Griffin v. Commissioner

• Decision Date: 09 January 2001
• Docket Number: Docket No. 12900-98.
• Citation: 81 T.C.M. 972
• Parties: Wade H. Griffin, III v. Commissioner.
• Court: U.S. Tax Court

81 T.C.M. 972

T.C. Memo. 2001-5

Wade H. Griffin, III v. Commissioner.

Docket No. 12900-98.

United States Tax Court.

Filed January 9, 2001.

William E. Frantz, Atlanta, Georgia, Brenda G. Bates, and Donald P. Edwards (specially recognized), for the petitioner.

David R. Mackusick and Gwendolyn C. Walker, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge:

Respondent, for petitioner's 1994 taxable year, determined a $1,443,439 income tax deficiency and an accuracy-related penalty under section 6662(a),¹ in the amount of $19,253. The parties have resolved some of the adjustments that were in controversy, and the following issues remain for our consideration: (1) Whether any portion of a $4,997,896 lawsuit settlement is excludable under section 104(a)(2); (2) whether the portion of the settlement paid to petitioner's attorneys under a contingency fee arrangement should be included in petitioner's gross income; and (3) whether petitioner is liable for an accuracy-related penalty under section 6662(a).

FINDINGS OF FACT²

Petitioner resided in Mobile, Alabama, at the time his petition was filed in this case. Petitioner purchased an automobile dealership in Mobile, Alabama, in 1982, and James R. Jordan (Jordan) was his sales manager. Around 1985, petitioner was advised of the availability for sale of a Toyota automobile dealership in Enterprise, Alabama. Representations were made by the sellers to petitioner concerning the amount of vehicles sold each month and the profits that could be expected. Petitioner and Jordan became interested in purchasing the Toyota dealership and provided personal information to the sellers, Toyota-GMC of Enterprise, Inc., an Alabama corporation. Petitioner and Jordan subsequently submitted an application and were accepted to become Toyota dealers.

Prior to entering into a dealership agreement, petitioner met with an executive of Southeast Toyota Distributors, Inc. (SET), one of a group of related companies that controlled the financing and distribution of the Toyota automobiles until they arrived at the dealers within the regional area. On April 24, 1987, petitioner and Jordan formed an Alabama corporation, Hamp Griffin Toyota-GMC, Inc. (HGTG), to operate the Toyota dealership, which was purchased on May 27, 1987. Based on representations of SET employees and others, petitioner had invested in the dealership with the expectation of selling approximately 30 cars and 30 trucks per month at a profit of about $800 or $900 per vehicle.

Petitioner arranged for and became guarantor of a $1 million line of credit and personally borrowed $350,000 to lend to HGTG to commence its business. After beginning operations, petitioner learned that some of the representations were exaggerated and/or false, including the ability to generate income in the expected amounts. Petitioner also discovered that SET encouraged dealers to falsely report their vehicle information in order to cause an increase in their allocation of Toyota automobiles. Petitioner and Jordan did not participate in the false reporting. As a result, HGTG did not receive as large an allocation of vehicles and was also forced to accept vehicles loaded with accessories that were more difficult to sell in its sales area because the increased price for the accessories made the selling price less competitive.

HGTG was also forced by SET to pay fees and participate in multiple-dealer "tent sales" because its allocation of vehicles was shipped to the tent location rather than to the dealership. In addition, HGTG was required to sell SET-related companies' extended service policies and financing with respect to any "tent sale". Petitioner consulted SET's vice president of sales regarding HGTG's poor performance, and it was suggested that Jordan was not an effective manager and should be replaced by Tom Strickland (Strickland), who was connected with SET. Ultimately, Strickland, beginning on April 14, 1988, became involved with HGTG by purchasing 15 percent of its shares and becoming its president and general manager.

In October 1988, Strickland's relationship with HGTG ended, and at that time petitioner found that HGTG's obligation to the finance company had not been paid under the floor plan financing agreement for the cars that had already been sold. HGTG's financial problems became public, and petitioner experienced great stress for which he was treated by a doctor. For the next several months petitioner was occasionally hospitalized for his condition, and, upon his July 1989 release from the hospital, he closed the Toyota dealership. In 1989, petitioner began seeing a psychiatrist and was experiencing symptoms of stress and anxiety and was diagnosed as being in a state of "major depression".

