Ackerman v. Price Waterhouse

• Decision Date: 10 November 1992
• Citation: 156 Misc.2d 865,591 N.Y.S.2d 936
• Parties: Carolyn ACKERMAN, Maia Chiat, Dr. Maurizio Daliana, Edward Frankel, Jack Gatewood, Adele W. Huey, Laurence Karp, Lester Kommit, Richard Leeds, William Magee, Mario Mandala, Robert Slutsky, Chester Thomson and Leonard A. Weiss, Plaintiffs, v. PRICE WATERHOUSE, Defendant. .A.S. Part 8
• Court: New York County Court

Page 936

591 N.Y.S.2d 936

156 Misc.2d 865

Carolyn ACKERMAN, Maia Chiat, Dr. Maurizio Daliana, Edward Frankel, Jack Gatewood, Adele W. Huey, Laurence Karp, Lester Kommit, Richard Leeds, William Magee, Mario Mandala, Robert Slutsky, Chester Thomson and Leonard A. Weiss, Plaintiffs, v. PRICE WATERHOUSE, Defendant.

Supreme Court, New York County,

I.A.S. Part 8.

Nov. 10, 1992.

Ronald D. Lefton, of Camhy, Karlinsky & Stein, Juan J. Harnes, of Silverman, Harnes & Obstfeld, and Levy, Sonet & Siegel, New York City, for plaintiffs.

David W. Rivkin and Lisa H. Lewin, of Debevoise & Plimpton, New York City (Rodman W. Benedict, Associate Gen. Counsel of Price Waterhouse, of counsel), for defendant Price Waterhouse.

DIANE A. LEBEDEFF, Justice.

This litigation springs from plaintiffs' investments in several limited partnerships under common management, all of which involved shopping center sites and were similarly structured as tax shelters. The catalyst for the suit was a determination by the Internal Revenue Service (the "IRS") that plaintiffs had claimed improperly high interest deductions. The IRS assessed plaintiffs for underpayment of taxes plus interest, computing interest at a penalty rate applicable to substantial understatements attributable to tax-motivated transactions under Section 6621(c)(3) of the Internal Revenue Code (26 U.S.C.). Plaintiffs here claim Price Waterhouse, the accounting firm, used an improper method to calculate the deductions, and seek recoupment of interest and legal expenses.

Price Waterhouse moves to dismiss the complaint pursuant to CPLR 3211(a)(7). In addition to urging that plaintiffs lack standing, Price Waterhouse argues that all four causes of action, of which two sound in negligence and two in professional malpractice, are barred by applicable statutes of limitations.

This case presents a novel issue relating to the limitations period to be applied to claims relating to federal income tax preparation. The complaint contains class action allegations but no class has yet been certified. Accordingly, the court treats the issues raised as limited to the individual plaintiffs.

Underlying Facts

Price Waterhouse was hired by the partnerships to conduct annual audits and to prepare the partnerships' tax returns and K-1s for the tax years 1980 through and including 1987. Price Waterhouse regularly prepared for each limited partner a K-1 Schedule ("K-1"), an information return entitled "Partner's Share of Income, Credits, Deductions, Etc." The K-1s reported each partner's pro rata share of the partnership's income and expenses, including interest. The last K-1 was prepared in February of 1988. Deficiencies in the audit aspect of Price Waterhouse's work are not alleged.

Apparently from the inception of the partnerships, Price Waterhouse used a method of interest computation called the Rule of 78's. The Rule of 78's allocates greater interest in the early years and lesser interest in the later years in the life of a debt. As a general description, under this method, the amount of interest is computed by multiplying the total interest payable over the life of the indebtedness by a fraction, of which the numerator is the number of periods remaining and the denominator is the sum of the digits in the number of periods comprising the term of the indebtedness.

In 1983, the IRS issued Revenue Ruling 83-84, which held that interest deductions based on the Rule of 78's would not be allowed on any amount "in excess of the amount of the economic accrual of interest." Nonetheless, Price Waterhouse continued to utilize the Rule of 78's in its annual computations for these partnerships. The complaint alleges that Price Waterhouse discontinued the use of the Rule of 78's for all other similar partnerships, but not for the partnerships involved here.

Price Waterhouse asserts that continuation of the use of the Rule of 78's resulted from its reliance upon an opinion of the partnerships' tax counsel dated December of 1983 which consisted of 10 single-spaced pages (notice of motion, exhibit F). By a letter issued in March of 1984, relevant to the 1983 tax year, Price Waterhouse advised the limited partners:

"Interest expense deductions have been reported ... on the Rule of 78's method. .... It is ... in accord with the existing case law and Revenue Rulings in effect at the time the transaction was entered into. .... [W]e have been furnished with an opinion of [the partnerships'] tax counsel to the effect that it is more likely than not that the interest deductions, as reported, will be upheld if challenged by the IRS based on research which indicates that the Commissioner cannot properly assert that Revenue Ruling 83-84 has retroactive effect. Our firm has relied on the opinion in preparing the 1983 Partnership Tax Return."

