid them per ton of coal and that’s very sizeable break.

They just don’t and — above all, the record is devoid of any indication that the miners ever asserted a right to be paid a certain amount.

The most that happens when there’s a change in price is they move into a bargaining posture and they don’t even do that.

They don’t have the power to do that, but no one asserts a legal right.

No one suggest they were right to evade anything except what Paragon tells them.

Finally, and this I regard as nearly conclusive, if you were going to find a right in this case, the most you could find, we believe, would be an obligation to pay the miners the fair market value of their services including the value of the equipment they bring into the job and the value of the capital they contribute.

You couldn’t find an obligation to pay them anything in respect to the coal in the ground which Paragon, the mineral lessee brought to the job.

I think Paragon would have screamed in righteous indignation if any court told them that they not only had to pay for the services and the equipment but also for the coal which they brought to the job, which Paragon brought to the job.

And if this is so, then the miners have no legally enforceable rights to share in the value of a coal in the ground and therefore they’re not entitled to depletion which is the allowance for the exhaustion of valuable rights to share in the coal in the ground, that’s the heart of our case.

Now, I’d would like to move before concluding I’m getting near the end.

I have said these are minimum standards.

Though the case is harder, we would reach the same result even if the contractors in this case keeping all the other facts constant were paid and had a right to be paid a fixed amount without change and could only be discharged for cause.

Now admittedly, this becomes a much closer case.

But we would think the same result follows.

I begin by looking at a contractor who’s paid by the hour or in a cost plus percentage of the cost basis.

He may be a contractor extracting coal from the ground.

He may be a contractor grading the coal, sizing it, dusting it, washing it, maybe a railroad that runs a little spur line between the mine and the processing plant that’s paid on a weekly basis and has a sizeable capital contribution.

Indisputably, each of these people has a sizeable capital contribution and the capital is going to run out with the life of the mine.

The railroad tracks are not going to be worth anything when the mine is not worth anything.

Indisputably, they’re in a — as a matter of practical reality, they’re paid out of the proceeds of the sale of the coal, even though they have an independent obligation.

Equally and indisputably, they’re not entitled to depletion.

No one has thought they were entitled to depletion.

The reason is depletion is recovery for the value of the coal in the ground not for the cost of taking it out, not for the cost of moving it and not for the cost of grading it and making it ready for sale.

The only difference in this case is that the miners are paid on a piece work basis and we don’t think that can be controlling.

I’m assuming in all miner cases that they have a right to stay on as long as they produce adequately.

Philip B. Heymann:

We don’t think that can be controlling.

As I’ve said to Justice Goldberg, it is possible that a man could in exchange for promise to render services or in exchange for services obtain a depletable interest.

As a matter of fact, it’s a familiar process in oil fields for a well to be dug — drilled in exchange for an oil payment and we allow depletion on the oil payment that the driller receives for having dug the well but what the miners got in this case, even if you assume that they had a right to be paid a fixed amount and it couldn’t be terminated for something very different from a royalty interest, from any interest we know of in oil or coal or on any mineral.

They weren’t to be paid out of the proceeds.

We know of no case yet where people have a right to be paid by someone else not out of proceeds in which they get depletion.

They have an absolute right to be paid out of Paragon’s pocket.

Their right to payment was only when they did the work and as they did the work on particular coal.

They didn’t have a right out of coal that they didn’t work on.

The rights were apparently non-assignable.

In ordinary royalty interest you could assign.

You could sell to someone else.

In this case —

Arthur J. Goldberg:


Philip B. Heymann:

Alright — I meant to put a shift and say when I was getting to four parts that could possibly be disputed.

In both assignments in this case Justice Goldberg, they are very careful to clear it with Paragon in both assignments they’re very careful to go to Paragon and ask Paragon’s consent and the transaction was conditioned on Paragon’s consent.

There was no right to demand production.Generally a man who has an interest in the mineral has a right to insist that the mineral come out of the ground and not lay there forever.

We think Merritt had no right to demand production.

Finally, and this too is disputed the —

Potter Stewart:

I don’t understand that, it was Merritt that was in — that was in charge of the production.

Philip B. Heymann:

Merritt had to stop.

Merritt had to stop apparently, Justice Stewart when Paragon said we got enough coal for awhile.

If Paragon’s mill — not Paragon’s processing mill where they graded, dusted and cleaned coal was filled up, they could just tell Paragon stop.

In one occasion, apparently this happened.

We believe from the record Paragon could say the market is bad.

The market is no good.

Coals flood on the market and they could say no coal for a while.

Potter Stewart:

You’re saying they could compel them to stop if they were getting tangled up with other contract miners too.

Philip B. Heymann:

The last thing I was going to say.

I wondering whether I should go on to say another dispute between Tax Court and the Fourth Circuit is whether they had particular boundaries assigned and we don’t believe they had particular boundaries assigned to them.

Tax Court found they didn’t, the Fourth Circuit found that they did but of all these we would rely on one as crucial.

Philip B. Heymann:

And that is, if a man is paid only for the mineral he processes or handles or works on and only when as he works on it, we would say he’s being paid for services and not for the mineral.

Not being paid for coal.

Merritt has only paid — excuse me, Justice White.

Byron R. White:

Is it going to make me any real difference that government in terms of money collected in terms of revenue in which way this case comes out?

Philip B. Heymann:

The government’s interest —

Byron R. White:

You are certainly taking a rather solid position on this — in this case and I think that it must have — means something to the government.

Philip B. Heymann:

No, I would — the government has three interests.

We do want to see the right person get the deduction, that’s not an interest personal to government.

