Alpert v. Shea Gould Climenko & Casey

• Decision Date: 19 July 1990
• Citation: 559 N.Y.S.2d 312,160 A.D.2d 67
• Court: New York Supreme Court — Appellate Division
• Parties: George ALPERT, Plaintiff-Appellant-Respondent, v. SHEA GOULD CLIMENKO & CASEY, Defendant-Respondent-Appellant. George ALPERT, Plaintiff-Appellant-Respondent, v. ESANU, KATSKY & KORINS, Defendant-Respondent-Appellant. Lee WOLFMAN, Plaintiff-Appellant-Respondent, v. SHEA GOULD CLIMENKO & CASEY, Defendant-Respondent-Appellant. Lee WOLFMAN, Plaintiff-Appellant-Respondent, v. ESANU, KATSKY & KORINS, Defendant-Respondent-Appellant.

Page 312

559 N.Y.S.2d 312

160 A.D.2d 67

George ALPERT, Plaintiff-Appellant-Respondent, v. SHEA GOULD CLIMENKO & CASEY, Defendant-Respondent-Appellant.

George ALPERT, Plaintiff-Appellant-Respondent, v. ESANU, KATSKY & KORINS, Defendant-Respondent-Appellant.

Lee WOLFMAN, Plaintiff-Appellant-Respondent, v. SHEA GOULD CLIMENKO & CASEY, Defendant-Respondent-Appellant.

Lee WOLFMAN, Plaintiff-Appellant-Respondent, v. ESANU, KATSKY & KORINS, Defendant-Respondent-Appellant.

Supreme Court, Appellate Division First Department.

July 19, 1990.

Allen J. Rothman, of counsel (Jessel Rothman, P.C., Mineola, attorney), for plaintiffs-appellants-respondents.

Jack G. Lerner, of counsel (Lord Day & Lord, Barrett Smith, New York City, attorneys), for defendant-respondent-appellant Esanu, Katsky & Korins.

James M. Kaplan, of counsel (Wilson, Elser, Moskowitz, Edelman & Dicker, New York City, attorneys), for defendant-respondent-appellant Shea & Gould.

Before KUPFERMAN, J.P., and MILONAS, ASCH and SMITH, JJ.

SMITH, Justice.

These consolidated actions arise out of investments made by plaintiffs-appellants George Alpert ("Alpert") and Lee Wolfman ("Wolfman") in a tax shelter known as the Logan Properties Program ("Logan") and the issuance of tax opinions by the defendant law firms in connection therewith.

On December 30, 1977 Alpert and Wolfman, who were facing substantial income tax liability for that year, invested $52,500 each in Logan which was structured by the defendant Esanu, Katsky and Korins ("the Esanu firm") and managed by Churchill Coal Corporation. The chief attraction of this investment was the apparent immediate deductibility of "an advance minimum royalty" to be paid by Logan for the right to mine coal.

On their 1977 federal income tax returns, both Alpert and Wolfman deducted $219,728 of which $216,645 represented a deduction for the Logan advance minimum royalty. Each similarly deducted $10,893 on his 1978 federal income tax return. These deductions were disallowed by the Internal Revenue Service ("IRS"), in July 1984 as to Wolfman and in March 1985 as to Alpert, on the basis that the advance minimum royalty was not deductible under section 612 of the Internal Revenue Code and that the Logan Program lacked economic substance. Accordingly, in December 1986 plaintiffs paid to the IRS the tax deficiencies arising from these deductions. The interest on these deficiencies exceeded the base back tax amount due. For example, Alpert paid $117,451 in back taxes and $165,818 in interest. There is no indication that the IRS assessed a penalty against either plaintiff.

On December 16, 1977 the United States Treasury Department had promulgated an amendment to Treasury Regulation § 1.612-3(b)(3) disallowing previously permitted deductions from gross income of advanced royalties paid in connection with mineral property. Revised Rule 77-489 (1977 1.R.B.51), issued by the IRS on December 19, 1977, advised that under this amendment advance minimum royalties could be deducted only over the period for which they were paid and not in the year of payment.

Consequently, the Esanu firm withdrew a previously rendered opinion used in connection with the Logan promotion and, on or before December 21, 1977, delivered a letter to Logan's operating manager stating in relevant part:

"The issuance of the Ruling ... substantially increases the likelihood that the deduction by each Participant of his entire proportionate amount of the Advance Minimum Royalty will be attacked on audit. However, while considerable uncertainty exists as to whether or not Participants' position may be sustained, it is our view, based upon existing law, regulations and judicial decisions, that there is a basis for the Participants' position. It should be emphasized, in the light of the present uncertainty that exists, that there is a substantial risk of disallowance of all, or substantially all, of such deduction. Furthermore, if the issue were litigated, there is a substantial risk that the Service's position would be ultimately upheld ..."

