Bancroft v. Indemnity Insurance Co. of North America

• Decision Date: 12 March 1962
• Docket Number: Civ. A. No. 8208.
• Citation: 203 F. Supp. 49
• Parties: T. O. BANCROFT and Vada S. Bancroft v. INDEMNITY INSURANCE COMPANY OF NORTH AMERICA.
• Court: U.S. District Court — Western District of Louisiana

203 F. Supp. 49

T. O. BANCROFT and Vada S. Bancroft v. INDEMNITY INSURANCE COMPANY OF NORTH AMERICA.

Civ. A. No. 8208.

United States District Court W. D. Louisiana, Monroe Division.

March 12, 1962.

Burt W. Sperry, Shotwell & Brown, Monroe, La., Clarence L. Yancey, Benjamin C. King, Cook, Clark, Egan, Yancey & King, Shreveport, La., for plaintiffs.

John C. Theus, Robert L. Curry III, Theus, Grisham, Davis, Leigh & Brown, Monroe, La., for defendant.

BEN C. DAWKINS, Jr., Chief Judge.

Presented here is an action for damages arising from an alleged breach of contract involving professional accounting services. It is brought by T. O. Bancroft, president of Bancroft Bag Factory, Inc., and his wife, of Monroe, Louisiana, against the professional liability insurer of a firm of Certified Public Accountants practicing in Monroe.¹

The facts forming the basis of the suit occurred during an accountant-client relationship which had existed between plaintiffs and defendant's insured since approximately 1938, the insured having been employed originally by plaintiffs while Bancroft was operating as an individual, then as a partnership, and later as principal stockholder of Bancroft Bag Factory, Inc., and Bancroft Paper Company, Inc.

May 23, 1955, Bancroft directed a letter to a member of the insured firm in which he explained that several stockholders in the bag factory, who were children of the Bancroft family, owed money to the bag factory and that a plan had occurred to him which possibly would effect a means of payment with minimum tax consequences. The following question was asked:

"T. O. Bancroft, Sr. owns a certain amount of stock in the Bancroft Paper Company, Inc. This stock was acquired during the married life of T. O. Bancroft, Sr., and Vada Speed Bancroft, and is community property. Would it be possible, and not in violation of any law, for a sufficient amount of this stock to be sold to the Bancroft Bag Factory, Inc., and one-half of the sale price to be credited to Vada Speed Bancroft account on Bancroft Bag Factory, Inc. books, and one half sale price credited to T. O. Bancroft, Sr. on Bancroft Bag Factory, Inc. books, and these credits could set-off the debit charges by gifts from Vada and myself to the three children at the rate of legal gift limits per year until the accounts are balanced.

"The Bancroft Paper Company stock is Par $100.00 per share, and is maintained at that value by the distribution of dividends and bonuses each year.

"Please let me have your opinion in writing concerning this proposal."

The insured C.P.A. replied May 25, 1955, in a letter addressed to Bancroft, in the following language:

"Reply to your letter of May 23, 1955, is made as follows:

"You and Mrs. Bancroft propose to sell a certain amount of Bancroft Paper Company, Inc. stock at $100.00 per share to Bancroft Bag Factory, Inc. We understand that Bancroft Paper Company, Inc. stock has been kept at a book value of about $100.00 per share by the payment of dividends and that its selling price is $100.00 per share and your cost is the same amount per share. In our opinion, there would be no Federal or Louisiana income tax on the sale of the stock.

"We further understand that you are not to receive cash for the stock but that a credit will be set up for you and Mrs. Bancroft on the books of the Bancroft Bag Factory, Inc. Each calendar year you propose to make a gift of $3,000.00 to each of your three children by crediting their account due the Bancroft Bag Factory, Inc. and charging your account. Mrs. Bancroft will do likewise. The total gifts to the three children will be $18,000.00 annually. Such a transaction would not involve any Federal Gift Tax as a person may give $3,000.00 (the maximum annual exclusion) per year to as many individuals as he may choose without gift tax."

Relying on this advice, September 15, 1955, plaintiffs sold 410 shares of their stock in the paper company to the bag factory for $41,000.00; and October 18, 1957, they sold an additional 187 shares of paper company stock to the bag factory for $18,700.00. These two transactions were accomplished by bookkeeping entries on the accounts of the two corporations, the two sums being credited to plaintiffs' accounts on the books of the bag factory, thereby satisfying their children's indebtedness and leaving a credit balance. Following the 1955 transaction, plaintiffs' accounts in the bag factory were debited for $8,149.17 and the accounts of their children were credited with an equal amount to reflect gifts from the parents to the children.