The government has a personal interest in seeing that a firm and workable rules develop.

In this case we had to deny that equation to two taxpayers make two of them go through.

Unfortunately, the actions were consolidated but we don’t want to be left holding the bag.

We like to see a firm and workable role develop.

One or the other taxpayer will get the deduction.

We’d like to see that one of them gets it and the two of them don’t.

William J. Brennan, Jr.:

Well, it might mean more to one than the other, might it not?

Philip B. Heymann:

Oh, excuse me?

William J. Brennan, Jr.:

It might mean more than one and the other might not.

Philip B. Heymann:


It might.

If I — I couldn’t guess which way the government would get more money.

If I had to guess and I would have made no effort to try, I would think that we would get more money by arguing the other way from that which I’m arguing.

I would think the bigger taxpayer has the higher net income and can use the deduction more.

We’re arguing against our immediate financial interest.

Arthur J. Goldberg:

And the third reason.

Philip B. Heymann:

The third reason is we do want to rule that isn’t tied to technicalities.

It’s tied to economic realities.

Whenever rules tied to technicalities the government finds that the taxpayer with a high bracket has much, many deductions and little income than taxpayer with a low bracket that they would never need a technical rule.

Taxpayers can manipulate it and we find that we have — the deduction is going to the high bracket taxpayer and the income going to low bracket taxpayer.

Byron R. White:

But if we’re going to go in economic reality, that isn’t quite the argument of your lessee?

Philip B. Heymann:

In terms of what lessee has?

Byron R. White:


Philip B. Heymann:

Justice White, I’m afraid I don’t quite understand.

In econo —

Byron R. White:

Well, say — say that the coal company leases to an operator, puts the word lease on the top of it because I’ll buy all your coal at reasonable sum in the lease is for five years.

Philip B. Heymann:

We would not — we would certainly follow the economic realities and not the word ‘lease’ Your Honor.

We don’t — we are totally indifferent to the word that’s written at the top of the document.

Byron R. White:

But normally the lessees share in depletion?

Philip B. Heymann:

Do lessees share in?

Byron R. White:


Philip B. Heymann:

Well certainly they do.

The normal range for this that the lessee pays for the lessor in oil of 1/8 royalty, in coal in this case 30 cents a ton and retains all the rest for himself.

What he does in the case of oil is that the landowner gets depletion on the 1/8 or on the 30 cents, well in coal on the 1/8 in oil — on oil on the 1/8 and the lessor gets all —

Byron R. White:

But if the lessee — but if the lessee is selling on the open market prices and he negotiates, agrees to sell to the lessor with reasonable price.

Philip B. Heymann:

I would want to know what reasonable meant and then I would be able to answer the question, Your Honor.

The word —

Byron R. White:

You don’t think the — you think this contract — I gathered you thought this contract might at least mean that the owner was agreeing to pay reasonable price.

Philip B. Heymann:

In terms of the fair market value of the services rendered, if they agree to sell at a price that reflects only — if its entitled to lease and the lessee agrees to sell the lessor the price which reflects only the fair market value of the services rendered by the lessee, it’s this case, no depletion to the lessee.

William J. Brennan, Jr.:

That’s unrelated to the value of the coal?

Philip B. Heymann:

Excuse me, Your Honor?

William J. Brennan, Jr.:

Is that unrelated to the value of the coal?

Philip B. Heymann:

Unrelated to the value of the coal.

William J. Brennan, Jr.:

You spoke this on the value of service.

Philip B. Heymann:

That’s right, Your Honor.

Byron R. White:

And this rule would have considerable application outside the mineral business too, I suppose.

I mean outside oil — in the oil business?

Philip B. Heymann:


It would have application in the oil business.

The problem doesn’t seem to arise in oil because the major expense of producing oil is drilling.

The drilling is completed before the oil payment is assigned.

At that point, we have a very clear example of completed services being exchanged for what is a traditional royalty interest.

Arthur J. Goldberg:

Mr. Heymann, you say the government wants to decide this case and the economic reality and so we see to it that the high paying taxpayer doesn’t get the deduction and low paying taxpayer in fact does but isn’t the practical result of the government’s position quite in reverse and let show this to you.

That your equality of bargaining power here that you have read from the record demonstrates there is none if you take the same arrangement and make a royalty.

Because after all the miners aren’t going to get paid unless Paragon sells and sale as you have said the amount that it paid really comes out of the process of sale because they could terminate the contract if they’re not going to get enough to pay the miner and in that result aren’t the government looking in your form here in that substance.

Philip B. Heymann:

Your Honor, I think the substance would be very different if you cast in the form of a royalty.

You’d have to give —

Arthur J. Goldberg:

But he has no bargaining power to do that.

Philip B. Heymann:

But the substance would be different not only the tax results but the substance.

Arthur J. Goldberg:

Why would — why would it be different?

Philip B. Heymann:

He would have to have the bargaining power to demand that exclusive right to a particular territory to demand to be paid a sum of money that was either fixed or could be determined by judicial standard, out of all coal from that area whether he withdrew it or not.

He would have to have a right to assign that royalty such that if he quit his services, he would be sued for damages but he would still have the proceeds of his royalty.

Arthur J. Goldberg:

But you’re demonstrating just that he doesn’t have any quality of bargaining power.

Philip B. Heymann:

I’m demonstrating that he couldn’t demand these things that would have made him the capitalist that depletion is given to.

Arthur J. Goldberg:

You’re saying the same thing.

Philip B. Heymann:

Yes, Your Honor.