The above letter was referred to in Price Waterhouse brief cover letters for the K-1s for the 1984 through 1988 tax years. An updated opinion of the partnerships' tax counsel was issued in March of 1985, consisting of 16 single-spaced pages, which contained a new analysis section including the view that litigation would be probable (notice of motion, exhibit H). This second letter was also referred to in subsequent Price Waterhouse letters. The Price Waterhouse letters for 1987 and 1988 mentioned that the substantial underpayment penalty had been increased from 10 per cent to 25 per cent.

By February of 1988, the partnerships fell into three groups, with some having received preliminary deficiency notices from the IRS, some being subject to settlement negotiations without such letters, and some escaping attention. The earliest preliminary deficiency notices to the partnerships were issued in 1985 (plaintiff's brief, p. 14). The IRS scrutiny related to a number of issues, including the propriety of the continued use of the Rule of 78's.

The legal issue was ultimately resolved in favor of the IRS's position by a United States Tax Court decision in an unrelated case in December of 1988. In that decision, Prabel v. Commissioner of Internal Revenue, 91 T.C. 1101, aff'd 882 F.2d 820 (3rd Cir.1989), the Tax Court concluded that the Rule of 78's had never been viewed as a proper treatment for anything other than a short-term loan, rendering any attack on the retroactivity of the Revenue Ruling irrelevant. The court unequivocally stated that tax advisors had no legal or accounting authority to justify use of this method of computation for long-term loans either before or after the Revenue Ruling. Following this stinging assessment of their argument, the partnerships settled their appeals.

A group of investors commenced two federal class actions against the partnerships and additional defendants, which were reportedly settled before Judge Platt of the Eastern District in February of 1990, with the plaintiffs receiving approximately $40 million. There, the claims against Price Waterhouse apparently were discontinued without prejudice (see, defendant's brief, pp. 15-16).

This action was commenced on April 10, 1990. The complaint requests damages equal to interest and legal fees paid in relation to tax years 1983 through 1988 (para. 31).

Standing

Price Waterhouse attacks plaintiffs' standing to sue, arguing that they were engaged by the partnerships and thus owed no duty of care to plaintiffs, the limited partners. This contention must be rejected.

Generally, even if an accounting firm is engaged solely by a limited partnership, the limited partners have standing to sue for breach of a duty of care owed directly to them by the accounting firm if there is "a relationship so close as to approach that of privity" (Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 546, 493 N.Y.S.2d 435, 483 N.E.2d 110 [1985]. This complaint, upon its face, makes adequate allegations to satisfy the specific three-prong test held to be applicable by the Court of Appeals, which is as follows:

"(1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance" (id., at 551, 493 N.Y.S.2d 435, 483 N.E.2d 110).

The "like privity" relationship and three-prong standard were held applicable to a claim of limited partners against an accountant engaged by general partners in White v. Guarente, 43 N.Y.2d 356, 401 N.Y.S.2d 474, 372 N.E.2d 315 (1977), in relation to a cause of action for negligence, "the gravamen of which [was] for professional malpractice" (43 N.Y.2d at 359, 401 N.Y.S.2d 474, 372 N.E.2d 315). In addition, the pleading of the delivery of Price Waterhouse letters and forms to the plaintiffs is an adequate allegation of a legally cognizable direct relationship or bond between the parties (compare, Security Pacific Business Credit v. Peat Marwick Main & Co., 79 N.Y.2d 695, 586 N.Y.S.2d 87, 597 N.E.2d 1080 [1992].

Based upon the foregoing, the standing argument is found to be without merit.

Untimeliness

Price Waterhouse asserts that "virtually all" of plaintiffs' claims are barred by the applicable statutes of limitations. Because the issue is actually more complicated than it might seem to be, the initial step must be to define the relevant actions. The claims relating to the three out-of-state plaintiffs will be addressed at the close of this decision.

For New York plaintiffs, claims of negligence and professional malpractice are governed by a statute of limitations of three years (CPLR 214[4] and [6]. As generally applicable, a cause of action in negligence accrues from the date of the injury and a cause of action for professional malpractice accrues upon the performance of the work by the professional (Fleet Factors Corp. v. Werblin, 114 A.D.2d 996, 997, ...