Merchant v. Kelly, Haglund, Garnsey & Kahn

• Court: U.S. District Court — District of Colorado
• Writing for the Court: Michael T. McConnell, Long & Jaudon, P.C., Denver, CO, for defendant
• Citation: Merchant v. Kelly, Haglund, Garnsey & Kahn, 874 F. Supp. 300 (D. Colo. 1995)
• Decision Date: 20 January 1995
• Docket Number: Civ. A. No. 92-B-2568.
• Parties: John MERCHANT, a Washington resident, Plaintiff, v. KELLY, HAGLUND, GARNSEY & KAHN, a general partnership, Defendant.

874 F. Supp. 300

John MERCHANT, a Washington resident, Plaintiff, v. KELLY, HAGLUND, GARNSEY & KAHN, a general partnership, Defendant.

Civ. A. No. 92-B-2568.

United States District Court, D. Colorado.

January 20, 1995.

Lance M. Sears, Sears, Anderson & Swanson, P.C., Colorado Springs, CO, for plaintiff.

Michael T. McConnell, Long & Jaudon, P.C., Denver, CO, for defendant.

MEMORANDUM OPINION AND ORDER

BABCOCK, District Judge.

In this legal malpractice action seeking damages caused by the alleged negligence and breach of contract by defendant, Kelly, Haglund, Garnsey & Kahn (the firm), plaintiff John Merchant claims the firm breached a national standard of care involving federal income tax law by dividing assets in a pension and profit sharing plan through a postnuptial marital agreement without the benefit of a Qualified Domestic Relations Order (QDRO). Although the firm has counterclaimed for a declaratory judgment that the marital agreement does not violate § 401(a)(13) of the Internal Revenue Code (IRC), this claim is considered the basis for the firm's argument that because there was no harm there was no foul and, thus, it is entitled to judgment as a matter of law.

The firm moves to dismiss this action. Both parties have submitted matters beyond the pleadings. Therefore, pursuant to Fed. R.Civ.P. 12(b), I treat the motion as one for summary judgment. The motions are fully briefed and orally argued. During argument counsel for Mr. Merchant conceded that his breach of contract claim is merged into his negligence claim. See F.D.I.C. v. Clark, 978 F.2d 1541, 1551 (10th Cir.1992). I conclude that the marital agreement constituted an alienation or assignment for purposes of 26 U.S.C. § 401(a)(13) and that genuine issues of material fact remain on Mr. Merchant's negligence claim. Consequently, I will deny the firm's motion.

I.

No genuine dispute exists as to the following facts. Mr. Merchant retained the firm in 1988 to represent him in a dissolution of marriage action against his wife Linda Merchant. After filing the action in Colorado state court, Merchant and his wife reconciled. As part of the reconciliation, on November 15, 1988 the parties entered into a post-nuptial marital agreement dividing the marital property (the agreement).

The marital property included pension and profit sharing plans of the Merchant Company (the plan) which contained non-alienation provisions under the Employee Retirement Security Program (ERISA), 29 U.S.C. § 1001 et seq. (Def.Exh. T & U). The firm took no part in the drafting or implementation of the plan. Mr. Merchant was the sole shareholder in the company and the sole plan participant. When the agreement was executed the plan was worth approximately $95,000. Paragraph 1(A)(2)(c) of the agreement provided:

Linda shall receive as her separate property an interest in the Merchant Company pension and profit sharing plan as follows: Within 60 days of this Agreement, John shall cause the segregation of a subaccount with a beginning value of no less than $42,750 in the Merchant Company pension or profit sharing plan, none of which shall include either note from John. This segregated account will be managed as required under the plan. On a continuing basis, John shall cause one-half of all Merchant Company pension and profit sharing contributions made in John's name, to be deposited into this segregated account for Linda, up to a maximum of $5,000 per year. To the extent permissible by law, the investment vehicle chosen for the segregated account shall be as selected by Linda, with John's assistance and/or with the assistance of third parties as she elects. Linda shall receive financial reports regarding this segregated account on a regular basis. John shall not borrow from this segregated account. (Dft.Exh.A).

In 1989 the Merchants moved from Denver to Seattle. Mr. Merchant then retained the Seattle law firm of Bogle & Gates (B & G) to terminate the plan because it was "too costly to maintain." (Dft.Exh.F, p. 2). As part of the termination process, Mr. Merchant submitted an application for determination upon termination, form 5310, to the Internal Revenue Service (IRS) to determine whether the plan was "qualified" for tax exemption under the IRC. The provisions of the agreement were not disclosed in the application. (Dft.Exh.F). In February 1991, Mr. Merchant received a "favorable determination letter" stating the plan was qualified for tax exempt status. (Dft.Exh.G). Based on this determination, B & G advised Mr. Merchant that he could roll the funds over from the plan into a simplified employee pension plan (SEP) and an individual retirement account (IRA) without triggering federal income tax. (Dft.Exh.H).

