In the spring of 1929, Pennsylvania management was aware that a crucial condition then existed with respect to Pennsylvania's less-than-carload freight business. It was believed indispensable to own or control a freight forwarding company which would operate in the company's1954 U.S. Tax Ct. LEXIS 255">*261 territory in order to offset the competition of New York Central Railroad Company operating through Universal Freight Company and to forestall the prospective competition of other forwarding companies operating with other railroad lines. A plan for 21 T.C. 1087">*1090 the formation of such a company was formulated, and since both Pennsylvania and its subsidiary, Pennsylvania Company, were legally disqualified to act, it was decided to put the plan into operation through the instrumentality of petitioner. Accordingly, in August 1929, Pennsylvania caused petitioner to form National Freight Company and to advance funds to the latter. Throughout its operations, National Freight Company suffered increasing deficits. It ceased operations in November 1931, at which time it sold all of its assets and goodwill to National Carloading Company for stock in the latter. In 1933 National Freight Company sold all of its stockholdings and other interest in National Carloading Company. The freight forwarding business conducted through National Freight Company consisted of soliciting less-than-carload freight shipments, combining them into carload lots and shipping them at carload rates. It was thus dependent1954 U.S. Tax Ct. LEXIS 255">*262 for its profit upon the difference between the railroad's lower rates charged for carload shipments and the higher less-than-carload rates which it charged. In fact, the business produced losses rather than profits. Pennsylvania, however, profited substantially from the freight forwarding venture through the added freight revenue received by it for hauling National Freight Company traffic, the rental of certain of its facilities to National Freight Company, and the promotion of its competitive position as long as National Freight Company operated.

On October 18, 1932, Joseph W. Perrine and Julia A. Perrine, on behalf of themselves and all other stockholders and voting trust certificate holders of petitioner, commenced suit in the Delaware Court of Chancery, joining as defendants therein petitioner, Pennsylvania, certain directors and officers of both companies, and the trustees of the voting trust holding petitioner's capital stock. The bill of complaint in the Perrine suit alleged, inter alia, the formation of petitioner as a mere sham or device to enable Pennsylvania to advance its own interests, and charged further that Pennsylvania and the individual defendants had 1954 U.S. Tax Ct. LEXIS 255">*263 caused petitioner to make investments in the corporations listed below, ¹ in the interest of Pennsylvania rather than Pennroad:

Detroit, Toledo & Ironton Railroad Company

Pittsburgh & West Virginia Railway Company

Seaboard Air Line Railway Company

New York, New Haven & Hartford Railroad Company

Boston & Maine Railroad

Lehigh Valley Railroad Company

Raritan River Railroad Company

1954 U.S. Tax Ct. LEXIS 255">*264 On March 30, 1939, Ione M. Overfield commenced a similar proceeding in the District Court of the United States for the Eastern District of Pennsylvania (hereinafter referred to as the District Court), joining as defendants petitioner, Pennsylvania, and certain directors of both companies and executors of deceased directors. The complaint, as subsequently amended by leave of court, alleged inter alia, that the defendants, pursuant to a premeditated and preconcerted scheme to use the funds and corporate powers of petitioner for the benefit and advantage of Pennsylvania, had caused petitioner to make investments in the following corporations: ²

Detroit, Toledo & Ironton Railroad Company

Pittsburgh & West Virginia Railway Company

Canton Company of Baltimore

Seaboard Air Line Railway Company

New York, New Haven & Hartford Railroad Company

Boston & Maine Railroad

Lehigh Valley Railroad Company

National Freight Company

On June 7, 1940, Grace Stein Weigle commenced a proceeding in the aforementioned District Court similar to the Overfield suit. The complaint contained allegations similar to those of the complaint in the Overfield suit and asked similar relief. On February 10, 1941, the 21 T.C. 1087">*1092 District Court ordered the Overfield and Weigle suits consolidated for purpose of trial.

