Billings Clinic v. Peat Marwick Main & Co.

• Decision Date: 16 August 1990
• Docket Number: No. 88-623,88-623
• Citation: 244 Mont. 324,47 St.Rep. 1464,797 P.2d 899
• Court: Montana Supreme Court
• Parties: The BILLINGS CLINIC, a partnership, Plaintiff and Respondent, v. PEAT MARWICK MAIN & CO., a partnership, and Donald A. Blackwell, Defendants and Appellants.

Page 899

797 P.2d 899

244 Mont. 324

The BILLINGS CLINIC, a partnership, Plaintiff and Respondent, v. PEAT MARWICK MAIN & CO., a partnership, and Donald A.

Blackwell, Defendants and Appellants.

No. 88-623.

Supreme Court of Montana.

Submitted June 6, 1990.

Decided Aug. 16, 1990.

John D. Stephenson, Jr., argued, Jardine, Stephenson, Blewett & Weaver, Great Falls, Leonard P. Novello, Gen. Counsel, James F. Kennedy, Asst. Gen. Counsel, Peat Marwick & Co., New York City, Katheryn A. Oberly, Scott P. Perlman, Mayer, Brown & Platt, Washington, D.C., for defendants and appellants.

Stuart Pack, argued, Sherman & Howard, Denver, Colo., Gerald J. Neely, Billings, for plaintiff and respondent.

Louis A. Craco, Deborah E. Cooper and Diana B. Simon, Wilkie, Farr & Gallagher, One Citicorp Center, New York City, amicus curiae, for American Institute of CPA's.

Ward A. Shanahan, Gough, Shanahan, Johnson & Waterman, Helena, amicus curiae, for Mt. Soc. of CPA's.

SHEEHY, Justice.

The Billings Clinic, a partnership of medical doctors in Billings, proposed in 1982 to liquidate a corporation under Sec. 331 of the Federal Internal Revenue Code, and contemporaneously to build a larger office facility financed by the issuance of industrial revenue bonds complying with federal tax laws. The Clinic retained Peat Marwick Main and Company, a national firm of accountants with offices in Billings, for "tax and accounting considerations" relating to the Clinic's plans. The critical issue here, among other important issues, is the outer extent of the professional duty owed to the Clinic by the accountants under the circumstances of this case. A jury in the Thirteenth Judicial District, Yellowstone County, found that Peat Marwick had breached its duty, and awarded damages in favor of the Clinic. Judgment was entered thereon and this appeal resulted. On consideration, we affirm.

FACTS

The principal business in 1982 and prior years of the partnership of medical doctors known as the Billings Clinic was the practice of medicine in Billings, Montana. It controlled two other entities, however. The Yellowstone Company was a Montana corporation, of which the shareholders were all of the medical doctors of the Clinic, and this corporation owned the Clinic building in Billings in which the doctors practiced medicine. The Yellowstone Realty was a Montana partnership comprised of the same medical doctors as the Clinic, and the chief asset of The Yellowstone Realty was also realty other than the Clinic building.

In 1981-1982, the partners of the Billings Clinic had two related problems. One was the high capital cost for admission of new A second problem confronting the Clinic was an immediate need for additional space in which to conduct its medical practice. The Clinic decided in 1981 to renovate its downtown building and build a larger addition to its medical facility. The Clinic intended to finance this construction project with industrial revenue bonds.

partners into the medical practice. To become a partner of the Billings Clinic, an incoming doctor was required also to become a partner in The Yellowstone Realty, and a shareholder in The Yellowstone Company. The value of the properties owned by The Yellowstone Realty and The Yellowstone Company had increased, so that the amount which doctors newly admitted to the Billings Clinic had to pay to "buy in" their share of the related entities had become expensive. This was described as the "buy-in/buy-out problem."

The two problems were related because the Clinic's planned expansion meant that newly-admitted physicians would be required to buy "more building" at a higher cost.

To meet these problems, the Executive Committee of the Clinic formed two committees. The Alternative Buy-in Committee (ABC Committee) was formed in 1981 to study the buy-in/buy-out problem. It was chaired by Dr. Thomas P. Gormley and this Committee hired the Los Angeles law firm of Pepper, Hamilton and Scheetz in 1982 to help solve the buy-in problem. In June 1982, the Pepper-Hamilton firm sent the Clinic a draft report containing recommendations. This report recommended that the Clinic reorganize and simplify its operations by making The Yellowstone Realty (the partnership) the sole property entity, and by eliminating The Yellowstone Company (the corporation) entirely. The report presented two ways to accomplish the reorganization: (1) the doctors could contribute their stock in The Yellowstone Company to The Yellowstone Realty partnership and then liquidate The Yellowstone Company pursuant to Sec. 333 of the Internal Revenue Code; or (2) the doctors could sell their shares of stock in the Yellowstone Company to The Yellowstone Realty at fair market value and then liquidate The Yellowstone Company pursuant to Sec. 331 of the Internal Revenue Code.

