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Shahid R. Khan; Ann C. Khan; Uviado LLC; Jonction, LLC; and Leman, LLC v. Bdo Seidman

October 17, 2012

SHAHID R. KHAN; ANN C. KHAN; UVIADO LLC; JONCTION, LLC; AND LEMAN, LLC,
PLAINTIFFS-APPELLANTS,
v.
BDO SEIDMAN, LLP; AND MICHAEL COLLINS, DEFENDANTS-APPELLEES,
AND
(NO. 4-12-0359) GRAMERCY ADVISORS, LLC; GRAMERCY ASSET MANAGEMENT, LLC; GRAMERCY FINANCIAL SERVICES, LLC; TALL SHIPS CAPITAL MANAGEMENT, LLC; JAY A. JOHNSTON; MARC HELIE; DECASTRO, WEST, CHODOROW, GLICKFIELD & NASS, INC.; FINANCIAL STRATEGY GROUP, PLC; AND PAUL SHANBROM, DEFENDANTS. SHAHID R. KHAN; ANN C. KHAN; SRK WILSHIRE INVESTMENTS, LLC; SRK WILSHIRE PARTNERS; SRK WILSHIRE INVESTORS, INC.; THERMOSPHERE FX PARTNERS, LLC; AND KPASA, LLC, PLAINTIFFS-APPELLANTS,
v.
(NO. 4-12-0360) BDO SEIDMAN, LLP; AND MICHAEL COLLINS, DEFENDANTS-APPELLEES, AND DEUTSCHE BANK AG; DEUTSCHE BANK SECURITIES, INC., D/B/A DEUTSCHE BANK; ALEX BROWN; DAVID PARSE; EQUILIBRIUM CURRENCY TRADING, LLC; SAMYAK VEERA; GRANT THORNTON, LLP; GRAMERCY ADVISORS, LLC; JAY A. JOHNSTON; MARC HELIE; AND PAUL SHANBROM,
DEFENDANTS.



Appeal from Circuit Court of Champaign County No. 09L139 No. 09L140 Honorable Jeffrey B. Ford, Judge Presiding.

The opinion of the court was delivered by: Justice Appleton

JUSTICE APPLETON delivered the judgment of the court, with opinion. Justices Pope and McCullough concurred in the judgment and opinion.

OPINION

¶ 1 The plaintiffs in these two consolidated appeals are Shahid R. Khan and his spouse, Ann C. Kahn, along with various partnerships and limited-liability companies that Shahid R. Khan formed, allegedly on the advice of BDO Seidman, LLC (BDO), for the purpose of creating tax shelters. Thermosphere FX Partners, LLC (Thermosphere), is one of the partnerships. (Whenever we refer to "Khan" in the singular, we will mean Shahid R. Khan, because, according to the complaint, he was the one who transacted all the business with BDO and the other defendants.) The only defendants who are parties to these two appeals, the only appellees, are BDO and one of its employees, Michael Collins. (When referring collectively to BDO and its employees named in these actions, we will call them the "BDO defendants.") Plaintiffs have sued BDO, Collins, and other persons and business entities for leading plaintiffs into some flawed "tax-advantaged investment strategies."

¶ 2 Plaintiffs have been before us twice before in this litigation. Khan v. BDO Seidman, LLP, 404 Ill. App. 3d 892 (2010) (Khan I); Khan v. BDO Seidman, LLP, 408 Ill. App. 3d 564 (2011) (Khan II). In Khan I, we decided which of plaintiffs' claims against the BDO defendants had to be arbitrated pursuant to plaintiffs' written "consulting agreement" with BDO. We held that only the claims for breach of contract came within the scope of the arbitration clause. Khan I, 404 Ill. App. 3d at 895. The Supreme Court of Illinois has denied BDO's petition for leave to appeal from our judgment in Khan I (Khan v. BDO Seidman, LLP, 239 Ill. 2d 555 (2011) (table)), and the Supreme Court of the United States has denied BDO's petition for a writ of certiorari (BDO Seidman, LLP v. Khan, ____ U.S. ____, 132 S. Ct. 96 (2011)). Thus, Khan I has reached finality in the appellate process.