On December 1954 U.S. Tax Ct. LEXIS 255">*266 20, 1941, following approximately 90 days of trial, the District Court rendered an opinion in the Overfield-Weigle suit, Overfield v. Pennroad Corporation, 42 F. Supp. 586">42 F. Supp. 586, in which it concluded, inter alia, that the defendants, by reason of their actions in forming and operating petitioner primarily for the benefit of Pennsylvania and its stockholders and employing the capital investments of petitioner's certificate holders for that purpose, had assumed a fiduciary relationship and obligation toward petitioner and its investors, which obligation it had breached. The court held that the applicable statute of limitations of the State of Pennsylvania constituted a bar to the suit as against the individual defendants. As to Pennsylvania, however, the court held that it must reimburse petitioner for the net amount of petitioner's capital lost in the National Freight Company venture, and further required it to account for and pay to petitioner all net profits received by it attributable to or arising out of the charges paid by National Freight Company for the hauling of freight by Pennsylvania or for the rental of facilities from that company. 1954 U.S. Tax Ct. LEXIS 255">*267 Three investment experts were appointed by the District Court to advise it regarding the measure of Pennsylvania's liability as to the investments other than in National Freight Company.

On January 19, 1943, the District Court issued a supplemental opinion, Overfield v. Pennroad, 48 F. Supp. 1008">48 F. Supp. 1008, in which it weighed the recommendations of the investment experts and set the measure of Pennsylvania's liability to petitioner. The District Court, in light of certain equitable considerations which it deemed important, declined to assess liability for the full amount of petitioner's losses on the investments in question with the exception of the investment in National Freight Company. The measure of liability imposed by the court was the excess of the price paid for the securities over their fair value at the time of purchase, as nearly as such figures could be approximated. On this basis, liability was assessed only as to the investments in Pittsburgh & West Virginia Railway Company, Seaboard Air Line Railway Company, and Boston & Maine Railroad (in addition to the entire net investment in National Freight Company). As to the other investments complained1954 U.S. Tax Ct. LEXIS 255">*268 of, the court found that losses were attributable to causes other than purchase at excessive prices.

The District Court entered judgment against Pennsylvania and in favor of petitioner on January 29, 1943, itemizing the award as follows: 21 T.C. 1087">*1093

All parties appealed from the judgment of the District Court to the United States Court of Appeals for the Third Circuit. The majority and dissenting opinions of the court of appeals were filed on December 28, 1944, Overfield v. Pennroad Corporation, 146 F.2d 889.1954 U.S. Tax Ct. LEXIS 255">*269 The majority opinion affirmed the judgment of the District Court in dismissing the bill as to the individual defendants but reversed the judgment entered against Pennsylvania, holding the suit barred by the statute of limitations of the State of Pennsylvania. The majority opinion expressly avoided consideration of the merits of the complaint. Judge Biggs in his dissenting opinion declared that the statute of limitations was not applicable to any of the defendants and that the defendants' liability extended to the full limits of the investments made and the losses sustained by petitioner regardless of cause. In January 1945, petitioner and the complaining stockholders were granted extensions of time within which to file petitions for rehearing. Extensions were granted from time to time until May 31, 1946.

After prolonged negotiations, petitioner and Pennsylvania on March 2, 1945, executed a settlement agreement providing for the payment of $ 15,000,000 by Pennsylvania to petitioner in settlement of all the matters complained of in the Overfield-Weigle and Perrine suits. The agreement specified that the settlement was subject to approval of the Chancery Court of Delaware1954 U.S. Tax Ct. LEXIS 255">*270 and conditioned upon final termination of both suits.

On March 16, 1945, petitioner filed in the Perrine case in the Delaware Court of Chancery a Petition for Approval of Agreement of Settlement. After extended hearings upon objections to the settlement, the court of chancery approved the agreement on August 9, 1945, Perrine v. Pennroad Corporation, 28 Del. Ch. 405">28 Del. Ch. 405, 43 A.2d 721. An appeal was taken and on May 10, 1946, the Supreme Court of Delaware affirmed the opinion of the chancery court, Perrine v. Pennroad Corporation, 29 Del. Ch. 531">29 Del. Ch. 531, 47 A.2d 479, certiorari denied 329 U.S. 808">329 U.S. 808. On February 19, 1947, after all conditions of the settlement 21 T.C. 1087">*1094 agreement had been fulfilled, Pennsylvania paid to petitioner the sum agreed to under the settlement.