In 1959, the Internal Revenue Service audited plaintiffs' income tax returns, including those for 1955 and 1957, and subsequently notified them that the two stock transactions were subject to the provisions of Section 304 of the 1954 Internal Revenue Code (26 U.S.C. § 304); that the sums received by plaintiffs from the sales of stock in 1955 and 1957 would be treated, for tax purposes, as dividends and taxed accordingly. The government's position was summarized in a letter dated December 1, 1959, from the office of the District Director, Internal Revenue Service, addressed to plaintiffs. After listing net adjustments (increases) to taxable income in the sum of $41,000.00 and describing them as "Dividends from Bancroft Bag Factory, Inc.," the letter explained:

"(1) The sale of 410 shares of stock of Bancroft Paper Co., Inc., in year 1955 to Bancroft Bag Factory, Inc., and the sale of 187 shares of stock of Bancroft Paper Co., Inc., to Bancroft Bag Factory, Inc., in year 1957, by the taxpayers, constitutes a distribution in redemption of the stock of Bancroft Bag Factory, Inc., in the amount of the sales proceeds. The proposed adjustment is to include in income the dividends resulting from the redemption. See Sec. 304 of the Internal Revenue Code of 1954. The assessment of additional tax in year 1955 is not barred by the statute of limitations because of the omission of over 25% of the amount of gross income stated in the return. See Sec. 6501(e) of the Internal Revenue Code of 1954."

In an effort to reach an accord with the Internal Revenue Service and for purposes of securing a review of the adjustments, an informal conference was held among Bancroft, representatives of the Internal Revenue Service, the insured C.P.A., and D. C. Bernhardt, an attorney and certified public accountant then representing plaintiffs. The insured C.P.A. testified that all parties agreed that the assessment was owed for the stock sales in 1955 and 1957:

"Q You agreed to the assessment by the Federal Government and, in substance, told Mr. Bancroft he would have to pay it; isn't that right?

"A Yes, sir.

"Q When did you tell him he would have to pay it? Would that be before this conference or after it?

"A No, sir. In this conference we all agreed the tax was owed. I don't believe the computation was made that day, but we discussed the items to be included in the settlement and he later submitted a computation to me of the tax.

"Q That result, * * * was very different from the advice set forth in your letter of May 25, 1955, that there would be no tax?

"A It sure was.

"Q How do you account for the results you got — let us say, bad result?

"A I simply, in my research, missed the new law.

"THE COURT: What section was it you missed?

"A 304.

"THE COURT: Of the 1954 Code?

"A Yes, sir.

"BY MR. KING:

"Q Didn't you just, frankly, admit to Mr. Bancroft that you made a mistake?

"A Yes, sir.

"Q When you say you missed this Section 304, you were not aware of it, or what do you mean by that, * * *?

"A I think when he posed the question, or rather outlining there was no profit or loss in the question, I simply didn't carry my research far enough.

"Q It was there.

"A The Section was there, yes, sir.

"Q Didn't the section fit this pretty much like a glove?

"A I would say so.

"Q Has there been any change in that law since then?

"A Not that I know of."

The insured further testified that he considered himself employed by Bancroft and his wife at the time the advice was given and when the 1955 stock transaction occurred. He also testified, as did Bancroft, that the latter paid the assessment on the strength of his opinion that the additional tax was due, Bancroft thus relying further, at least partially, at the date of the extra assessment, on the professional advice of the insured.

Following the conference, adjustments were made by I. R. S., including an allowance for the tax-exempt gifts from the parents to the children, and a total additional assessment for the years 1955 and 1957 was fixed at $35,419.74. This amount was paid to the government April 5, 1960, and is the sum sued for here.

Defendant denies liability to plaintiffs for the amount of the additional income tax paid on the grounds that, notwithstanding payment of the extra assessment, the taxes were not legally owed under Section 304 and related sections of the Internal Revenue Code of 1954; that its insured did not fall below the standard of reasonable care required of professional accountants in advising his clients as to their tax problems; that, assuming the advice given plaintiffs was erroneous and the result of professional negligence, plaintiffs were not "justified" in relying thereon in the transactions which occurred, in the first instance, approximately four months and, in the second, two years and five months after rendition of the written opinion; that the insured C.P.A. committed a criminal act within the meaning of LSA-R.S. 37:213 (1950)² by engaging in the unauthorized practice of law and, therefore, the terms of the professional liability policy did not extend coverage to include this.

We must, accordingly, determine the duty owed to plaintiffs by the insured. Accountants, "a skilled professional class * * * subject generally to the same rules of liability for negligence in the practice of their profession as are members of other skilled professions," have been held liable for...