Zola v. Gordon

• Citation: 685 F. Supp. 354
• Decision Date: 04 May 1988
• Docket Number: No. 86 Civ. 4790 (KC).,86 Civ. 4790 (KC).
• Parties: Ralph J. ZOLA, Paul A. Zola, and Irving Zola d/b/a Biscayne Associates, Plaintiffs, v. Larry GORDON and Edward Wagner, Defendants.
• Court: U.S. District Court — Southern District of New York

685 F. Supp. 354

Ralph J. ZOLA, Paul A. Zola, and Irving Zola d/b/a Biscayne Associates, Plaintiffs, v. Larry GORDON and Edward Wagner, Defendants.

No. 86 Civ. 4790 (KC).

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

April 25, 1988.

Supplemental Opinion and Order May 4, 1988.

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Lawrence A. Procari, Jr., Ralph Zola, Zola and Zola, New York City, for plaintiffs.

Neal Schwarzfeld, Schwarzfeld, Ganfer and Shore, New York City, for Larry Gordon.

Robert Frey, Deutsch and Frey, New York City, for Edward Wagner.

OPINION AND ORDER

CONBOY, District Judge:

This case arises out of a failed tax shelter. In substance, plaintiffs claim, inter alia, that a movie in which they invested, given an assessed valuation by the IRS of $60,000.00, had been represented by the defendants as being worth $3.15 million. Plaintiffs seek to recover damages for violations of the federal securities laws, civil RICO, and state common law. Defendants, already convicted of criminal wrongdoing in connection with the marketing of movie tax shelter investments, including the limited partnership plaintiffs invested in, assert, inter alia, that the statutes of limitations have lapsed on various claims, and that liability under RICO has not been pleaded properly. Accordingly, interesting time bar, equitable estoppel, choice of law, and pleading questions are presented for resolution.

At an undetermined time prior to August, 1975, plaintiffs formed a partnership called Biscayne Associates ("Biscayne") to make investments. In September, 1975, the partnership paid $180,000 to acquire an interest of approximately twenty percent in Arlington Properties ("Arlington"), a limited partnership formed to invest in a movie entitled "The Romantic Englishwoman." It is undisputed that one of the main reasons Biscayne made its investment was the possibility of obtaining large tax write-offs. The limited partners believed they would receive tax losses over the amount invested. From 1975 to 1979, the plaintiffs took federal income tax deductions for their shares of Biscayne's partnership losses on the Arlington investment.

In 1979 the IRS began to audit the individual plaintiffs' tax returns. Plaintiff Ralph Zola knew, by 1980 at the latest, that the IRS was investigating Arlington, and challenging the partnership's cost evaluation of the movie of $3,150,000.00. In 1983, the IRS decided that the actual value of the movie was $60,000.00. The depreciation expense (or investment tax credit deductions) taken by Arlington and passed on to the limited partners, was disallowed.¹

Plaintiffs first received notice of the position of the IRS with respect to the actual value of the movie in June 1984. At that time, Myron Weinberg, an attorney whose firm then was providing tax representation to defendant Gordon and Arlington, mailed to Ralph Zola a copy of a report prepared by an IRS agent for Arlington's partnership years 1975-79. See Affidavit of Myron Weinberg, executed April 24, 1987, at paras. 2-3 & Exhibit A. The report states that the movie had been screened and valued by three independent outside experts, and that the average value assigned was $60,000.00. The report concludes that the partnership's assigned value of $3,154,000.00² "is highly inflated," and that all tax losses claimed by the partnership "are ... disallowed." See Weinberg Aff. Exhibit A.

Plaintiffs filed this action in June, 1986. The amended complaint alleges that Gordon made misrepresentations concerning the cost of the movie, and converted assets owned by Arlington to his own personal use and benefit. The amended complaint also alleges that Gordon violated his fiduciary duty to the plaintiffs by producing false and fraudulent partnership documents and income tax return forms, violated the federal securities laws, and violated the provisions of civil RICO. Jurisdiction is predicated on the existence of a federal question, 28 U.S.C. § 1331 (1982), and on the doctrine of pendent jurisdiction.

The action is before the court on various motions made by the two defendants. First, Gordon moves to dismiss the amended complaint under Fed.R.Civ.P. 9(b) and 12(b)(6), or in the alternative for summary judgment under Fed.R.Civ.P. 56(b). Second, Gordon seeks a protective order, pursuant to Fed.R.Civ.P. 26(c), precluding the discovery of certain personal financial records. Third, Gordon moves, pursuant to 28 U.S.C. § 636(b)(1)(A), for review of an order issued by Magistrate Nina Gershon granting plaintiffs' motion to compel discovery from Wendy Camarda, Gordon's daughter. Wagner moves for dismissal of the amended complaint on two grounds. First, Wagner objects that he was not served with the complaint within one hundred twenty days after its filing, as required by Fed.R.Civ.P. 4(j). Second, he moves to dismiss the complaint pursuant to Rule 12(b)(6) for failure to state a claim for relief. Wagner also seeks the imposition of sanctions against the plaintiffs pursuant to Rule 11.