¶ 3 The appellate process is not yet exhausted in Khan II-but first let us recount what Khan II is all about. In Khan II, we rejected the contention that plaintiffs' claims against Deutsche Bank AG; Deutsche Bank Securities, Inc.; and an accounting firm, Grant Thornton LLP, were barred by statutes of limitations and a statute of repose. Khan II, 408 Ill. App. 3d at 566. (We will refer to Deutsche Bank, Deutsche Securities, and their employees as the "Deutsche Bank defendants.") Those three defendants in Khan II petitioned the supreme court for leave to appeal. The supreme court granted their petitions and consolidated their appeals. Khan v. BDO Seidman, LLP (Nos. 112219 & 112221, cons.) (Sept. 28, 2011). On March 20, 2012, the supreme court heard oral arguments in the consolidated appeals, and its decision is pending.

¶ 4 On March 14, 2012, on remand from our decisions in Khan I and Khan II, the trial court granted motions by BDO and Collins to stay the trial court proceedings until (1) the supreme court issued its decision in Grant Thornton's appeal and (2) plaintiffs' claims of breach of contract were arbitrated. Plaintiffs disagree with this stay. They appeal pursuant to Illinois Supreme Court Rule 307(a)(1) (eff. Feb. 26, 2010).

¶ 5 We find no abuse of discretion in staying the trial court proceedings until the supreme court issues its opinion in Grant Thornton's appeal. We find an abuse of discretion, however, in staying the proceedings until the claims of breach of contract are arbitrated, considering that after our analysis in Khan I, little or nothing of the breach-of-contract claims is left. Therefore, we modify the stay so as to make it last only for the duration of Grant Thornton's appeal to the supreme court. We affirm the trial court's judgment as modified and remand this case for further proceedings subject to the stay-which the trial court, in its discretion, may eventually lift if it finds that Grant Thornton's appeal is not proceeding with sufficient dispatch.

¶ 6 I. BACKGROUND

¶ 7 In Champaign County case Nos. 09-L-139 and 09-L-140, plaintiffs brought actions against the BDO defendants; the Deutsche Bank defendants; Grant Thornton, LLP; and other persons and business entities for duping plaintiffs into setting up tax shelters that the Internal Revenue Service (IRS) regarded as abusive and illegal. According to the complaints in the two cases, these tax shelters were designed to follow, at least ostensibly, a two-pronged strategy-"Plan A" and "Plan B," so to speak. First, in Plan A, Khan was to make an "investment," by which, the BDO defendants told him, he stood a good chance of making a profit. It is unclear how much Khan understood about this "investment," but it was a bet with Deutsche Bank on what a certain foreign currency would be worth on a certain date. If Khan lost money in this "investment," he was not to worry, because Plan B would kick in and that very loss would be put to lucrative use. Through some transfers between partnerships and limited-liability companies specially created for this purpose, Khan would be able to use the "investment" loss as a tax loss, to reduce his federal income tax. Not just one but a series of these tax shelters was created.

¶ 8 Both prongs of this "tax-advantaged investment strategy" were a falsehood, plaintiffs allege. For one thing, the "investments" were designed to ensure that Khan would lose money (and that the broker, Deutsche Bank, would make money), and further, plaintiffs allege, it should have been apparent to anyone with a reasonable degree of competence in tax law that the IRS would disallow the claimed tax losses as a sham-and then impose large penalties for the overdue income tax. The strategies appear to be variations on the "Son of BOSS" plan, which, reduced to its essence, works this way. X pays Y, say, a million dollars. Y pays X a million dollars. X counts the million dollars he paid Y as a tax loss without offsetting it by the million dollars Y paid him. See 106 Ltd. v. Commissioner of Internal Revenue Service, 684 F.3d 84, 86 (D.C. Cir. 2012). In their complaints in the two cases, plaintiffs raised a variety of legal theories, e.g., fraud, negligent misrepresentation, fraudulent concealment of a cause of action, rescission, an illusory contract, and (as an alternative to the theories of rescission and an illusory contract) breach of contract.