Arthur J. Goldberg:

You’re saying that the miner does not have the bargaining power which would give him the totality the royalties that you think are necess —

Philip B. Heymann:

It would give him the five additional rights to become — that are necessary to become an owner of mineral on the ground.

He doesn’t have the power to demand those and he didn’t get them.

Thank you Your Honor.

Earl Warren:

Mr. Merrell.

John Y. Merrell:

Mr. Chief Justice, and may it please the Court.

I want to get one thing straight at the beginning.

This Court has very wisely held that ownership of the mineral in the ground is not essential to the depletion allowance.

It has been written into the government regulations.

What the government regulations say is that the ownership of an economic interest when this controversy started that government was neutral.

Somewhere along the line they were persuaded to abandon their neutrality and I’m distressed to learn that the best reason that the Commissioner can give is that it was a bargain between unequals and they chose to take the big man.

I’ll dare say that when the law of this case is analyzed, you’ll find that the position of the coal mine operators who were the respondents in number 237 is more closely and more consistent with published rulings and regulations of the Commissioner and with opinions of this Court.

The government went through its argument here without once discussing the most recent case of this Court which was Parsons versus Smith and the only case in which this court has dealt with the depletion allowance of a coalminer.

I want to say this on the law.

I feel that if I can adequately inform this Court as to the facts of this case that I need not concern myself the law.

It says that these general principles of law are to be applied according to the peculiar circumstances in the case.

John Y. Merrell:

This Court has never gone into the question of drift binding from a taxation standpoint.

It’s a practice that developed some 20 years ago in the areas of Virginia, West Virginia and Kentucky when they learned that there were low thin seams of coal that the big mine operations have not been able to mine out and could not be mined with expensive equipment but they left themselves to mining by hand loading and that a small operator if he had enough courage and a little bit of resources that he could go in there and make a living at it.

It was high quality coal but it lent itself to handle loading rather than to machine loading.

Now, this case is typical.

One individual acquired a certain acreage of coal leases.

He then forms a corporation to which he transfers his leases.

Then the corporation develops what we call a processing plant to receive the coal, process it, load it, size it, enters into an agreement with a sales agent and a sales agent agrees to sell it.

Now, that’s what Paragon did in this case they were all ready to go in 1952 but lacked one thing that was production of coal.

None of this was a value to anybody unless somebody was willing to mine the coal.

Now, Paragon was obligated under its leases to mine this coal.

It also as a matter of fact — practical economics had to mine the coal in order to survive but the difficulty was and this is in the record.

Paragon did not have the funds to invest in the production and mining the coal and its priced and dominant stockholder Mr. Claiborne said he would not expose his personal funds to the hazards of the coal mining business.

Now why it’s hazardous because as I have said this is a thin seam.

The big coal operators don’t bother them with it.

It never gets more than 30 inches high.

That means that all work has to be done in an area that’s never more than 30 inches high.

You can’t use this big expensive equipment.

It’s an irregular seam which means that it will be going on 30 inches high and the first thing you know it’s pitched down until it’s two inches high or pinches out completely.

Then you’ve got no coal to mine but if you’re going to mine the coal beyond where you mine, you got to drive through the sandstone and the limestone which is a more onerous burden than extracting the coal itself.

It’s necessary to develop these areas by hand loading.

The men go in there and work on their knees and as I said, it’s means by which a man of modern means in that area and assemble a workforce maybe of 20 to 40 individuals and make a fairly good living at it if he’s got enough courage and if he’s got a little bit of luck.

Now, drift mining is as different from strip mining as night is from day.

Now, that’s a pretty good way to put it because when you strip mine you have all the freedom of good surface you don’t have it when you drift mine.

We don’t disturb the surface, we’re not the people who make all this restoration of surface mining necessary and if all the coal, new mine comes out of one ton, one entry.

It’s all done underground.

Now, the Fourth Circuit says — the court below says, our decision — their decision’s within the rationale of Parsons versus Smith.

Paragon says it’s not, the Tax Court says it’s not, the Commissioners says it’s not.

Well let’s discuss what this Court did in Parsons versus Smith and see how it compares with the facts in his case.

This Court reviewed the law, cited the regulations then came to the facts and it said first that in Parsons versus Smith, the investment was an equipment all of which was movable not in the coal in place.

The — that was true.

John Y. Merrell:

The strip mining is no different than any large excavation job such as road building, bridge building or airport building and you have a certain problem moving your equipment on to the site, once you get it there and made a few minor preparations you’re ready to go and you can be in production immediately, you just move the earth and scoop up the coal.

Now, in both of those cases, in the Parson’s case if the agreement was terminated by the coal owner, the coal — the landowner, the strip miner had the right to mine and be paid for all uncovered coal in the Huss case the agreement was that the strip miner was obliged only to remove coal which lied a prescribed distance, more than a prescribed distance from the surface.

The point I’m making here is that their operation was predictable, it was premised on expensive equipment and it was perfectly proper for this Court to say that their investment was in their equipment rather than in the coal in place.

Let’s contrast it with the facts in this case and I don’t believe these facts are subject to dispute.

Paragon was obligated to open, develop, preserve and produce the coal under its leases if more than anybody else knew the obligation it was placing on the mine operators.

It says, “We’ll place this all on you and we’ll encourage you to do it.”

Now I’ve outlined in my brief pages 5 and 6 and 11 to 7 deem what these investments were.

I’ll just outline them briefly here.

There was a certain amount of preparatory work but had to be done at the mine entry, what we call the mouth of the mine.

This would take maybe from a month to six weeks.

After that was completed they start driving them to mountain and remove coal.

