Grant Thornton, Llp v. Yung, 091616 KYCA, 2014-CA-001957-MR

CourtCourt of Appeals of Kentucky
Writing for the CourtMAZE, JUDGE.
Docket Number2014-CA-001957-MR




No. 2014-CA-001957-MR

Court of Appeals of Kentucky

September 16, 2016


BRIEF FOR APPELLANT: Sheryl G. Snyder Theresa A. Canaday Griffin Terry Sumner Jason P. Renzelmann Louisville, Kentucky

ORAL ARGUMENT FOR APPELLANT: Sheryl G. Snyder BRIEF FOR AMICUS CURIAE: KENTUCKY CHAMBER OF COMMERCE: Virginia Hamilton Snell Chelsea K. Painter Louisville, Kentucky

BRIEF FOR APPELLEES: Michael D. Risley Bethany A. Breetz Matthew M. Breetz Louisville, Kentucky Gerald F. Dusing Covington, Kentucky And George M. Vinci, Jr. David B. Picker Philadelphia, Pennsylvania

ORAL ARGUMENT FOR APPELLEES: Michael M. Risley George M. Vinci, Jr.




Grant Thornton, LLP (Grant Thornton) appeals from a judgment of the Kenton Circuit Court in favor of William J. and Martha A. Yung (collectively, the Yungs), and the 1994 William J. Yung Family Trust (the Trust). Following a bench trial, the circuit court found that Grant Thornton engaged in extensive fraud and negligence in the course of providing tax and accounting services to the Yungs and the Trust. Based on these findings, the trial court awarded the Yungs and the Trust compensatory damages totaling nearly $20 million and punitive damages of $80 million.

Grant Thornton challenges the trial court's findings of fraudulent misrepresentation and omissions. Grant Thornton also argues that the trial court improperly calculated compensatory damages. Grant Thornton objects to the trial court's failure to enforce the limitation-of-liability clause in its Engagement Letter, as well as the award of damages based upon the taxes and interests which the Yungs and the Trust incurred as a result of the transactions at issue. Grant Thornton also contends that punitive damages were not warranted or should be limited to no more than the amount of compensatory damages. Lastly, Grant Thornton seeks a modification of the trial court's awards of prejudgment and postjudgment interest.

The trial court's findings of fraud, gross negligence, and the amount of compensatory damages were supported by substantial evidence and were not clearly erroneous. We further find that punitive damages were appropriate under the facts of this case. However, we must conclude that the amount of punitive damages was unconstitutionally excessive in light of all relevant factors. We further find that the trial court properly directed that the judgment shall bear interest at the statutory rate. However, the trial court incorrectly stated the prejudgment interest rate. Therefore, we affirm the trial court's judgment in all respects except for the award of punitive damages and the amount of prejudgment interest. Consequently, we must vacate the award of punitive damages and remand for entry of a new judgment of punitive damages in the same amount as compensatory damages. The trial court shall also enter a new judgment which sets out the correct prejudgment interest rate of 8% per annum.

I. Facts and Procedural History

William J. Yung is a successful hotelier and entrepreneur. He, along with his wife, Martha, and the Trust, own a hospitality company, Columbia Sussex Corporation (CSC), headquartered in Crestview Hills, Kentucky. Yung also oversees and owns controlling interests in a large number of other business enterprises. Of particular significance to this case, the Yungs and the Trust are the owners of two holding corporations, Wytec, Ltd. and Casuarina Cayman Holdings, Ltd.

These two corporations are based in the Cayman Islands and own hotel and casino facilities. The Cayman corporations are not obligated to make distributions to their shareholders. As a result, profits could accumulate in the Caymans with no United States tax consequences. However, the corporations had made prior distributions to the U.S. shareholders.

Grant Thornton is a public accounting firm headquartered in Chicago, Illinois. The firm offers audit, tax, and business consulting services, and targets mostly middle-market companies for those services. Prior to 2000, Grant Thornton had provided a range of tax-related services to the Yungs, the Trust, and their affiliated corporations. In 1999, Sara Williams, a former employee of Grant Thornton, became CSC's tax director. Upon returning to Grant Thornton later that year, Williams informed Grant Thornton of the funds held by the Cayman corporations. Based on this information, individuals within Grant Thornton began to develop strategies for transferring the money to the United States while avoiding or minimizing tax liability.

