Lustgarten v. MERRILL LYNCH, ETC.

• Decision Date: 31 December 1981
• Docket Number: Civ. A. No. 79-3481.
• Citation: 528 F. Supp. 1125
• Parties: Paul G. LUSTGARTEN and Jacqueline Lustgarten v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.; Krekstein, Shapiro, Bressler & Wolfson, P. C.; Michael R. Harris, Esq.; Bradford E. Beadle; and American Guaranty & Trust Company.
• Court: U.S. District Court — Eastern District of Pennsylvania

528 F. Supp. 1125

Paul G. LUSTGARTEN and Jacqueline Lustgarten v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.; Krekstein, Shapiro, Bressler & Wolfson, P. C.; Michael R. Harris, Esq.; Bradford E. Beadle; and American Guaranty & Trust Company.

Civ. A. No. 79-3481.

United States District Court, E. D. Pennsylvania.

December 31, 1981.

Leonard Schaeffer, William H. Bishop, Pechner, Dorfman, Wolffe, Rounick & Cabot, Philadelphia, Pa., for plaintiffs.

Stewart Dalzell, Lynne E. Prymas, Philadelphia, Pa., for American Guaranty.

C. Clark Hodgson, Jr., Georganne Daher Terrill, Philadelphia, Pa., for Merrill Lynch and Bradford E. Beadle.

Bruce D. Lomardo, Philadelphia, Pa., for Krekstein, Shapiro.

MEMORANDUM

LOUIS H. POLLAK, District Judge.

This is an action for professional malpractice. Plaintiffs Paul and Jacqueline Lustgarten, faced with the distressing prospect of owing the Government a sizeable sum of money in the way of a deficiency in their federal income tax return for 1971, seek to recover money damages. They allege that their predicament results from the negligence of the various defendants in rendering tax advice in connection with an ill-fated stock sale transaction. Defendants have moved to dismiss.

I.

The allegations embodied in the complaint — allegations assumed to be true for the purpose of deciding defendants' motions — describe the following chronology of events:

In early 1971, Paul Lustgarten decided to sell his shares of stock of Cooper Laboratories, Inc., worth, at fair market value at the time of sale, $1,017,000. In order to structure an appropriate stock sale transaction, Mr. Lustgarten began to consult with, and eventually retained, the various defendants as expert financial and legal advisors. Although plaintiffs are Florida residents, these consultations were conducted in Philadelphia. Mr. Lustgarten's reasons for disposing of the Cooper stock were two-fold. He informed defendants that he sought to: (1) reduce his federal income tax liability by the fullest extent allowable under the law; and (2) generate sufficient income to support him and his wife during their imminent retirement years. Defendants advised Mr. Lustgarten that these twin goals would be best implemented by structuring the proposed transaction as an installment sale under section 453 of the Internal Revenue Code of 1954. By reporting the gain from the Cooper sale on the installment basis, plaintiffs would substantially reduce their income tax liability for the year of sale. These considerable tax savings would, in turn, generate the desired retirement income. To assure additional retirement security, defendants also suggested that the shares of Cooper stock not be retained by the purchaser but instead be resold. The proceeds of this subsequent sale would then be reinvested in shares of a mutual fund. These shares would be held in escrow until the initial purchaser liquidated his indebtedness to Mr. Lustgarten. Plaintiffs would thereby receive additional retirement income in the form of mutual fund dividends distributed by the escrow agent. Finally, Mr. Lustgarten was advised that a valid installment sale could be structured whereby plaintiffs' son, Bruce Lustgarten, would become the initial purchaser. In this way, defendants opined, the transaction would have the added benefit of providing for the Lustgarten children.

In April, 1971, after giving the matter their joint consideration, defendants advised Mr. Lustgarten that they could structure the stock sale transaction as described. They assured him that the transaction would: (1) be exempt from the registration requirements of the Securities Act of 1933; (2) meet the requirements of section 453 of the Code; and (3) satisfy the Lustgartens' personal objectives. Relying upon defendants' advice, Mr. Lustgarten instructed defendants to prepare the documents necessary to execute the installment sale of Cooper stock to his son Bruce. The deal closed on November 15, 1971. The gain on the sale was reported in plaintiffs' 1971 federal income tax return on the installment-sale basis.

Problems developed at some time after April 15, 1974. Plaintiffs were informed that the Internal Revenue Service had audited their income tax returns for the years 1971 and 1972 and, on the basis of this audit, had decided to disallow the installment sale of Cooper stock under section 453. The Service informed the Lustgartens that the entire gain from the sale should have been reported in full in their 1971 return. Plaintiffs consequently received a notice of deficiency for tax year 1971 in the amount of $345,810. On October 10, 1975, a written protest was filed with the Commissioner of Internal Revenue contesting the assessed deficiency. The protest was denied and a statutory notice of deficiency, dated July 23, 1976, was issued against plaintiffs by the Miami Appellate Office of the Internal Revenue Service.