However, in April of 1991, B & G advised Mr. Merchant that the agreement was "inconsistent with federal law insofar as it purports to assign benefits under these plans." (Dft.Exh.K). B & G recommended that Mr. Merchant obtain a QDRO. A QDRO is a domestic relations order issued pursuant to a state domestic relations statute which provides an exception to the non-alienation provision of 26 U.S.C. § 401(a)(13). (Dft.Exhibits K & L). If issued, the QDRO would have maintained the division of the proceeds from the plan as contemplated in the agreement. Mr. Merchant declined to follow this course of action.

For Mr. Merchant to receive a distribution of funds under the terminated plan, Mrs. Merchant had to sign a waiver of joint and survivor annuity benefits. (Dft.Exh.H). An amendment to the agreement was executed by the Merchants in March 1992 (amended agreement). (Dft.Exh.N). The amended agreement provided:

John and Linda agree that John's entire interest in the Merchant Company Pension and Profit Sharing Plan ("the Plan") is his separate property; provided, however, John shall immediately cause the Plan to terminate and he shall thereafter rollover his entire interest in the Plan to an individual retirement account held in his name ("IRA Rollover"). In connection with such termination, Linda shall agree to waive her rights to Plan assets (including her right to an annuity if she survives John) and to take any and all action necessary to permit a lump sum distribution to John. The IRA rollover shall thereafter be marital property. (Dft.Exh.N, P. 2).

The distribution of the plan funds as originally contemplated by the agreement was, by this amendment, negated.

Mrs. Merchant filed for divorce in Washington state court in July 1992. A divorce decree was entered in July 1993. The amended agreement served as a blueprint for the division of the marital property in the divorce proceeding, (L. Merchant Depo., Dft. Exh.P, p. 8), and Mr. Merchant claims he received substantially less from the proceeds of the plan than he would have received under the original agreement. (Evans Depo., Dft.Exh.Q, pp. 32-33). Ultimately, in June of 1994, Mr. Merchant entered into a "Closing Agreement" with the IRS by which the tax issues surrounding the plan were settled for $500. (Pl.Exh. 12).

Mr. Merchant filed this lawsuit claiming that the firm committed malpractice for failure to consider, research, and advise him of the potential federal tax implications of the agreement.

II.

Summary judgment shall enter where there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). If a movant establishes entitlement to judgment as a matter of law given uncontroverted, operative facts contained in the documentary evidence, summary judgment will lie. Mares v. ConAgra Poultry Co., Inc., 971 F.2d 492, 494 (10th Cir.1992). The operative inquiry is whether, based on all the documents submitted, a reasonable trier of fact could find by a preponderance of evidence that the plaintiff is entitled to a verdict. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986); Mares, 971 F.2d at 494. Summary judgment should not enter if, viewing the evidence in a light most favorable to the nonmoving party and drawing all reasonable inferences in that party's favor, a reasonable jury could return a verdict for that party. Anderson, 477 U.S. at 252, 106 S.Ct. at 2512; Mares, 971 F.2d at 494.

III.

The first issue, one of law, is whether the agreement created an alienation or assignment under 26 U.S.C. § 401(a)(13). If it did, the plan funds lose their tax deferred status. I conclude that the agreement created an assignment or alienation of an interest in the plan in violation of § 401(a)(13).

Section 401(a)(13)(A) provides: "A trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that benefits provided under the plan may not be assigned or alienated." Assignment or alienation includes "any direct or indirect arrangement (whether revocable or irrevocable) whereby a party acquires from a participant or beneficiary a right or interest enforceable against the plan in, or to, all or any part of a plan benefit payment which is, or may become, payable to the participant or beneficiary." 26 C.F.R. § 1.401(a)-13 (emphasis added).

The firm contends the plan complies facially with § 401(a)(13) because the trusts provide that plan benefits may not be assigned or alienated. Thus, the firm argues that the provision of the Merchant's marital agreement in question here is unenforceable against the plan. Consequently, no violation of § 401(a)(13) occurred. Mr. Merchant responds that not only must the trust contain appropriate non-alienation language but that language must be followed in its operation. Here he asserts the agreement violated the prohibition against assignment or alienation by granting Mrs. Merchant, a non-participant in the plan, rights and interests in its assets. I agree with Mr. Merchant. The agreement was not a mere "bookkeeping" measure but was a voluntary partition of plan assets without the benefit of a QDRO.

None of the specific...