One of these strategies involved a new product which Grant Thornton was developing: the Leveraged Distribution 301 (Lev301). To carry out the Lev301 transaction, a foreign corporation would first borrow money to purchase Treasury Notes. These Notes would be encumbered for their full amount to secure the debt incurred by the foreign corporation to purchase the Notes. Next, the fully encumbered Notes would be transferred to corporate shareholders in the United States. Since the Notes were fully encumbered, they had no taxable value and would not be reported as income. When the foreign corporations repaid the loans, the loan repayment would not result in reportable income to the shareholders because they were not co-obligors on the loans.

Grant Thornton met with the Yungs during July 2000 to discuss the Lev301. At that meeting, J. Michel, an agent of Grant Thornton, advised the Yungs that the product could serve as an effective means of transferring the Cayman funds without tax liability. Michel told the Yungs that, in the "worst-case scenario, " the Yungs could be liable for payment of the taxes and interest but no additional penalties. At a later meeting in September, Michel told the Yungs that a local large aircraft engine manufacturer and a large consumer product manufacturer had successfully used the Lev301 strategy.[1]

But in order to avoid that liability, the Internal Revenue Service (IRS) requires a non-tax-related "business purpose" as the primary motivation for using a tax shelter such as the Lev301. The Tax Code provides a defense to penalties for taxpayers who act in reasonable reliance on the advice of a qualified tax advisor. Pursuant to these provisions, the Yungs sought a "Short-Form Model Opinion" stating that they were relying on the advice of Grant Thornton that the Lev301 strategy had a non-tax-related business purpose. On December 28, 2000, Grant Thornton issued its Short-Form Opinion letter which set out the Lev301 strategy and stated that the IRS would "more likely than not" uphold the non-taxability of the Lev301 transaction.

After issuance of the Short-Form Opinion letter, the Yungs and their affiliated corporations began carrying out the Lev301 transactions. In early 2001, the IRS issued new regulations which called into question the viability of the Lev301 strategy. In response to the regulations and based on other concerns, Grant Thornton removed the Lev301 from its Client Matrix and suspended the sale of the product to new customers. However, Grant Thornton advised the Yungs that the new regulations would not adversely affect the transactions, and it encouraged them to continue with the strategy.

In April 2001, Grant Thornton resumed the sale of the Lev301 product. However, Grant Thornton did not disclose substantial internal or external concerns about the viability of the product. During that same period, Grant Thornton prepared the 2000 tax returns for the Yungs and the Trust, but those returns did not report the Lev301 transactions. In August 2001, Grant Thornton issued a Long-Form Opinion in which it reiterated its prior "more likely than not" opinion regarding the taxability of the Lev301 transactions. However, this Opinion Letter failed to note that the underlying loans had been changed from recourse to non-recourse, thus affecting their taxability under the IRS regulations. Grant Thornton issued similar letters to other customers using the Lev301 product, and pointed to CSC as a successful user of the strategy.

During the first part of 2002, Grant Thornton prepared the 2001 tax returns for the Yungs and the Trust. These returns did not disclose the repayment of the loans which the Treasury Notes secured. In internal correspondence, Grant Thornton suggested that the Yungs could only avoid IRS scrutiny if they "won the audit lottery." After much internal discussion, Grant Thornton permanently discontinued the Lev301 product in July 2002.

In December 2002, the IRS issued a summons to Grant Thornton for documents relating to its promotion of Lev301 and the names of its clients who participated in the product. Grant Thornton did not disclose the summons to the Yungs or other clients using the Lev301. The Yungs did not learn of the summons until September 2003, when the Department of Justice brought an action to enforce the December 2002 summons from the IRS. Pursuant to that action, Grant Thornton informed the IRS that the Yungs, the Trust, and the affiliated corporations had employed the Lev301 strategy.

In May 2004, the IRS commenced an audit of the Yungs and the Trust concerning the Lev301 transactions. Grant Thornton undertook a defense of the audit on behalf of the Yungs and the Trust. The IRS ultimately found that the Lev301 transactions did not have a non-tax-related business purpose, and concluded that the distributions were fully taxable. In addition to taxes and interest, the IRS assessed a twenty-percent penalty. In January of 2007, the Yungs and the Trust...

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