Ackerman v. Price Waterhouse

• Decision Date: 01 December 1998
• Citation: 252 A.D.2d 179,683 N.Y.S.2d 179
• Parties: , 1998 N.Y. Slip Op. 10,942 Carolyn ACKERMAN, et al., Plaintiffs-Appellants, v. PRICE WATERHOUSE, Defendant-Respondent. Carolyn Ackerman, et al., Plaintiffs-Respondents, v. Price Waterhouse, Defendant-Appellant.
• Court: New York Supreme Court — Appellate Division

Page 179

683 N.Y.S.2d 179

252 A.D.2d 179, 1998 N.Y. Slip Op. 10,942

Carolyn ACKERMAN, et al., Plaintiffs-Appellants, v. PRICE WATERHOUSE, Defendant-Respondent.

Carolyn Ackerman, et al., Plaintiffs-Respondents, v. Price Waterhouse, Defendant-Appellant.

Supreme Court, Appellate Division First Department.

Dec. 1, 1998.

Richard J. Schager, Jr., of counsel (Michelle Rago, Ronald D. Lefton and Steven G. Sonet, on the brief, Stamell & Schager, LLP, Camhy Karlinsky & Stein, LLP and Levy, Sonet & Siegel, attorneys) for plaintiffs-appellants/plaintiffs-respondents.

David W. Rivkin, of counsel, New York City (Mark W. Friedman, Leigh R. Schachter and Rodman W. Benedict, Deputy General Counsel, on the brief, Debevoise & Plimpton and Price Waterhouse LLP, attorneys) for Price Waterhouse.

ELLERIN, J.P., RUBIN, TOM, MAZZARELLI and ANDRIAS, JJ.

MAZZARELLI, J.

In these consolidated appeals, ¹ important issues are raised involving the liability of professional accountants for allegedly negligent tax advice rendered to the individual limited partners of 54 co-sponsored limited partnerships. Among the issues to be resolved are whether the IAS court properly denied the Ackerman plaintiffs' four separate motions for class action certification, whether defendant Price Waterhouse is entitled to summary judgment based upon the plaintiffs' inability to demonstrate reliance on defendant's alleged misrepresentations, or because the claims are barred by the Statute of Limitations, and whether a settlement in a related Federal action entitles Price Waterhouse to a setoff of the damages obtained by the plaintiffs in that settlement. As detailed below, in Appeal No. 61788, we affirm the IAS court's denial of the Ackerman plaintiffs' second motion for class certification for the reasons stated by that court. In Appeal No.61789, we modify to the extent of granting the Ackerman plaintiffs' third motion for class certification relating to New York residents only and vacating the imposition of sanctions against counsel for the Ackerman plaintiffs. In Appeal No. 61790, we affirm the order of the IAS court granting Price Waterhouse's

motion for summary judgment only to the extent of limiting the damages recoverable.

I. FACTS

The Ackerman plaintiffs are individuals from 38 different States and four foreign nations who invested in tax shelter limited partnerships between 1980 and 1982. The limited partnerships were formed to acquire K-Mart shopping centers throughout the United States. All of the 54 limited partnerships were sponsored by the same entity, Commercial Properties Group, Inc. ("CPG"). From 1980-1989, CPG engaged defendant Price Waterhouse ("PW") to render annual accounting services and to prepare the limited partnerships' Schedules K-1, which report each limited partner's pro rata share of income and expenses. ² PW transmitted these returns and schedules to CPG each year, and was aware that the documents would be transferred to the individual limited partners "for filing" with their Federal and State income tax returns.

It is undisputed that between 1980 and 1988, PW utilized an accounting practice known as the Rule of 78's in calculating each limited partner's accrued interest deduction on their Schedules K-1. The Rule of 78's is an accounting practice that allocates greater interest deductions to the earlier years of the debt. CPG informed potential investors, by way of the offering materials, that the general partners intended to employ the Rule of 78's in calculating the accrued interest deduction, and that the IRS might disapprove such method, possibly resulting in an audit and the loss of tax benefits.

In 1983, the IRS issued Revenue Ruling 83-84 which specifically barred the use of the Rule of 78's in cases where the resulting deduction exceeded the true economic accrual of interest. Plaintiffs allege that after Revenue Ruling 83-84 was issued, PW discontinued the use of the Rule of 78's in calculating the accrued interest deductions for other clients, but continued to utilize it for the CPG partnerships.