LEGAL ANALYSIS

A. Gordon's motion to dismiss or for summary judgment

1. Plaintiffs' claims under the federal securities laws

The plaintiffs allege in count five of the amended complaint that the defendants are liable for violations of various sections of the federal securities laws.³ Gordon does not raise the issue whether the limited partnership interests sold in Arlington are securities within the meaning of the Securities Act of 1933 ("the '33 Act") or the Securities Exchange Act of 1934 ("the '34 Act"). Instead, Gordon argues that the statutes of limitations governing these claims have lapsed.

Sections 11 and 12⁴

Section 11 subjects the issuer of registered⁵ securities, and others, to liability for damages when the registration statement is materially false or misleading. Section 12(1) creates liability for the offering or sale of a security in violation of the registration or prospectus provisions of section 5. Section 12(2) creates liability for the offering or sale of a security, whether registered, not registered, or exempt from registration, by means of false or misleading statements made orally or contained in a prospectus. See L. Loss, Fundamentals of Securities Regulation 1016 (1983). Both sections are subject to a statutory time bar, contained in section 13 of the '33 Act, 15 U.S.C. § 77m (1982).

The court has a basis in law to dismiss plaintiffs' claims under these sections of the '33 Act, because plaintiffs have failed affirmatively to plead compliance with the statute of limitations contained in section 13, as they are required to do. See Beres v. Thomson McKinnon Sec., Inc., 1987 Transfer Binder Fed.Sec.L.Rep. (CCH) para. 93,395 at 97,069 (S.D.N.Y.1987) available on WESTLAW, 1987 WL 16977 (there "is a general congruence of opinion" that in circumstances such as these the plaintiffs have the burden of pleading facts showing they come within the statute of limitations); Jacobson v. Peat, Marwick, Mitchell & Co., 445 F.Supp. 518, 525 (S.D. N.Y.1977) ("When Congress creates a new right of action by statute and in that same statute expressly limits the time in which a suit to enforce it may be brought, compliance with the period of limitations must be affirmatively pleaded before a suit to recover on the right of action may be instituted."); Brick v. Dominion Mortgage & Realty Trust, 442 F.Supp. 283, 291-92 (W.D. N.Y.1977) (compliance with section 13 "is an essential substantive ingredient of a private cause of action" based on the sections it relates to); accord Adair v. Hunt Int'l Resources Corp., 526 F.Supp. 736, 748-49 (N.D.Ill.1981). This notwithstanding, the court elects to proceed to consider whether summary judgment is appropriate as to these claims.

Section 13 provides that ordinarily an action under section 11 or section 12(2) must be brought within one year after the actual or constructive discovery of the false or misleading statement. See 15 U.S.C. § 77m (1982). An action under section 12(1) normally must be brought within one year after the violation on which it is based occurs. Id. The section further provides that "in no event shall any ... action be brought to enforce a liability created under section 77k section 11 or 771(1) section 12(1) of this title more than three years after the security was bona fide offered to the public." Id. The majority of courts have held "that the three-year period begins to run from the date the security is first offered to the public." Waterman v. Alta Verde Indus., 643 F.Supp. 797, 808 (E.D.N.C.1986) (emphasis in original); accord Fischer v. International Tel. & Tel. Corp., 391 F.Supp. 744, 747 (E.D.N.Y.1975). This period is an absolute outer limitation. Bresson v. Thomson McKinnon Sec., Inc., 641 F.Supp. 338, 343 (S.D.N.Y.1986) (section 11); Clute v. Davenport Co., 584 F.Supp. 1562, 1576-77 (D.Conn.1984) (section 12(1)); accord Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301, 1308 (9th Cir.1982) (section 11); Summer v. Land & Leisure, Inc., 664 F.2d 965, 968 (5th Cir. Unit B Dec. 1981) (section 11), cert. denied, 458 U.S. 1106, 102 S.Ct. 3484, 73 L.Ed.2d 1367 (1982). Construing the complaint liberally in plaintiffs' favor, it would appear the latest date shares in Arlington first could have been offered to the public is August, 1975. Thus, the statute of limitations on these claims lapsed at the latest in August, 1978. As this action was not filed until 1986, the claims under sections 11 and 12(1) of the '33 Act appear to be time-barred.

Section 13 states that, for actions based on section 12(2), "in no event shall any ... action be brought to enforce a liability created ... under section 771(2) section 12(2) of this title more than three years after the sale." 15 U.S.C. § 77m (1982). Again, this bar is absolute. Bresson, 641 F.Supp. at 343; Brick, 442 F.Supp. at 291. Plaintiffs admit that they purchased their share in Arlington in September, 1975. Thus, the allowable period for...