Judge Welsh, who had heard the Overfield-Weigle case in the District Court, agreed to act as arbitrator of the claims of those entitled to compensation for services and expenses in connection with the suits against Pennsylvania. On May 5, 1947, he awarded a total of $ 2,495,794.18 for fees and1954 U.S. Tax Ct. LEXIS 255">*271 expenses. In 1947 and subsequent years, petitioner paid from the $ 15,000,000 fund the aggregate sum of $ 2,797,195.69 in satisfaction of these awards and a further award made by the Delaware Court of Chancery to one not a party to the arbitration agreement. The remaining $ 12,202,804.31 was credited by petitioner on its books of account to capital surplus. No part thereof was reported by petitioner as income in its published statements or as taxable income in its returns.

Petitioner's board of directors had originally opposed the efforts of the plaintiffs in the Overfield-Weigle and Perrine suits to enforce the claims asserted therein. However, in February 1942, after the rendering of the first opinion of the District Court in the Overfield-Weigle suit, the board of directors reviewed its position and determined to become an active participant in the prosecution of the two suits in support of and in association with the complaining shareholders and the District Court was so advised. In July 1942, petitioner retained special counsel to represent it in the litigation with Pennsylvania. He was to represent the interests of petitioner itself, cooperating and not interfering1954 U.S. Tax Ct. LEXIS 255">*272 with counsel for the individual parties plaintiff. His services continued throughout the litigation and settlement. It was understood that his compensation was not contingent on the outcome of the litigation. During the same period, petitioner from time to time retained a Delaware law firm and incurred miscellaneous expenses in connection with the litigation, settlement, and related matters. None of these fees and expenses totaling $ 141,994.58 was considered in the arbitration before Judge Welsh or in the Delaware Court of Chancery, being fixed rather by agreement with officers of petitioner. They were paid from petitioner's general funds.

Petitioner disposed of all of certain of the investments complained of, realizing actual losses as follows: ³

1954 U.S. Tax Ct. LEXIS 255">*273 21 T.C. 1087">*1095 Petitioner sustained a net loss of $ 3,852,000 on its investment in National Freight Company.

In a comprehensive revision of ledger values in 1938, based primarily on market quotations at the time, petitioner reduced the ledger values of certain of the investments complained of in the following amounts:

Petitioner's unrecovered bases for the following investments were no less than the amounts listed below at the time of settlement:

Of the investments in question, petitioner still owned securities costing more than $ 93,000,000 at the time of settlement.

At the time of the institution of the three stockholders' suits, and at the time of settlement, 1954 U.S. Tax Ct. LEXIS 255">*274 petitioner's unrecovered capital losses on the various shares of stock named herein were in excess of the $ 15,000,000 received in settlement from Pennsylvania.

Petitioner's unrecovered capital losses on those investments for which the District Court awarded damages were greater than $ 15,000,000 even though the basis of petitioner's investment in the National Freight Company be adjusted to $ 1,532,460.30 as determined by respondent.

OPINION.

The principal issue herein involves the tax treatment of $ 15,000,000 received by petitioner from Pennsylvania in settlement of two derivative stockholders' suits alleging, in substance, that through Pennsylvania's domination and control of petitioner it had caused petitioner to make certain investments with the primary intention of benefiting Pennsylvania rather than petitioner, and to pay excessive prices for the securities acquired. It was charged that Pennsylvania, by reason of the interlocking directorate and the voting trust arrangement, and in light of the admitted organization of petitioner 21 T.C. 1087">*1096 as an expedient means of accomplishing its own purposes, otherwise barred by regulations of the Interstate Commerce Commission, had placed1954 U.S. Tax Ct. LEXIS 255">*275 itself in a fiduciary relationship, the breach of which resulted in heavy losses to petitioner.

