CHARLESTON – The West Virginia Supreme Court of Appeals has issued an opinion in an appeal regarding double taxation of shareholders during the sale of a company that occurred 17 years ago.

Former shareholders for Kay Company and Kay Co. LLC appealed to the West Virginia Supreme Court of Appeals from two orders entered by Kanawha Circuit Court through which summary judgment was granted to McGuireWoods in connection with claims that the shareholders filed against MW, their former legal counsel.

As grounds for their appeal, the petitioners argue that the circuit court erred in ruling that a settlement reached by all but one of the petitioners with the Internal Revenue Service prevents them from establishing causation and damages on any of their claims, according to the Nov. 9 opinion.

Chief Justice Allen Loughry II authored the majority opinion.

The shareholders also challenged the circuit court’s finding that there are no factual issues in need of resolution and its ruling regarding one of the shareholder’s, Jennie Graham, status as a non-settler with the IRS prevents her from asserting claims against MW.

“As part of this appeal, McGuireWoods alleges that the petitioners’ claims are barred by the five-year statute of limitations which governs Virginia contract claims,” Loughry wrote. “Upon our careful review of this matter, we conclude that the circuit court erred in reasoning that the settlement with the IRS prohibits the petitioners from going forward on all of their claims.”

The court also affirmed the lower court’s ruling with regard to detrimental reliance and joint venture.

“With regard to the cross-appeal raised by McGuireWoods, we find no merit to the claim and, accordingly, it is denied.”

At the center of the case is the sale of Kay Co., in which the shareholders hired MW to represent their interests. The petitioners conferred to MW to obtain tax advise with regard to the sale of the company’s stock.

“One of the specific issues addressed was a concern that gains from the sale and distribution of the Kay Co. stock would be taxed twice — once to the corporation and then again to the individual stockholders,” the opinion states. “Due to the low basis of such stock, a huge tax consequence was anticipated as a result of the sale.”

When Skip Roberts conferred with MW on an unrelated matter, he mentioned the double taxation issue and was referred to a specific attorney at MW who had successfully avoided the double taxation in a similar transaction. The firm advised Roberts that it could arrange the sale of Kay Co. with favorable tax consequences for a contingent fee of $125,000.

The attorney later contacted Roberts to disclose a buyer with sufficient capital losses to offset gains from the sale of Kay Co.’s portfolio. As a result of the transaction, the MW attorney advised Kay Co. shareholders that they would be taxes only once on the capital gains from the sale.

The sale of Kay Co. occurred on Oct. 26, 2000. On Aug. 3, 2007, the IRS assessed 12 former shareholders of Kay Co. $2.7 million in taxes and $556,000 9in penalties. In 2009, all but one of the 12 assessed shareholders elected to execute closing agreements and settle the tax dispute with the IRS.

“Collectively…shareholders paid almost $1.8 million,” Loughry wrote. “Mrs. Graham successfully obtained a tax court decision that her husband’s estate had no liability as a transferee of the assets…for the tax year ending October 26, 2000.”

When the IRS later sought to collect the federal tax deficiency from Kay LLC, the claim was settled for $5,000.

On April 14, 2011, the shareholders filed the action against MW in Kanawha Circuit Court. The circuit court later granted a motion for summary judgment in favor of MW. The shareholders then appealed.

“At the center of the challenged rulings is the postulate that the absence of a tax court ruling validating the IRS assessment automatically precludes any claim by the petitioners against McGuireWoods arising from its legal advice,” the opinion states. “Because the shareholders elected to settle after incurring substantial legal fees in challenging the tax assessments, the circuit court ruled that certain issues bearing on the petitioners’ claims against MW can never be adjudicated. While both the circuit court and MW view this Court’s decision in Calvert [v. Scharf] as compelling this conclusion, a judicious reading of that opinion demonstrates otherwise.”

Loughry wrote that by insisting that the IRS settlement precludes any subsequent determination of negligence on its part, MW demonstrates a flawed understanding of Calvert.

“Moreover, MW goes further astray in claiming that the petitioners’ proof of damages is dependent on a judicial upholding of the IRS tax assessment,” he wrote. “Critically, the petitioners have not limited the recovery they seek from MW to the amounts they paid to settle the IRS tax assessment. The nature of their malpractice-based claims is decidedly broader than that.”

Loughry wrote that in ruling that there were no genuine issues of fact to be resolved with regard to the shareholders’ claims of legal malpractice, negligent misrepresentation and fraud, the circuit court committed error.

“However, we find no error in the trial court’s rulings with regard to detrimental reliance and joint venture, and accordingly affirm judgment for MW on those claims,” Loughry wrote. “Given the clear formation of the contract of legal representation in this state, we find no merit to the cross-assignment through which MW seeks to apply Virginia’s five-year statute of limitation for contract claims.”

The summary judgment ruling entered by Kanawha Circuit Court May 27, 2015, is reversed; with regard to the clarifying rulings issued on Dec. 5, 2016, the Supreme Court affirmed the finding that the detrimental reliance claim is part of the petitioners’ fraud claim and affirmed the finding that the petitioners have failed to prove the existence of a joint venture; it reversed the findings that the petitioners’ claims of legal malpractice, negligent misrepresentation and fraud fail as a matter of law due to their settlement with the IRS; and remanded the case to the circuit court to permit the petitioners to proceed on their claims of legal malpractice, negligent misrepresentation and fraud.

W.Va. Supreme Court of Appeals case number: 15-0606

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