The only problem they got is that the coal lying near the outside is what they call outcrop coal.

It’s not marketable nobody wants it so it may go for 20 feet, it may go for 200 feet.

They never know so they have to drive in till they get to quality coal that can be sold.

The second problem is, it’s low coal and no more than two or three people can work in an area and you can’t have a productive drift mine with only two or three employees so you’ve got to expose enough working areas, working faces as they call it so you can engage an adequate compliment and make your mine profitable that you need to expose these.

Sometimes this takes six months, eight months.

I’ll show in a minute that in two of the mines here it took eight months before they got into what we call a production end of the business rather the than the developed end of it.

While they’re doing this, they have to comply with all state and federal regulations and these are very onerous, they are known to Paragon, they are known to the drift mine operators.

They require safety measures.

You’re going to have to drive an air course that will go from a separate entry so that air can be pumped through all of your working places.

You set a large fan at the mouth of your air course.

It pulls the air through.

That has to be in your mind constantly and if — before you can send and compliment them in there, you’ll have to conduct what they call a fire bust, running a gaseous mine, that is send a man through with an instrument to measure the methane content of the mine and then if it’s inspectors says, it’s alright you can send your workers in there.

Secondly, you got to provide for the roof of your mine and this is a real burden.

You got to support the mine because, and this is all in the record, once that mountain falls after you’ve mined an area of coal, if it falls in the coal beyond there is, if not lost, extremely difficult to obtain.

You would have to go around by some circuitous course and obtain it.

Well, you support the roof by setting timbers on what they call 18-inch centers.

A timber is nothing more than a piece of lumber or a timber that four to six inches wide and as you mine you prop it up to hold the roof up.

In addition, you leave what they call pillars.

These are large bodies of coal.

John Y. Merrell:

They would, sometimes as large as 60 foot square.

You have to leave them to support the mouth as you’re driving back.

In addition you run into certain adverse mining conditions.

You’ll go into your mind some morning and find it’s full of water and no choice but to set pumps and draw it to the outside.

This may take a day; it may take two or three days.

The worse problem one that always brings the miners down is what they call rolls and that’s this situation where the coal squeezes out.

They get in these rolls the record shows that one of these miners were in the roll for 87 days.

Now while he was in that roll he was not mining coal, he was mining rock and it has to be mined and moved to the outside of the mine and he gets paid absolutely nothing for it.

In addition, you have such things as bad top and other problems.

Now, these things I’ve mentioned are capital investments to my mind for this reason.

They serve the — to enhance the value of coal in place.

Depletion is of value to no one unless somebody willing to enter into the production end of it and the development of the mine.

It needs no belaboring that point that a developed mine is worth more than a mine at the time you’re initiating it.

These such costs all of which have been regarded not only by miners but by the Internal Revenue Service as development costs until a mine gets into what we call a production stage.

I asked the clerk to pass to you, to pass a little schedule.

Now, this will give you an idea better than any words I could employ this is the Caiva mine.

It started in August 1954.

It shows the tons mine.

They didn’t do any good in August and September.

They were getting ready to mine.

Then it shows their gross from Paragon, their deduction, their net income.

Nine months later at April 1955, they were $5400 behind.

Now, this isn’t their total investment.

This is the amount they put into the mine less what they received and I might say that this isn’t my answer though.

This is an exhibit that Paragon put into the record.

They asked permission the conclusion of the Tax Court hearing to go down and check our records and make this exhibit.

The exhibit I put in which showed a much more unfortunate picture but I’ll rely on theirs.

It shows that after nine months of hard work, they’re $5400 behind and there’s another investment on top of this and I think were too inclined to talk about investment in terms of money.

It’s easy to say we spent $200,000 for a processing plant or for a drag line but in addition to any monetary investment these men are full time miners.

They’re not gentlemen miners.

John Y. Merrell:

They don’t do their mining at the barbershop or other local gathering places, they’re everyday.

So in addition to what I have indicated there you have the services of three full time grown adult miners for 10 months.

If you’ll check Exhibit 102, I believe it is, that shows the same history 102 is an exhibit which Paragon put in with reference to the steel well mine.

It shows the same type of history.

You work there for eight or nine months before you’re doing any good at all and at that time your probably anywhere from $2000 to $10,000 behind, plus the time you’re out, plus the investment that you put no the property.

Now, make the statement that we’d explained any capital investment in the coal, that’s not accurate.

What they ask in the court several times was did you own the coal.

You don’t contend that you own the coal.

We’ve never contended that we own the coal.

I frankly, don’t know who owns the coal while it’s there in the mine but we didn’t disclaim the fact that we had certain rights in the coal in place.

Now, let’s go to Parsons versus Smith again.

They said there’s and tying in with this question I just made, this point I just made they said the strip miners’ investment was in their equipment all of which was recoverable through depletion and depreciation not depletion and Paragon picks that up and it makes this statement in its brief two or three times.

To allow the drift miners’ depletion what enabled them to recover for the exhaustion of a capital investment which they never made.

Well, I’ll turn it around on them to allow Paragon the full depletion allows would enable it to recover for a capital investment which it never made because it specifically refused to make the capital investment essential to production of coal.

Now, I — we’re not here saying Paragon does not have an economic interest.

They do have they made certain investments, they paid the minimum loyalties which were minor, they paid the real estate taxes, they established the processing plant and they had the right to receive the mineral but they did not make and they cannot find — you cannot find in the record any place where they made an investment for the production of coal.

They put that obligation on the contract miners and I don’t like this double standard they talk about.

Everything that Paragon has put into this operation they deducted for tax purposes.

You’ll find that on record 84.