Plaintiffs next petitioned the United States Tax Court for a review of the Commissioner's determination. On November 30, 1978, the Tax Court ruled against petitioners. Lustgarten v. Commissioner, 71 T.C. 303 (1978). The court's decision rested, in part, on the grounds that: (1) the placement of the funds in the escrow account resulted in constructive receipt by Paul Lustgarten of the entire purchase price in the year of sale; and (2) the documents containing the terms of the sale placed too much control over the entire transaction in the hands of Mr. Lustgarten. As evidence of this control, the court took particular note of the fact that Bruce Lustgarten was required, within the terms of the sale, to purchase shares of the mutual fund as the sole security on the indebtedness owed to his father. On this basis, the court concluded that a true installment sale, within the meaning of section 453, could not occur. Plaintiffs allege that the defendants were, at all times, aware of these specific factors, yet continually assured the Lustgartens that the transaction would qualify as a valid installment sale under section 453.

The Lustgartens filed their complaint in this court on September 25, 1979, alleging, on the basis of the foregoing recital, that defendants are liable to them for their negligent failure accurately to advise plaintiffs of the tax consequences of the stock sale. In a separate count, plaintiffs also allege that defendants are liable under a contractual theory for their breach of implied promises to render accurate tax advice and properly to structure a valid installment sale transaction.¹

Defendants contend that plaintiffs' claim is time-barred under what they deem to be the applicable statute of limitations and must therefore be dismissed. Because each of the various defendants advances similar arguments, their submissions will be considered as comprising a single motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

II.

The central issue presented in this motion is whether the applicable statute of limitations is Florida's or Pennsylvania's.

The parties agree that plaintiffs' claim accrued no later than July 23, 1976, the date when the statutory notice of deficiency was issued against plaintiffs by the Miami Appellate Office. Defendants claim that the applicable statute of limitations is the Florida statute barring professional malpractice claims filed more than two years after they accrue.² Plaintiffs contend that the applicable period of limitation is either Pennsylvania's four-year limitation on contract actions or Pennsylvania's six-year catch-all limitation covering causes of action not otherwise specifically provided for.³ The parties' divergent views derive from their disagreement over the appropriate choice-of-law principles to be applied in this case.

In cases where federal court jurisdiction is predicated on the diversity of the citizenship of the parties, federal courts sitting in Pennsylvania are required to apply the same period of limitation as would a Pennsylvania state court. Guaranty Trust Co. v. York, 326 U.S. 99, 65 S.Ct. 1464, 89 L.Ed. 2079 (1945). For federal courts in Pennsylvania choosing between conflicting state statutes of limitation, the rule in Guaranty Trust necessarily implies application of the Pennsylvania choice-of-law principle which governs in the limitations context. See Mack Trucks, Inc. v. Bendix-Westinghouse Automotive Air Brake Co., 372 F.2d 18, 20 (3d Cir. 1966), cert. denied, 387 U.S. 930, 87 S.Ct. 2053, 18 L.Ed.2d 992 (1967); Jones & Laughlin Steel v. Johns-Manville Sales, 453 F.Supp. 527, 531 (W.D.Pa.1978); Gross v. McDonald, 354 F.Supp. 378, 382 (E.D.Pa. 1973). Cf. Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941).

That choice-of-law principle is a familiar one — namely, application of the appropriate Pennsylvania limitation period because Pennsylvania is the forum, Freeman v. Lawton, 353 Pa. 613, 617, 46 A.2d 205 (1946), subject, however, to the caveat that, when the cause of action accrues in a jurisdiction other than Pennsylvania, the limitation period to be applied is the appropriate limitation period of that other jurisdiction if it is shorter than Pennsylvania's. 42 Pa. Cons.Stat.Ann. § 5521(b) (Purdon's 1981 Pamphlet). Mack Trucks, supra, 373 F.2d at 20.⁴

In this case, the action is barred if Florida's two-year limitation period applies, but survives under either of the arguably appropriate Pennsylvania limitation periods (four and six years respectively). Accordingly, the dispositive question is whether plaintiffs' cause of action arose in Florida or Pennsylvania.

Defendants contend that Florida is the place where the cause of action arose, since — as all parties agree — it was the receipt there of the statutory notice of tax deficiency which spelled accrual of the cause of action. Plaintiffs argue for Pennsylvania on the ground that...