Eaves v. Designs For Finance Inc.

• Decision Date: 30 March 2011
• Docket Number: No. 09–cv–3952 (CS).,09–cv–3952 (CS).
• Citation: 785 F.Supp.2d 229
• Court: U.S. District Court — Southern District of New York
• Parties: Leland EAVES and Cando Consultant Services, Inc., individually and for all others similarly situated, Plaintiffs,v.DESIGNS FOR FINANCE, INC., Moritt, Hock, Hamroff & Horowitz LLP, and Prusky Law Associates, P.C., Defendants.

785 F.Supp.2d 229

Leland EAVES and Cando Consultant Services, Inc., individually and for all others similarly situated, Plaintiffs,

v.DESIGNS FOR FINANCE, INC., Moritt, Hock, Hamroff & Horowitz LLP, and Prusky Law Associates, P.C., Defendants.

No. 09–cv–3952 (CS).

United States District Court, S.D. New York.

March 30, 2011.

John Balestriere, Geisa Balla, Balestriere Fariello, New York, NY, for Plaintiffs.David S. Richan, Baritz & Colman LLP, New York, NY, for Defendant Designs for Finance, Inc.Anthony P. Colavita, Scott E. Kossove, L'Abbate, Balkan, Colavita & Contini, L.L.P., Garden City, NY, for Defendant Moritt, Hock, Hamroff & Horowitz LLP.Jeffrey B. McCarron, Kathleen M. Carson, Swartz Campbell LLC, Philadelphia, PA, for Defendant Prusky Law Associates, P.C.

OPINION AND ORDER

SEIBEL, District Judge.

Before the Court are Defendants' Motions to Dismiss Plaintiffs' Second Amended Complaint. (Docs. 53, 56, 59.)

I. BACKGROUNDA. Facts

For the purposes of the instant motions, the Court assumes the facts, although not the legal conclusions, in the Second Amended Complaint to be true. Plaintiff Leland Eaves is a Colorado resident and the owner of Plaintiff Cando Consultant Services, Inc. (“Cando”), a Florida-based construction services company. (SAC ¶¶ 89.) ¹ Plaintiffs allege that in the late 1990s and early 2000s, Defendants Designs for Finance, Inc. (“Designs”), Moritt, Hock, Hamroff & Horowitz LLP (“Moritt”), and Prusky Law Associates, P.C. (“Prusky”) devised a scheme to market and sell illegal tax shelters, including, and most notably for the purposes of this case, the BETA Multiple Employer Death Benefit Plan (the “BETA Plan”). ( Id. ¶¶ 1, 31.) Despite knowing it to be an illegal tax shelter, Defendants represented the BETA Plan as a legitimate multiple-employer welfare benefit plan under Section 419A(f)(6) of the Internal Review Code (“IRC”). ( Id. ¶ 2.) Such plans are funded through the purchase of life insurance and annuities, and their purpose is to fund the insurance needs of the small businesses that buy into them. ( Id. ¶ 32.) As such, the Internal Revenue Service (“IRS”) permits participating businesses to take tax deductions for contributions to the plan—but only to the extent that such contributions are for legitimate insurance needs, not as a form of deferred compensation. ( Id.)

Designs acted as the BETA Plan Sponsor and, in that capacity, created and “primarily advocated” for the plan. ( Id. ¶¶ 2, 36a.) Knowing that the IRS considered plans structured similarly to the BETA Plan to be illegal tax shelters, Designs opted not to obtain a private letter ruling from the IRS regarding the plan; instead, it sought legal analysis from Defendant Moritt, a New York-based law firm. ( Id. ¶¶ 6, 12.) Despite knowing that, as Plaintiffs allege, “IRS laws were not strong and that it was skating on thin ice by approving the BETA Plan,” Moritt endorsed the plan in a 54–page opinion letter to Designs dated September 24, 2000–a letter, Plaintiffs allege, that contained “questionable analysis of IRS code and case law.” ( Id. ¶¶ 6, 36b.)

In July 2001, Plaintiffs' accountant Jack Winebrenner suggested to Eaves that he look into the BETA Plan for use with his small business, Cando. ( Id. ¶ 37.) Winebrenner had received information regarding the plan from John Rau, an agent of CNA, one of the plan's marketers and funders, who himself had received information from Designs. ( Id. ¶ 38.) Winebrenner prepared a packet of information for Plaintiffs (the “BETA Plan Sales Packet”), which included a letter from Rau, an overview of the plan, questions and answers regarding the plan, cost information, and Moritt's September 24, 2000 opinion letter to Designs. ( Id. ¶¶ 3839, Ex. B.) After reading through the BETA Plan Sales Packet, which Plaintiffs allege was “endorsed” by both Designs and Moritt, Plaintiffs decided to enroll in the BETA Plan in October 2001. ( Id. ¶ 40.)

Starting in 2001, and continuing through 2007, Plaintiffs made annual contributions of $40,000 to the BETA Plan and, “as advised by Rau and Defendants Moritt ... and Designs,” claimed the same amount as annual tax deductions. ( Id. ¶¶ 4041.) In 2003, the IRS issued stricter regulations on multiple-employer benefit plans under Section 419A(f)(6) of the IRC. ( Id. ¶ 34.) In response to those regulations, Designs signed a BETA Plan Severance Agreement, effective January 1, 2003, that effectively transformed the BETA Plan from one multiple-employer plan (“MEP”) into several single-employer plans (“SEP”). ( Id. ¶¶ 34, 43.) This change in plan structure resulted in a split-dollar life insurance arrangement for plan participants, pursuant to which plan benefits would be separated between employers and shareholder-employees. ( Id. ¶ 34.)