We ask their accountant, “Is there anything you put into this operation that you haven’t heretofore deducted in some means other than depletion?”

He said, “Nothing.”

I think there was some life insurance payments on their president’s life or something but I don’t think it’s fair for them to say you’ve deducted these things so therefore you shouldn’t get depletion.

The fact is they’ve deducted every penny they put into this operation.

Byron R. White:


John Y. Merrell:

Its obligation under all its leases was to pay a minimum royalty $1000 on one piece of land, $4000 on the other.

Byron R. White:

A year?

John Y. Merrell:


On minimum royalty if you excuse me, Justice White, I might say that they did advance a little minimum royalty but it’s all recouped after — out of production.

They could recoup it in later years out of production in any payment rather.

Byron R. White:

And what was the term in their lease?

John Y. Merrell:

The term of their lease, it varied in most cases.

I think one lease was a five-year with a right to renew for additional period.

Some of their leases, there is one lease here where they have the right to terminate themselves.

It was terminable and at their will, not any of these contractors remained under.

Byron R. White:

Well, what if — you say the fact that Paragon himself didn’t put out any money in developing this coal and that the contract operator did, that the contract operator were one of the economic interest rather than Paragon?

John Y. Merrell:

I said — what I said and what I meant to say was that Paragon did not invest in the development and production of the coal.

Now, under statute, coal mining is defined as including the production of coal plus certain processing factors that take place.

Now, Paragon did invest for the processing of coal and they had the right to receive and sell it but the point I’m making is they invested nothing for the production of coal aside from the minimum royalty and the real estate.

The third thing that this Court mentioned in Parsons versus Smith was that the rights there were completely terminable at will on short notice.

In the Parsons case, the Parsons was a road builder.

He went there and they offered him a long term contract.

He said I don’t want it, I’m a road builder.

I insist on a 10-day, right of termination in 10 days because if I get a good opportunity to go back to road building, I want to do it and they entered into an oil contract 10-day terminable on either side.

In the Huss — and as I mentioned, if it was terminated by the landowner, he could extract all uncovered coal.

In Huss, the agreement terminable without cost and without liability on 30 days notice.

Now, let’s go to the facts of this case.

I think it’s clear from the record that nothing was said at the time these agreements were made about termination.

Witnesses for both sides so testified and the Tax Court so found.

The miners were going there with the idea in mind of developing the property.

They knew and Paragon knew that they could not make any income out of this operation until they’ve been on the premises for at least four weeks and that would be in the event of the lucky situation and probably more likely than not that it would be a matter of eight months or two years so they both bargained with idea in mind that they would stay on the property, that was certainly the intent of the contractors.

Now, they refer to this Exhibit 86 and 87 where it has a statement in there that well it says, “In two places that the question of termination never arose and then in the argument part of the protest there is some statement to the effect that the agreement specified the right of termination by either party but the question never arouse between the party for the agreement.

The Tax Court put no weight on it.

The court below put no weight on it.

It’s an inconsistent document.

The record explains clearly how it was developed, how it was created and the reasons behind it.

Mr. Merritt testified with respect thereto and I won’t burden the Court further with that at this time but I want to deal with this a minute.

They say that some of the miners quit.

That’s — we admit that a number of them quit.

You have them quitting all the time.

It’s not an easy occupation.

John Y. Merrell:

It’s not for the fainthearted and it’s not for those who do not have sufficient resources to see it through and if a man goes in and takes one of these operations and goes broke, he’s got no choice but to quit but the point is when he quits, everything that he’s putting to that operation accrues to the benefit of Paragon because when he went there, they had nothing.

When he left there was the benefit of whatever work he had done and if he brought it up to a point where it was a developed and productive mine, then Paragon had a developed and productive mine.

And I want to put this point out, none of these people before this Court went.

These people were going in there with the idea of putting their own money and their own efforts into it and they didn’t quit and the record’s also clear that paragon never terminated anybody.

So I don’t I think —

Earl Warren:

The men will be likely to quit if he fill it up though it was a profitable thing?

John Y. Merrell:

They not only wouldn’t be likely to quit but he wouldn’t let him throw him off either.

This is when —

Earl Warren:

You’re talking about these fellows who quit after they build it up to a profitable standpoint.

John Y. Merrell:


I see your point.

Well, they wouldn’t quit if they got into a probable standpoint but say they got it 50% of the way.

Then if they weren’t able to make it, the next person taking over would at least 50% of this development worked out.

No, it’s not likely that they would quit as long as the — if they had it operating productive mine.

I think if you go back to Parsons v. Smith there’s some language in there to the effect that the landowners did not agree to surrender and did not surrender any interest in the coal in place.

I’ll agree with that.

They agreed to — they gave a right to mine for 10 days to one, the right to mine for 30 days to another.

Here Paragon surrendered.

It didn’t own the coal to start with.

That did belong to landowner.

It was lessee.

It didn’t own the coal in the ground but it did have the right to remove it, reduce it to possession and to sell it.

It surrendered that right to the coal mine operator.

Thereafter, they have the right to reduce, extract the coal, reduce it to possession and to be paid by Paragon for the coal and I submit to you that Paragon by entering into that agreement and putting the obligations on the contractor also surrendered a real substantive right in the coal in place.

The right to mine coal is a very definite interest in coal because unless somebody has the right to extract in these depletion cases, nobody is going to get the depletion.

The argument has generally not been with the producer.

The man who is actually producing the coal is generally with some taxpayer who acquires a lease and then assigns the operating interest to another party for an additional interest of some kind.

