Horne v. Peckham

Decision Date28 September 1979
Docket NumberNo. C,C
CourtCalifornia Court of Appeals Court of Appeals
Parties, 207 U.S.P.Q. 527 Roy C. HORNE et al., Plaintiffs and Respondents, v. Jordan N. PECKHAM, Defendant and Appellant. Jordan N. PECKHAM, Cross-Complainant and Appellant, v. Thomas J. McINTOSH et al., Cross-Defendants and Respondents. iv. 16906.

Price, Burness, Price & Davis and R. E. Burness, Chico, for defendant, cross-complainant and appellant.

Richard F. Mills and Robert C. Schleh, Sacramento, for plaintiffs and respondents.

Boornazian, King & Schulze and Richard M. Schulze, Oakland, for cross-defendants and respondents.

PARAS, Acting Presiding Justice.

Defendant, an attorney, appeals from a judgment entered after a jury awarded damages of $64,983.31 against him for legal malpractice in connection with the drafting of a "Clifford Trust" for plaintiffs Roy C. Horne (Horne) and Doris G. Horne, husband and wife. He contends that the judgment should be reversed or in the alternative that another attorney, Thomas J. McIntosh, upon whom he relied for advice, should indemnify him.

In 1960, Horne obtained a patent for processing low grade wood into defect-free material known as "Perfect Plank Plus." In 1962, he founded a business called "Perfect Plank," and in 1967 began to produce the patented product. The business was incorporated in 1965, with the Hornes as sole shareholders. Horne anticipated that production of the product might generate substantial income, so he became interested when he read in a newsletter of the tax advantages of a so-called "Clifford Trust." On July 18, 1967, on the recommendation of Herbert McClanahan, his accountant, he went to defendant and asked him to prepare such a trust, Horne's three sons to be its beneficiaries.

Defendant testified he told Horne " . . . that I had no knowledge of tax matters. I had no expertise in tax matters; that if somebody else could figure out what needed to be done, I could draft the documents." He said that McClanahan had provided him with " . . . a couple of pages of translucencies . . . governing Clifford Trusts," and he also consulted the two-volume annual set of American Jurisprudence on federal taxation, which included a discussion of Clifford Trusts; he otherwise relied on McClanahan's judgment.

The original plan was to put the patent, which had 10 more years of life, into the trust. However, on October 11, 1967, Horne told defendant he no longer desired this and asked " . . . if it wouldn't be just as good to put in a (non-exclusive) (l)icense . . . " of the patent rights. Horne testified that he preferred not to put the patent itself into the trust, because the substantial royalties from it would result in more money than should properly be given to his sons.

Defendant testified he told Horne that " . . . I didn't know whether . . . (a license) would be just as good or not, but that we were having a high-priced tax expert come up here like the following day who was undoubtedly going to charge plenty of money for the consultation, and that we should ask him on that point." The tax expert to whom defendant referred was McIntosh, an attorney from Albany, California, who had been recommended by McClanahan as an expert in deferred compensation and profit-sharing plans. Such plans for Horne's company were to be discussed at a meeting with McIntosh arranged by McClanahan and scheduled for the next day, October 12. Unknown to defendant, McIntosh had been licensed to practice law less than a year, although he was also a certified public accountant and had worked for two and one-half or three years as a tax accountant.

The meeting of October 12 was attended by Horne, his wife, one son, McClanahan, defendant, and McIntosh. Defendant testified that he asked McIntosh whether it would be just as effective to transfer a license agreement into the contemplated trust as the patent itself, and received an affirmative answer. He further testified that Horne had been talking of a nonexclusive license during the meeting, thus McIntosh should have been aware that such a license was contemplated. However, defendant also testified that no one told McIntosh that the contemplated license would have a five year duration.

Horne testified that he thought the subject of license versus patent arose at that meeting, but he had no independent recollection of it. McIntosh testified that even though at his deposition he thought he recalled such a discussion, he did not recall it at trial.