At the time of the settlement the Overfield-Weigle suit had been tried in the District Court and judgment in the amount of $ 22,104,515.92 entered against Pennsylvania, itemized as set forth in our Findings of Fact. On appeal, the Court of Appeals set aside the judgment holding that recovery was barred by the statute of limitations of Pennsylvania which applied to the controversy. The majority did not reach the merits of the claim of petitioner against Pennsylvania. The dissenting circuit judge, however, was of the opinion that the claim was not barred and, furthermore, that the District Court had improperly applied the rule of damages to petitioner's claim. He would have applied a rule which would have resulted in a recovery far in excess of the $ 22,104,515.92 awarded by the District Court. Petitioner and the complaining stockholders had applied for and been granted extensions of time within which to file petitions for rehearing before the Court of Appeals.

The Perrine suit was still pending in the Delaware court.

It is the respondent's position that the net amount received1954 U.S. Tax Ct. LEXIS 255">*276 in settlement of the suits against Pennsylvania, $ 12,060,809.73, ⁴ should be allocated for the purpose of tax computation in the manner employed by the District Court in the Overfield-Weigle proceedings. We are asked to attribute that entire amount to those few acts of Pennsylvania for which the District Court, employing its unique measure of liability, would have awarded damages in the proportions applied by that court. Under this theory, respondent finds that the amount attributable to one investment exceeds petitioner's unrecovered basis for that investment by $ 569,292.99, which amount he would tax as ordinary income. ⁵ He would also tax in full the amount attributed by him to Pennsylvania's profits from its dealings with National Freight Company.

1954 U.S. Tax Ct. LEXIS 255">*277 We disagree with respondent's theory of allocating the settlement according to a ratio based on the formula on which the District Court determined its judgment of $ 22,104,515.92 in the Overfield-Weigle suit. We conclude that the record shows that the $ 15,000,000 was paid not merely in settlement of the Overfield-Weigle proceedings but of all the matters resulting from Pennsylvania's derelictions, including 21 T.C. 1087">*1097 the assertions in the Perrine suit. Clearly, the statute of limitations of Pennsylvania, which was the basis of the reversal of the District Court proceedings, had no application to the Perrine case which had been filed in the Delaware courts as early as 1932. Had the Perrine suit gone to trial, the result could have been anything from complete denial of relief to an award many times greater than that of the District Court. Moreover, the possibility of further appeal in the Overfield-Weigle proceedings kept open the full range of possibilities as to the ultimate liability resulting from that litigation.

Therefore, at the time of the settlement agreement, there had been no final adjudication of the merits of the complaints nor could the parties1954 U.S. Tax Ct. LEXIS 255">*278 to the settlement accurately determine the full extent of the liability of Pennsylvania to Pennroad. We do not understand respondent to contend that the District Court's award of $ 22,104,515.92 was intended as a measure of petitioner's damage through the acts complained of since the opinions of that court make it clear that its judgment set forth its findings only as to Pennsylvania's liability to petitioner. The measure of liability imposed by that court was not in fact the measure generally imposed after a finding of a breach of fiduciary relationship. The analogy to the law of trusts being apparent, we quote from 2 Scott, Trusts, section 205.1:

It is no defense to the trustee that if he had purchased proper trust investments there would probably have been a loss equally great because of general economic conditions and the general fall in values. In such a case the loss results from the breach of trust, although it is possible that a similar loss would have occurred even if there had been no breach of trust.

The District Court in its original opinion (42 F. Supp. 586">42 F. Supp. 586, 42 F. Supp. 586">616) recognized this principle, saying:

Generally speaking, a fiduciary1954 U.S. Tax Ct. LEXIS 255">*279 is under a duty to administer the trust solely in the interest of the beneficiary, and upon failure to do so, he is chargeable with any loss or depreciation resulting therefrom, and even though a similar loss might have occurred due to economic conditions in the absence of such breach.