It’s generally a middle man that was the case in Palmer versus Bender and these other cases.

There hasn’t been any real question whether a producer have the right as long as his rights were absolute, as long as they could not terminated.

I have already touched briefly on the point of ownership.

John Y. Merrell:

They talk so much about ownership.

I’m not sure as just what they mean.

I regard ownership as a bundle of rice in an asset and certainly among the bundle of rights here, the coal mine operator certainly had the rights of real substance.

Let’s get to the question of price and I’m sticking with Parsons versus Smith and that’s the case the court below relied on, that’s the one the government says doesn’t control here.

There on the question of compensation, the Parsons was to receive a fixed price per ton, Huss was to receive a fixed price per ton.

In the Huss case, it was specifically understood between the parties that this would be as compensation for work performed.

The market or the sale of the coal by the landowners in that case didn’t enter into the agreement between Parsons and the landowner in any way you can search the case from the District Court up and you cannot find where the market played any part with respect thereto.

Now, this — Commissioner’s counsel conceded that at the beginning of these negotiations the operators were told that they would be paid a certain price per ton, $4 per ton but a price will be governed to some extent by the market.

If the market drops we reserve the right to decrease the price, if the market goes up we will give you an interest.


John Y. Merrell:

Or has taken an equitable apportionment.

That’s what we’re seeking here and on this particular point by making that provision part of the agreement, Paragon refused to give its personal covenant.

It said you’ve got to look behind us to the market to see what you from whence you recovery your investment and the record is clear that the price did fluctuate in accordance with the market.

In fact, the present where Paragon said that it did vary indirectly with the market price for coal.

When they said, what do you mean indirectly?

What other factors?

He couldn’t mention any other factors which entered into the price arrangement.

Earl Warren:

Can you suggest any division — depletion allowance here between you and Paragon?

John Y. Merrell:

The government has made a division in accordance with its regulations.

Now, it works this way.

Paragon is obliged to pay a royalty which it pays to the assignor, Mr. Claiborne and he takes that royalty in and reports it as capital gain and to pay in any sub-royalties, offset in royalties that he has to pay.

The division and the regulation is that if Paragon sells it for 6 1/2 a ton and the royalty comes out, that’s its rule 625 and it pays us $4 a ton, then the parties themselves have made the apportionment.

We get it on $4 a ton and they get it on $2.25 cents a ton, that’s the way these statute works.

If you once grant the proposition that the mine operators are entitled to it.

I think I had some other points here but Mr. Heymann has conceded that the operators were interested in what Paragon was realizing for their coal, rightfully so because if Paragon did well then under their agreement, if their market price went up they could get it in.

He quoted certain testimony from one of the witnesses which would happen to be witness of Paragon who had some obligation to Paragon where he said that he didn’t care about the price or the price didn’t mean anything to him but I think the record is clear upon analysis and as I pointed out in my brief that they were definitely interested in the market price.

Well, that’s the only industry in the Buchanan County of any cost or these if a dock changes its price at 8 o’clock in the morning everybody up the lunch stop knows about it by 12.

Now the Tax Court didn’t make a finding that the price was apparently changeable at the will of Paragon.

It said that the price did fluctuate based on overextended periods based on market conditions and then at the conclusion and to some extent on labor cost then in its opinion towards the conclusion it says that this amount that Paragon paid was apparently changeable at the will of the Paragon suggesting that the Tax Court itself was very certain about it but I think what it refers to is this that Paragon being the party that receive the coal and marketed, it always initiated the price changes and since all of the price changes which it initiated were in accordance with the market, there was no occasion for the operators to object.

I just want to move on to one other point and then I think I’m nearing the conclusion here.

John Y. Merrell:

There’s been some testimony here that the fact that these individuals were not given a specific area to mine.

The Tax Court was a little wishy washy on it.

It didn’t bother the court below any but upon the record, you can examine the testimony of the operators and you’ll find that they testified that they were assigned a specific area.

Now, the testimony of the — I mean the only testimony on the contrary is the engineer who was in charge of the operation and who the operators have to pay for all inside engineering work.

Now, he at the beginning of his testimony jumped all over the place as to whether there was or wasn’t an error, but on three occasions towards the end of his testimony, he was pinned down on his question.

Once by counsel for the mine operators, twice by the Tax Court and these appear at records 78 through 83 and he conceded that no change that he had ever made caused any operator to lose coal that was always a question of adding coal, that all of it — that at no time did he make a change on the operator’s projections of maps which cost any operator operating at that time to lose any coal.

It was always to add coal.

What would happen is this.

They drive in the mine and Operator A let’s take the Merritt’s, they would operating.

Operator B would go broke or quit or something.

After he had stopped operating then Merritt’s would make a deal to mind some coal otherwise it would have been mined by Operator B and a new allocation would be made or Paragon would acquire additional leases then they would come to the operator and ascertain whether he wanted to take on the burden of mining an additional amount of coal.

So there is no case when any coal was ever taken away from an operator who was operating at that time.

If the Commissioner desires a workable rule in this case in this whole situation, I submit he’s got one.

He submit — he issued a GCM in 1950.2629 is the number of it, which spells out the rules with reference of the strip mine and I submit our case comes within.

I won’t go into it now.

I submit that he would — if he would update that a little, he hasn’t revoked it since Parsons v.Smith bring in the principles of Parsons v. Smith either have not only a workable rule but an equitable rule and if it’s going to be workable, it has got to be placed on the economic realities of the situation rather than some fine legal distinction as to whether they own the coal, whether they have legal title to it because taxation is a practical matter and it is the burdens that you place on people that should give rise to the deductions in the benefits.

