Case v. New York Central R.R. Co.

Mahoning Coal Railroad Company (Mahoning) owned railroad lines in Ohio and leased lines in Pennsylvania. New York Central Railroad Company (Central) (defendant) rented railroad lines from Mahoning, paying 40 percent of the gross revenues. Central paid all expenses including property taxes, and Mahoning paid federal income taxes. Mahoning stood to make a profit as long as Central rented Mahoning’s railroad lines. In August 1955, Central and 34 of its subsidiaries sought to take advantage of changes to the tax code by filing consolidated returns in cases in which there was 80 percent of stock ownership of one corporation by another. From 1955 to 1956, Central owned 74 percent of Mahoning’s stock. In 1956 Central proposed to Mahoning’s board of directors to acquire enough stock to reach 80 percent of Mahoning’s stock so that Mahoning could include itself in the consolidated tax. Mahoning’s board of directors was composed entirely of Central officers and employees, except for one individual, and the proposal was unanimously accepted. The tax agreement complied with federal tax laws and was approved by federal tax officers. The tax agreement provided a greater advantage to Central, but there was no loss or disadvantage to Mahoning. From 1957 to 1960, Mahoning utilized Central’s loss and was relieved of paying $3,825,717.43 in income taxes that would have been owed had Mahoning filed a separate tax return. Central received $3,556,992.15 from Mahoning, and $268,725.28 was kept by Mahoning. This amount represented the difference between what Mahoning would have to pay in a separate tax return and what Central received. Minority stockholders of Mahoning (the minority stockholders) (plaintiffs) brought an action to rescind the tax agreement and to compel an accounting for the amount that Central benefited during the three tax years. The minority stockholders argued that Mahoning’s board of directors was controlled by Central, and that as a fiduciary parent corporation, Central could not retain the benefits of the unfair tax agreement. The minority stockholders believed they should have received a larger share of Central’s tax losses, but they could not elaborate on what the share should be. The Special and Trial Term court held that the tax agreement was not unfair. The Appellate Division court held that the tax agreement was unfair and required Central to repay Mahoning a substantial part of Mahoning’s income-tax benefit that had been paid to Central. Central appealed.