During April 1989, petitioner received a purchase offer for the Toyota dealership, but SET would not approve a sale, and instead SET instituted a foreclosure action against HGTG. On May 5, 1989, HGTG voluntarily filed for a chapter 11 bankruptcy (reorganization), which was converted to a chapter 7 (liquidating) proceeding on November 2, 1989.

During September 1990, petitioner and HGTG retained attorney Vincent F. Kilborn (Kilborn) by means of a contingent fee arrangement under which the attorney's fee was 52-1/2 percent of any recovery or zero if there was no recovery. Petitioner and HGTG were responsible for costs and expenses. Thereafter, an action on behalf of petitioner and HGTG was commenced against Toyota Motor Sales U.S.A., Inc., and related companies, SET and related companies and its officers, and others. Kilborn became aware of a South Carolina case involving SET and dealer allegations of being required to make false sales reports in order to stay in business. Ross M. Goodman (Goodman) was brought in to assist in the representation. Goodman was associated with a law firm that was representing dealers in connection with other Toyota cases.

Goodman was aware of a North Carolina dealer's case against SET where a State administrative law judge had issued extensive findings of fact, and Goodman relied on the findings and record in that case as a source for the allegations in petitioner's complaint against SET, et al. Kilborn and Goodman worked together to draft the final complaint, which was filed in the Circuit Court of Mobile County, Alabama, on or about September 27, 1990. Because the complaint was designed to replicate the approach used in other suits, it focused on the commercial losses of the dealership attributable to the defendants' misconduct.

The complaint is 60 pages in length and contains 123 jurisdictional and factual allegations and 13 counts, broadly categorized as follows: Count I, breach of contract; count II, promissory fraud; counts III to V, violations of the Alabama Motor Vehicle Franchise Act; count VI, felonious injury; count VII, interference with business relations; count VIII, willful misrepresentation; count IX, reckless misrepresentation; count X, suppression of material fact; count XI, promissory fraud; count XII, conspiracy; and count XIII, violation of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. sections 1961 and 1964(c). The factual allegations do not contain a claim or allegation that petitioner suffered any mental stress or depression. The allegations in the complaint address the business relationship and the improper and unfair tactics and activities of the defendants that resulted in the "demise" of petitioner's and HGTG's Toyota dealership. Likewise, the 13 counts allege injuries and damages that are commercial in nature, and, although some of the counts sound in tort as the cause of action, no claim of mental stress or depression is set forth in the 13 counts.

Subsequent to the complaint's being filed, Toyota Motor Sales, U.S.A., Inc., and Toyota Motor Credit Corp. (the defendants) argued in HGTG's bankruptcy proceeding that Goodman and Kilborn could not represent both petitioner's and HGTG's interests, and the attorneys elected to represent petitioner. The defendants also moved to dismiss petitioner from the case on the grounds that he was not a party to the dealership agreement and that the alleged injuries were to the corporation and not petitioner. In those motions and related documents, the defendants pointed out that the complaint focused on commercial harm to the corporate entity and that no claim appeared to have been made with respect to petitioner. The defendants' motion was referred to a magistrate judge, who issued a report and recommendation that set forth a proposed denial of the defendants' motion, and the report was adopted by a U.S. District Court Judge. The report did not address the merits of the cause of action but contained the conclusion that it was premature for a court to decide whether petitioner had standing. The report also contained the recommendation that petitioner be given leave to amend the complaint and to distinguish between the individual's claim and those derivative through the corporate entity.

Thereafter an amended complaint was filed on behalf of petitioner outlining the personal items of fraud and coercion and the personal services nature of the contract. The amended complaint contained allegations that petitioner was personally involved in the transactions with the defendants, had a financial stake and obligations in connection with the auto dealership, and was harmed because of the flow-through nature of HGTG, an S corporation. The amended complaint did not contain allegations that petitioner suffered any mental stress or depression, and no demands were made for damages attributable to petitioner's mental stress or depression.

Late in 1993, the decision was made by petitioner and his attorneys to attempt settlement. A settlement agreement containing a confidentiality clause was entered into and approved by the bankruptcy court. The total settlement amount was $6 million, of which $557,257 was...