We go in here our people.

We make this investment and when we don’t make it — when we don’t make it, then there’s no income to pay but when we do make it we think we’re entitled to, we’re obligated to pay our tax and also entitled to any benefits that true to us.

I particularly dislike the Commissioner’s argument in this case because it’s based primarily on speculation as to what might have happened or what could have happened.

He says that they have no rights, that Paragon could just pay them for services and if they came down to a question of bargaining power — this is the little man and this is the big man.

Well, I’ll close by saying this that our position of this argument has been known to Paragon since 1956.

At that time the Stillwell case was being litigated and it was decided favorably to the coal mine operators by the court below.

He has known since then our position with respect to this.

He has never attempted to clarify our contract, never attempted to renegotiate it and never even threatened the prices out of our contract by reducing the level to a price at which we couldn’t operate or any of these things.

On the contrary, he has taken the benefits of the agreement and knowing that we had a certain understanding with respect thereto.

This has been onerous litigation for my people.

They’re not wealthy people and the amounts aren’t big and if this whole question if they have the right determination they could have been decided for a fraction of the expanse that has been spent in this tax litigation.

All Paragon has to do is bring action of ejectment in Buchanan County, Virginia then we would find out directly and quickly whether they could terminate or not.

Byron R. White:

Do you think your case will be stronger or weaker if there was a fair price in sale of coal to some of your clients to Paragon?

John Y. Merrell:

I think it would be — I think it would be weaker.

John Y. Merrell:

I really don’t think it makes as much a difference as we say for this reason.

The regulations doesn’t say, the regulation says this.

Byron R. White:

So the more discretion — the more discretion you give the buyer to set the price, the stronger your case is for economic interest?

John Y. Merrell:

No, I think if the price depends upon the market price of coal I think it presents stronger situation, yes.

Byron R. White:

Well does it?

John Y. Merrell:

I think it does.

Byron R. White:

In this contract, let’s say it depends on the market?

John Y. Merrell:

It depends on market.

I think it definitely depends on the market price of coal.

Every change that was made during the term of this agreement was made in accordance with a significant shift in the market price of coal.

Byron R. White:

Now what — you just said a word, why do you think Parsons had no control of it?

John Y. Merrell:

Why it doesn’t?

Byron R. White:

Yes, because there were strip miners involved there?

John Y. Merrell:

No, because the mine operators here made a capital investment which enhanced the value of the unmined coal.

Their rights would not be terminated.

They were given the right to mine not just for 10 days but for 30 days and they —

Byron R. White:

But the capital investment was the work.

John Y. Merrell:

Sure it was the work.

Byron R. White:

I mean it wasn’t the equipment or anything.

John Y. Merrell:

The labor, their labor.

There was more on that.

It was the labor.

It was the timbers that they put up.

It was the coal the facing of the pillars that they have to leave.

All that is a capital investment because it produces —

Byron R. White:

And whereas in a strip mining operation the more overburdened area is the closer that gets to break your case.

John Y. Merrell:

The — over by burden and the strip mining operation is generally measurable.

In most strip mining contracts you don’t have to —

Byron R. White:

Whether it’s measurable or not, it doesn’t mean that it is important to getting ready to mine and remove it.

John Y. Merrell:

You can get in the full scale production almost immediately in a strip mining operation.

John Y. Merrell:

The investment is in equipment.

Byron R. White:

Thus in strip mining that’s quite a bit of overburden to remove, isn’t it?

John Y. Merrell:

Right, I agree.

Yes strip mining can be a burdensome thing so there can be a large amount of overburden

Byron R. White:

And if there was enough — if there was enough that had to be removed in order to sort of like timber that’s stripped, you’re really getting ready to mine and the more of that there is most likely parts he would control even though he is a strip miner?

John Y. Merrell:

No, I submit because in strip mining you can move from site to site or from location on a particular site without any problem at all.

In drift mining, it’s all must come out at one entry and one tunnel and that makes a real difference because these mines I might say they’re a mile-and-a-half deep, they were at the time of trial.

What you did up here at the mouth of the mine is valuable now for extracting coal that lies a mile-and-a-half deep.

Byron R. White:

Are these levels straight or are they slanted?

John Y. Merrell:

Their level are at some variation.

They don’t go straight.

Byron R. White:

But no shaft?

John Y. Merrell:

This isn’t shaft mining, no.

It’s not shaft.

I think there’s a fundamental distinction between this operation and drift mining.

Byron R. White:

But it’s the — it’s the — it’s the labor that takes to put the mine in shape?

John Y. Merrell:

The labor and the supply, yes, and it will go on over period varying from like I say four months, sometimes a year before they have an income producing mine.

Byron R. White:

Whose rail was it that was laid?

John Y. Merrell:

The Stilwell brothers always mined on the rail and —

Byron R. White:

He had rail is it’s mine isn’t it.

John Y. Merrell:

In one mine yes some mines on a rail some mine on rubber.

Byron R. White:

Whose rail was it?

John Y. Merrell:

It was the mine operators.

They have to build a little railroad into the mine.

It was there.

The remaining now they take it out or not when they leave whether it’s worth anything in another mining operation.

Equipment they do use is special equipment for this low seam of coal only.

Byron R. White:

Did — are these development costs in this contract that these miners put in I suppose are deductible.

John Y. Merrell:

Prior to 1950 they were not.

Byron R. White:

Well, I didn’t say 1950.

John Y. Merrell:

They are deductible, yes.

Byron R. White:

They’re deductible against straight income from mining.