In view of this tenuous endorsement, Logan sponsors obtained a supplementary tax opinion letter dated December 20, 1977 from defendant Shea Gould Climenko and Casey ("Shea Gould"), which stated:

"Accordingly, we believe that there is a reasonable basis for concluding that Rev.Rul. 77-489 is invalid. Nevertheless, we recognize that the foregoing arguments may not necessarily prevail in any future litigation with the Internal Revenue Service. In the event that the Service is successful in applying the material distortion of income concept as set forth in Rev.Rul. 77-489 to the payment of the advance minimum royalty, Participants who acquire working interests may not be able to deduct the advanced minimum royalty until such time as the coal in respect to which the royalty was paid is sold."

In April 1984 plaintiffs commenced separate actions against each of the defendant law firms claiming, inter alia, fraudulent misrepresentation. As damages, plaintiffs sought lost profits and the tax benefits which they would have obtained had they not relied upon defendants' opinions and, instead, invested in a viable tax shelter.

In September 1987, following extensive discovery, defendants moved against each plaintiff for, inter alia, partial summary judgment dismissing so much of their damage claims as sought recovery of taxes, interest and penalties. Plaintiffs cross-moved for leave to amend their complaints against defendants to assert claims for breach of fiduciary duty against both defendants and an additional fraud claim against the Esanu firm based upon allegations that it had knowledge that the Logan program was a sham.

The IAS court granted defendants' motion for partial summary judgment to the extent of dismissing damage claims for back taxes, but denied defendants' motion for partial summary judgment as to plaintiffs' recovery of interest paid. The court granted plaintiffs' motion for leave to amend the complaint to the extent of permitting the assertion of breach of fiduciary duty claims against both defendants but denied plaintiff summary judgment as to an additional cause of action for fraud against the Esanu firm. Upon reargument the IAS court adhered to its decision.

The parties appeal from the respective portions of the order adverse to them.

The IAS court was correct in rejecting plaintiffs' damage claims for back taxes. The recovery of consequential damages naturally flowing from a fraud is limited to that which is necessary to restore a party to the position occupied before commission of the fraud. Hotaling v. A.B. Leach & Co., 247 N.Y. 84, 87, 159 N.E. 870 (1928) (citing Reno v. Bull, 226 N.Y. 546, 124 N.E. 144 (1919)); Orbit Holding Corp. v. Anthony Hotel Corp., 121 A.D.2d 311, 315, 503 N.Y.S.2d 780 (1st Dept.1986). Cayuga Harvester, Inc. v. Allis-Chalmers Corp., 95 A.D.2d 5, 465 N.Y.S.2d 606 (4th Dept.1983), wherein plaintiff recovered the value of crops destroyed by repeated breakdowns of farm equipment it was fraudulently induced to purchase, is not to the contrary. In Cayuga Harvester, Inc. the Fourth Department found that the destruction of the plaintiffs' crop was a direct result of defendants' fraud and placed plaintiff in a far worse position than had it not purchased the equipment. By contrast, in the instant case, recovery of back taxes would place plaintiffs in a better position than had they never invested in the Logan program.

It is also well settled that the victim of fraud may not recover the benefit of an alternative agreement overlooked in favor of the fraudulent one. Kensington Publishing Corp. v. Kable News Co., 100 A.D.2d 802, 474 N.Y.S.2d 524 (1st Dept.1984). Hence, plaintiffs' argument that but for the fraud they would have invested in some other tax shelter must fail.

The recovery of interest payments to the IRS also should have been precluded. In Freschi v. Grand Coal Venture, [767 F.2d 1041 (2nd Cir.1985); vacated on other grounds 478 U.S. 1015, 106 S.Ct. 3325, 92 L.Ed.2d 731 (1986); on remand 800 F.2d 305 (1986); mod. 806 F.2d 17 (1986) ], a case involving violations of federal securities law, the United States Court of Appeals found that a defrauded investor in a coal mine tax shelter, similar to the one herein, was not entitled to recover interest paid to the IRS upon disallowance of tax deductions. The Court reasoned that such interest was not damages suffered by plaintiff but rather was a payment to the IRS for his use of the money during the period of time when he was not entitled to it. There is support for such a result in New York case law as well. In Cowart v. Lang, 252 A.D. 720, 298 N.Y.S. 875 (4th Dept.1937) a finance charge was held to be "consideration for the privilege of deferring payment of the purchase price and thus ... an accommodation or benefit to the plaintiff and not a proper element of damage." Moreover, the equities militate in favor of barring recovery of such interest rather than...