In a parallel action, the Executive Committee of the Clinic had established in 1981 a Building Committee, chaired by Dr. Stephen Kramer. This Committee was responsible for the construction and financing of a new addition to the Clinic building. In January, 1982, this Committee hired the Seattle law firm of Kieburtz and Simmonds as consultant for industrial revenue bond financing. Earlier in March or April of 1981, the Clinic had consulted Gareld Krieg of the Billings law firm of Crowley, Haughey, Hanson, Toole, and Dietrich, seeking a legal opinion as to the amount of capital expenditures the Clinic had available for the new addition without exceeding the $10 million capital expenditure ceiling in Sec. 103 of the Internal Revenue Code. In June of 1982, Kreig was retained to prepare and file, on behalf of the Clinic, an IRB application.

We must now inform the reader that the $10 million capital expenditure limitation in Sec. 103 is the central factor upon which this case is based. As the law then stood, purchasers of properly-issued industrial revenue bonds obtained a favorable income tax status for federal tax purposes on interest received from the bonds. There was no limit as to the total amount of bonds to be issued, but there was a limit to the total capital expenditures made by the project owners within the same municipality within a six-year period, three years before and three years following the date of the issuance of the bonds. Based on figures supplied by the Clinic, Gareld Krieg had written to the Clinic on April 13, 1981, that after deducting such capital expenditures the Clinic had available to it $8.5 million in additional IRB financing authorized under the law.

In early June 1982, Dr. Gormley personally delivered the Pepper-Hamilton report to Ronald Haugan of the defendant Peat Marwick at its office in Billings. What instructions were given by Dr. Gormley to Haugan and Peat Marwick's view of what it was required to review for Dr. Gormley Peat Marwick recommended to the Clinic that the doctors proceed with the reorganization by selling their shares of The Yellowstone Company stock to The Yellowstone Realty partnership at fair market value and then liquidating the corporation pursuant to Sec. 331 of the Internal Revenue Code. The doctors voted at their August 10 meeting to adopt the recommendation and proceed with the Sec. 331 reorganization. The reorganization was implemented through the Crowley firm on September 1, 1982, and became final on September 30, 1982.

are a point of high dispute and will be discussed more fully under the issues hereafter. Mr. Haugan referred the review of the Pepper-Hamilton report to Donald A. Blackwell, one of the partners of Peat Marwick, for his attention. His review resulted in three letters to Dr. Gormley, one dated June 25, 1982, another dated July 20, 1982, and the third, hand delivered, dated August 10, 1982. None of the letters mentioned any adverse impact that the recommended reorganization and liquidation of the corporation would have on the Clinic's industrial revenue bond financing.

In the meantime, the Clinic's Building Committee had not been idle. In September 1982, it let a construction contract for enlargement of the Clinic's office building. The Yellowstone Realty Partnership on September 23, 1982, accepted an offer of Security Mortgage Company to purchase $7.5 million of industrial revenue bonds for an interest rate of 75% of the prime rate subject to certain conditions, one of which was that laws relating to the bonds would be complied with. In turn, Security Mortgage hired the Minneapolis firm of Dorsey and Whitney as bond counsel to determine the legality of the bonds. William Johnstone, a partner in that firm, began work on the bond transaction.

The bond closing was to take place in Billings on December 16, 1982. Prior to that date, Johnstone was unaware that a restructure of the Clinic entities had taken place. While reviewing the Clinic's certificate of actual and projected capital expenditures, Johnstone noticed that no capital expenditures were projected for The Yellowstone Company after 1982. He asked Peggy O'Leary, the Clinic's comptroller, why the capital expenditures for The Yellowstone Company ceased in 1982. She explained that the Yellowstone Company had gone out of existence in 1982 as a result of the reorganization. Johnstone then raised the issue whether the reorganization constituted a capital expenditure. Amid general consternation among all concerned, it was finally determined that the reorganization itself constituted a capital expenditure in the contemplation of Sec. 103 of the Internal Revenue Code. In fact, it constituted a capital expenditure of approximately $4.5 million. When this capital expenditure was combined with the Clinic's $1.5 million of past and future capital expenditures and the $7.5 million bond issue, the Clinic was substantially over the $10 million capital expenditure limit. Therefore, neither Johnstone nor any other bond counsel would give the necessary opinion that interest on the bonds would be income-tax exempt. As a result, the industrial revenue bond...