John Y. Merrell:


Byron R. White:

And they’re carry over —

John Y. Merrell:

Oh yes, you can —

Byron R. White:

— and forward or back.

John Y. Merrell:

You can have that if you have a lot.

Byron R. White:

Straight ordinary deduction.

John Y. Merrell:


Byron R. White:

And you think that those kind of investments which your total investment are deductible on a formal basis or an economic interest so that you can deduct it in here.

John Y. Merrell:

Yes and for this reason.

No, I want to give you my reasons for it since I have time.

The question of what represents a capital asset or capital investments for purposes of depletion was decided long before 1950.

Now, Congress by statute has said that you can deduct these things that otherwise you would recover through depletion but the legislative history of that section which is Section 16 indicates quite clearly that they did not reclassify them for purposes of percentage depletion.

It was quite clear that this was an additional benefit on top of other benefits.

Byron R. White:

I oppose that — can the coal mining business, can you elect cost depletion?

John Y. Merrell:

Oh yes.

Byron R. White:

If you elected that way you would have include in your base the development cost, would you?

John Y. Merrell:


No there’s a distinction between the cost depletion and the percentage depletion.

Byron R. White:

Because you’re already deducting them right?

John Y. Merrell:

There are nonetheless capital investments and they were what this court has spoke about, has meant when it referred to capital investment.

Byron R. White:

Well, you could never (Inaudible).

John Y. Merrell:

Oh! No.

Byron R. White:


John Y. Merrell:

No, no.

In fact —

Byron R. White:

As part of the capital (Inaudible).

John Y. Merrell:

Well it depends on what the purpose of the balance sheet was.

If I were go into a banker, I would sure put them on.

John Y. Merrell:

Actually, these people don’t keep that kind balance sheets down there.

The records were kept by a local bookkeeper and he — they’re not the kind of you’ve expect.

Byron R. White:


John Y. Merrell:

If I were — if I were given a balance sheet to the Internal Revenue Service I would not put them on.

Byron R. White:


John Y. Merrell:

If I were — if I were a certified public accountant were given to a banker for the purposes of obtaining a loan I would definitely put them on because they’re —

Byron R. White:


John Y. Merrell:


These are development expenses which I have incurred in connection with bringing a mine to a development stage.

I might also add how much coal is there farmed in a mine at this particular time and how these were a value to them.

So in conclusion, I’d like to state that if you go back to the basic statute, it’s says that the language of this statute, this is Palmer versus Bender.

It’s broad enough to provide at least for every case in which the taxpayers acquired by investment, any interest in the coal in place and secures by any form of legal relationship income derived from the extraction of the mineral to which it must look for the return of its capital.

If the statute is broad enough to provide for middlemen, who can buy the rights and transfer them to others as in the various oil cases which this case is beside it, it certainly broad enough to provide for the mine operators on the basis of the obligations which they assumed and performed in this case.

We thank you for the opportunity of presenting our positions.

Frederick Bernays Wiener:

If the Court please —

Earl Warren:

Mr. Wiener.

Frederick Bernays Wiener:

The Commissioner has very kindly yielded his remaining time to me but since the totality is only six minutes, I won’t be detaining Your Honors very long unlike them.

I don’t think the Court is going to be assisted in determining this case by consideration of whether the competing taxpayers are rich or poor or by dealing with equality of bargaining power.

We’re dealing here with a statute and the only way we can construe that statute properly is to look at its language to avoid fictions, to avoid semantics.

Now, we have a statute and its interpretations here notably Parsons against Smith say that the deduction for depletion follows ownership or capital interest or capital investment.

It doesn’t make any difference what.

It is if you please a capitalist statute that makes no difference but it might be a better statute in some points of view if it were different.

Now, the size of the investment made is immaterial.

In the Parsons’ case there was Parsons.His investment in machinery was $200,000, costs had $500,000.

Now, every investment that the contractors here have made is deductible.

The current expenses are deductible under Section 162.

The capital expenses are deductible under 167 and their development expenses are deductible under 616.

The only thing they can’t deduct for is coal but as Mr. Merrell revealed in answering the questions by Mr. Justice White, they didn’t capitalize their development expenses.

They expensed in the jargon of the tax technician, they expensed every penny they spent except the investment in machinery, that’s the only thing they capitalized.

And it doesn’t do any — it doesn’t very helpful I think to talk about selling coal.

Frederick Bernays Wiener:

You sell only what you own.

These contractors didn’t sell Paragon its own coal.

They couldn’t take it elsewhere.

They couldn’t give it to anyone else.

They couldn’t take it on the market to see whether possibly they could make a better bargain with someone else.

It was Paragons’ coal they were paid for mining.

Now, everyone of the seven factors here with a possible exception of terminability on which Your Honors rested in Parsons v. Smith is here, and the one factor which the Court in Parsons pointed to as determinative.

The one factor that dispelled the fiction of Parsons and Huss tried to persuade Your Honors to it adopt was that there had never been any surrender, any transfer, any conveyance of the capital interest in the coal in the ground.

Now, the court below disregarded the statute, disregarded the regulations rough shot over the findings.

Used — relied on authorities that were patently not in point.

Relied on the same kind of semantiticized fiction that Parsons v. Smith rejected and reverted to the pre-Parsons decisions which it had on the basis of which Parsons was brought here under a conflict.

The court below simply ignored Parsons against Smith, maybe that to paraphrase Alexander Pope only very slightly, a court convinced against its will is also of the same opinion still but if you read Paragon — Parsons v. Smith objectively and look at the findings actually found here, then I think Your Honors will agree with the Commissioner and with the petitioner Paragon where there must be a reversal.