In response to Revenue Ruling 83-84, PW adopted internal policy guidelines prohibiting the use of the Rule of 78's for accrued interest deductions unless (1) an alternative, acceptable method justified the deduction, or (2) an opinion letter of tax counsel was obtained stating that it was "more likely than not" that the practice would be upheld if challenged by the IRS. In December 1983, PW was furnished, at its own request, with a letter from tax counsel stating that it was "more likely than not" that the CPG limited partners would prevail if the IRS challenged the use of the Rule of 78's with respect to transactions, such as this one, which pre-dated Revenue Ruling 83-84. Tax counsel further gave its opinion that based on its analysis of current IRS policy and prior revenue rulings, "the Commissioner cannot properly assert that [Revenue Ruling] 83-84 has retroactive effect." In its 1984 transmittal letter to the limited partners accompanying the Schedules K-1, PW summarized tax counsel's opinions regarding the revenue ruling and stated that it had relied on such opinion in preparing the partnership tax returns. However, PW's transmittal letter omitted much of the detail in counsel's opinion letter, including the warning that the IRS had explicit statutory authority to determine whether a Revenue Ruling "shall be applied without retroactive effect" (IRC § 7805[b] ).

In March 1985, PW obtained an "updated" opinion letter from tax counsel regarding the continued use of the Rule of 78's. ³ In this second letter, counsel again expressed its opinion that it was more likely than not that any challenge by the IRS to the use of the Rule of 78's regarding the CPG limited partnerships would fail. This letter included several specific warnings including that the IRS Revenue Rulings are "presumed to be retroactive" Meanwhile, in 1983 the IRS began auditing the CPG sponsored limited partnerships, resulting in deficiency notices being issued to several limited partners. During the pendency of the audits, PW continued to advise the limited partners that the interest deductions would be upheld. In PW's 1988 audit reports sent to the limited partners, PW stated that "the General Partner and special tax counsel continue to be of the opinion" that the continued use of the Rule of 78's in computing interest deductions would survive IRS challenge. Further, PW stated in a 1985 letter that it would be "handl[ing] [the audit] on behalf of the partnership in general and on your behalf as limited partner," and advised the partners to refuse a pending IRS settlement offer.

unless otherwise indicated, that an interest rate penalty of 120% could be imposed if the IRS found the investments to be "tax motivated transactions", that continued use of the Rule of 78's in computing interest deductions "would no doubt provoke vigorous opposition from the IRS and probably result in litigation," and that if the limited partners were unsuccessful in this litigation they would have to recapture interest deductions previously taken and be liable for interest and penalties for the amount recaptured. Again, these specific warnings were omitted from PW's subsequent transmittal letters sent to plaintiffs.

The Ackerman plaintiffs contested the tax deficiencies by commencing administrative proceedings. Once the administrative appeals were exhausted, several plaintiffs filed petitions in the United States Tax Court, while others stayed their protest pending determination by the Tax Court in an unrelated test case. In that December 1988 test case, the United States Tax Court upheld the retroactive application of Revenue Ruling 83-84 by the IRS (see, Prabel v. Comm. of Internal Revenue, 91 TC 1101, 1988 WL 138769 [hereinafter "Prabel "] ), which determination was affirmed by the Third Circuit Court of Appeals in August 1989 (see, Prabel v. Comm. of Internal Revenue, 3rd Cir., 882 F.2d 820). In Prabel, the Tax Court held that there were no revenue rulings or any other existing authority permitting utilization of the Rule of 78's accrual method in long-term real estate loans, and that therefore, the tax advisors to the partnerships in Prabel could not have relied on authority that "did not exist."

As the limited partnership investments in this case were similar to the long-term loans in Prabel, it became clear that the IRS would reject the use of the Rule of 78's with respect to the CPG limited partnerships. In March 1989, three months after the Prabel decision, PW prepared and forwarded to the limited partners the 1988 Schedules K-1, which continued to utilize the Rule of 78's. This time, however, CPG (not PW) attached a letter advising the limited partners not to rely on the Schedules K-1.

Prior to the determination in Prabel, the IRS had offered plaintiffs a 100% deduction of capital contributions--but in the wake of Prabel, it reduced that offer to 85%, which the plaintiffs were encouraged by new counsel to accept, and plaintiff Ackerman did so. In addition, the IRS concluded that the CPG limited partnerships were "tax motivated transactions" and assessed penalty interest on the unpaid taxes.

In 1989, some of the limited partners of CPG partnerships commenced a class action in United States District Court for the Eastern District of New York (see, Graf v Commercial Properties Group, 89 Civ.2057 [hereinafter "Graf " action] ), against CPG, PW and others, alleging fraud in relation to the sale of the limited partnership interests. ⁴ CPG and other defendants settled the action with the plaintiffs for $40 million, plus an agreement to restructure the limited partnerships. PW, however, was not a party to the Graf settlement and the action was discontinued against it without prejudice.

In April 1990, the Ackerman plaintiffs commenced this action in State court against PW, alleging negligence and accountant malpractice regarding PW's continued use of the...