In February 2004, Rau sent a letter to Winebrenner (who presumably forwarded the letter to Plaintiffs, as they have attached the letter to their Second Amended Complaint) stating that the IRS regulations had made the BETA Plan strategy “stronger than ever.” ( Id. ¶ 42, Ex. C.) Plaintiffs allege, instead, that the changes made the plan strategy riskier, and that Designs should have been aware of the risks associated with the regulations and alerted Plaintiffs to such risks. ( Id. ¶ 42.) In December 2004, the BETA Plan Administrator sent plan participants a letter notifying them of the plan's re-characterization as a SEP, as described above. ( Id. ¶ 45.) The letter informed Plaintiffs that the changes did not affect them and were made for compliance purposes only. ( Id.) Plaintiffs allege, however, that such changes “solidified the [BETA] Plan as a deferred compensation plan rather than the legitimate welfare benefit plan it was marketed to be,” ( id. ¶ 35); that, under the new plan structure, plan participants' contributions were subject to funding limitations that rendered Plaintiffs' contributions no longer tax-deductible, ( id. ¶¶ 34, 43); and that, had they been properly informed of how to comply with the IRS regulations, they would not have claimed plan contributions as deductions, and would have paid the necessary taxes on such contributions, ( id. ¶ 46).

In December 2007, Designs sent a letter to plan participants alerting them to other, new IRS rulings and “attempt[ing] to reassure” them that the plan was still valid. ( Id. ¶¶ 47, 49, Ex. E.) Designs included with that letter a December 7, 2007 memorandum from Defendant Prusky, a Philadelphia-based law firm, to Designs that “further advocated for the legality of the BETA Plan in spite of the IRS revisions.” ( Id. ¶ 48, Ex. E.) The Prusky memo also recommended that plan participants file a Form 8886 with the IRS disclosing contributions to the BETA Plan and associated tax deductions, and warned participants that even if the IRS found the deductions to be appropriate, it could nonetheless opt to impose penalties for a failure to file a Form 8886. ( Id. ¶ 50, Ex. E.) ² Eaves filed his Form 8886 shortly thereafter. ( Id. ¶ 53, Ex. G.) Eaves did not trust Prusky's evaluation of the BETA Plan and therefore opted not to claim as a tax deduction his $40,000 contribution to the BETA Plan for the 2007 tax year. ( Id. ¶ 57.)

Eaves received a letter from the IRS dated March 26, 2008, notifying him that he would be audited due to his participation in the BETA Plan for the years 2005, 2006, and 2007. ( Id. ¶ 54, Ex. A.) He received another letter from the IRS on February 26, 2010, analyzing his involvement in the BETA Plan as an employee-shareholder and stating that he owed approximately $250,000. ( Id. ¶ 54, Ex. D.) ³ Cando also received a letter from the IRS on February 26, 2010, detailing the taxes, interest, and penalties owed to the IRS for its involvement in the BETA Plan for tax years 2004 through 2008. ( Id. ¶ 56, Ex. H.) Because Eaves did not claim a tax deduction for his 2007 contribution to the plan, Cando suffered no fines for that year. ( Id. ¶ 57.) Nonetheless, the letter specified that Cando owed $4,422.47 in penalties, and a total of $33,620.80 to the IRS. ( Id. ¶ 57, Ex. H.) Eaves's IRS letters stated that contributions to the BETA Plan were not deductible, as the plan “was not created or designed as, nor does it operate as, an employee welfare benefit fund.” ( Id. ¶ 58, Exs. A, D.) The letters further stated that the BETA Plan was a deferred compensation plan—that is, it was “simply a means of distributing corporate earning[s] and profits to the shareholder-employee(s) [Eaves] in the guise of providing employee benefits,” and plan contributions were “made for the personal benefit of the Shareholder–Employee to fund an investment in a cash value life insurance policy as an alternative means of distributing earning and profits.” ( Id. ¶ 58 (second alteration in original) (internal quotation marks omitted).) Plaintiffs' contributions to the BETA Plan totaled over $300,000 (including fees to Designs and others), and they allege ongoing audits that will cost them that same amount. ( Id. ¶ 64.)

For allegedly knowingly misrepresenting and/or endorsing the BETA Plan as a legal welfare benefit plan, when it was instead a disguised deferred compensation plan under which tax deductions were not permitted, Plaintiffs assert the following causes of action: (1) fraudulent inducement, as against Designs; (2) breach of contract, as against Designs, (3) breach of the implied duty of good faith and fair dealing, as against Designs; (4) fraud, as against Moritt and Prusky; (5) breach of fiduciary and co-fiduciary duties under the Employee Retirement Income Security Act (“ERISA”), as against all Defendants; (6) violation of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), as against all Defendants; (7) violation of New York General Business Law Section 349, as against all Defendants; (8) conversion, as against all Defendants; (9) negligent misrepresentation, as against all Defendants; and (10) civil conspiracy, as against all Defendants. ( Id. ¶¶ 81161....