The District Court, however, for equitable reasons which it deemed sufficient adopted an unusually restricted measure of liability.

We have found as a fact that although petitioner at the time of settlement still retained the majority of the securities in question with a remaining cost in excess of $ 93,000,000, it had sustained actual losses of $ 22,250,033.81 on the disposition of the balance of the securities, plus an actual net loss of $ 3,852,000 on the investment in National Freight Company. The record leaves no doubt that as to those securities retained by petitioner losses running to many millions of dollars had been suffered and we think it significant that in 1938 petitioner reduced the ledger values of 3 of the securities still held by 21 T.C. 1087">*1098 petitioner by nearly $ 63,000,000. ⁶ Moreover, petitioner's unrecovered basis for only those 4 investments on which the District Court made awards1954 U.S. Tax Ct. LEXIS 255">*280 was many times the entire amount received in settlement.

We think that respondent's insistence on treating each investment complained of as a separate claim to which a portion of the settlement must be allocated is unwarranted. The several transactions were actually nothing more than steps in the carrying out of Pennsylvania's plan to create and use petitioner as a vehicle for its own purposes otherwise barred by governmental restrictions. The basic nature of the claim lay in losses arising from a series of Pennsylvania's acts in furtherance of a containing conspiracy.

The sum received by petitioner in settlement was only a fraction of the losses it sustained by reason of Pennsylvania's actions. As stated in Lucas v. American Code Co., 280 U.S. 445">280 U.S. 445, 280 U.S. 445">449, the law is concerned only with realized losses and realized gains and "In order to determine whether there has been gain or1954 U.S. Tax Ct. LEXIS 255">*281 loss, and the amount of the gain if any, we must withdraw from the gross proceeds an amount sufficient to restore the capital value that existed at the commencement of the period under consideration." Doyle v. Mitchell Bros. Co., 247 U.S. 179">247 U.S. 179, 247 U.S. 179">185. In Drier v. Helvering, 72 F.2d 76, the court was confronted with a case where an award made by a mixed claims commission was in terms of both principal and interest. The Court of Appeals concluded, however, that if the total sum received was not sufficient to restore the capital value that existed at the commencement of the period under consideration there was no taxable income. Cf. Helvering v. Drier, 79 F.2d 501; Commissioner v. Ullman, 77 F.2d 827.

Under the circumstances present in the instant case, we think that to apply to the settlement the allocation set forth in a vacated judgment covering only one of the suits involved and adopting an unusual measure of liability would be arbitrary and unreasonable.

We hold, accordingly, that the entire sum received in settlement constituted a recovery1954 U.S. Tax Ct. LEXIS 255">*282 of capital resulting in no income taxable to the petitioner.

An additional issue is raised as to certain legal fees and expenses amounting to $ 141,994.58. The expenditures in question are principally those paid to counsel by petitioner after abandoning its earlier position of neutrality and actively participating in the litigation against Pennsylvania. Petitioner contends that since these fees were not contingent upon the outcome of the litigation but payable in any event and since they were paid from the general funds of petitioner rather than from that portion of the recovery set aside for counsel fees, they are deductible under section 23 (a) (1) (A) of the Internal 21 T.C. 1087">*1099 Revenue Code as ordinary and necessary business expenses. We find no merit in this contention. It is well settled that expenses of acquiring, perfecting, or recovering title to property are nondeductible capital expenses. Virginia Hansen Vincent, 18 T.C. 339, 348. In Helvering v. Stormfeltz, 142 F.2d 982, the question involved the deductibility of expenses of a suit against a guardian for wrongful appropriation of guardianship funds. 1954 U.S. Tax Ct. LEXIS 255">*283 While that portion of the legal expenses allocable to the recovery of interest was held to be deductible, the part attributable to recovery of principal was held to be a nondeductible capital expenditure analogous to title defense litigation. Having found in the case at bar that the settlement represented recovery of capital, we think it clear that the fees and expenses paid in connection with that settlement were of a capital nature and may not be deducted as ordinary and necessary business expenses.

Decision will be entered under Rule 50.