Sometime after the meeting, defendant drafted the final documents and sent them to McClanahan for approval. He had no further discussions or correspondence with McIntosh. The documents were signed in November 1967, although dated February 1, 1967, the date production of the product began. The first document was an irrevocable trust agreement between the Hornes as trustors and McClanahan, defendant, and one Bill Ryan as trustees for the Horne's three sons, to terminate in twelve years (1979). The second was a license agreement between Horne and Perfect Plank, granting the corporation a license to produce the patented product for two years with an option to renew for an additional three years, in return for royalty payments determined by production; inter alia, the agreement stated "This license is not exclusive. Licensor retains the right to issue other licenses of the same patent to any other parties whatsoever." The third document was an assignment to the trustees by Horne of Horne's rights under the license agreement thus furnishing the trust with a corpus.

The license royalties were paid into the trust until 1970 when the Internal Revenue Service (I.R.S.) audited Horne's tax returns. Horne was notified of the audit by mail sometime prior to March 18, 1970, and knew within a few days thereafter of a challenge to the favorable tax aspect of the trust. In August 1970, the I.R.S. assessed a deficiency on the ground that the trust did not transfer tax liability for the licensor's income to the beneficiaries. Horne hired McIntosh to contest the assessment.

After losing at the first administrative level, Horne conceded his tax liability rather than contest it further. On May 12, 1972, he sued defendant for damages for malpractice. On June 18, 1973, defendant filed a cross-complaint for indemnity against McIntosh and his law partnership. After a jury trial, judgment was entered against defendant on the complaint, and in favor of McIntosh on the cross-complaint.

I

Defendant's first argument on appeal is that "It is not legal malpractice (negligence) on the part of an attorney general practitioner to draw documents without doing research on a point of law on which there is no appellate decision or statute in point."

The argument has two parts; first, that the trust documents were in fact valid as a tax shelter, second, that even if invalid, their invalidity is so debatable that he should not be liable for making an error regarding a matter about which reasonable attorneys can disagree. He is wrong on both points. The documents are invalid for their intended purpose, and the invalidity is rather obvious. To demonstrate this, one need go no further than the original Clifford case, from which the name "Clifford Trust" is derived, and the legislation it brought about.

In Helvering v. Clifford (1940) 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788, the United States Supreme Court held that notwithstanding "niceties of the law of trusts or conveyances, or the legal paraphernalia which inventive genius may construct as a refuge from surtaxes," (309 U.S. at p. 334, 60 S.Ct. at p. 556), the grantor of a trust may be taxed as owner, depending on "an analysis of the terms of the trust and all the circumstances attendant on its creation and operation." (309 U.S. at p. 335, 60 S.Ct. at p. 556.)

In that case the taxpayer had established an irrevocable five-year trust, with himself as trustee and his wife as beneficiary. The trust corpus consisted of securities owned by the taxpayer. The income was payable to the wife, and the corpus reverted to the taxpayer at the end of five years. The Supreme Court ruled that ". . . the short duration of the trust, the fact that the wife was the beneficiary, and the retention of control over the corpus by (the taxpayer) . . . all lead irresistably to the conclusion that (the taxpayer) . . . continued to be the owner for purposes of § 22(a) (now § 61(a), defining gross income)." (Ibid.)

On the issue of control, the Clifford court made the following observations, which are directly applicable to this case:

"So far as his dominion and control were concerned it seems clear that the trust did not effect any substantial change. In substance his control over the corpus was in all essential respects the same after the trust was created, as before. The wide powers which he retained included for all practical purposes most of the control which he as an individual would have. There were, we may assume, exceptions, such as his disability to make a gift of the corpus to others during the term of the trust and to make loans to himself. But this dilution in his control would seem to be insignificant and immaterial, since control over investment remained." (Ibid.)

In the present case, the Hornes, by control of the patent and the licensee corporation, also controlled the license. They not only retained the absolute power to control the income from the license agreement by increasing or reducing production of the patented product; they could also cease production entirely, form a new corporation, license it under the patent, and individually receive all future royalties. This would effectively work a termination or revocation of the sole income generating asset of the trust.

Following the Clifford decision, the I.R.S. adopted regulations to implement it, and these formed the basis for sections 671-678 of the Internal...

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