¶ 9 Some of the defendants raised affirmative defenses. The BDO defendants invoked an arbitration agreement between BDO and Khan. Khan I, 404 Ill. App. 3d at 894. The Deutsche Bank defendants invoked the statute of limitations in section 13-205 of the Code of Civil Procedure (735 ILCS 5/13-205 (West 2008)). Khan II, 408 Ill. App. 3d at 566. Grant Thornton invoked the statute of limitations in section 13-214.2(a) (735 ILCS 5/13-214.2(a) (West 2008)), as well as the statute of repose in section 13-214.2(b) (735 ILCS 5/13-214.2(b) (West 2008)). Khan II, 408 Ill. App. 3d at 566.

¶ 10 In Khan I, we considered the BDO defendants' affirmative defense that all of plaintiffs' claims against them had to be arbitrated.

¶ 11 In Khan II, we considered, inter alia, the affirmative defenses of the Deutsche Bank defendants and Grant Thornton that plaintiffs' claims against them were time-barred.

¶ 12 A. The Scope of the Arbitration Clause (Khan I)

¶ 13 In preparation for each of the "investments," which were supposed to yield a profit for Khan or, alternatively, a loss that, after being passed through partnerships, would reduce his federal income-tax liability, BDO required Khan's signature on "consulting agreements," each of which contained an identically worded arbitration clause. Khan I, 404 Ill. App. 3d at 893, 910. The trial court held that all of plaintiffs' claims against the BDO defendants came within the scope of this arbitration clause. Id. at 894.

¶ 14 Plaintiffs appealed, and in Khan I we affirmed the trial court's judgment in part and reversed it in part, concluding that, by its terms, the arbitration clause covered only plaintiffs' alternative claims against the BDO defendants for breach of contract. Id. at 895. (Justice Turner dissented in part: he was of the opinion that the arbitration clause covered not just the claims of breach of contract but all the claims against the BDO defendants: tort claims and contract claims alike. Id. at 920 (Turner, J., specially concurring in part and dissenting in part).)

¶ 15 In our analysis in Khan I, two features of the consulting agreement led us to the conclusion that the arbitration clause covered only the claims for breach of contract. (We will refer to "the consulting agreement" in the singular because the consulting agreements were "identical in their germane provisions." Id. at 894.) The first feature was the wording of the arbitration clause itself. The arbitration clause said: " 'If any dispute, controversy or claim arises in connection with the performance or breach of this agreement and cannot be resolved by facilitated negotiations (or the parties agree to waive that process) then such dispute, controversy or claim shall be settled by arbitration ***.' " (Emphasis added.) Id. at 911. We observed that, in its wording, this arbitration clause was "more narrow than the typical arbitration clause, such as the one in [Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 398 (1967)], which referred to ' "any controversy or claim arising out of or relating to this Agreement." ' " Id. at 913. The arbitration clause in the consulting agreement between BDO and Khan "contemplate[d] the arbitration of a narrower class of claims-those relating to the performance of the agreement-not claims relating to the agreement." Id. at 913-14 (citing Midwest Window Systems, Inc. v. Amcor Industries, Inc., 630 F.2d 535, 537 (7th Cir. 1980)).

¶ 16 The second significant feature of the consulting agreement was the language specifically excluding certain activities from BDO's promised performance. The consulting agreement said: " 'BDO is not in the business of providing investment advice or services, thus, none of the services to be rendered are to be considered as investment advice, and it is understood that the Client is not relying upon BDO for investment advice or services.' " (Emphasis omitted.) Khan I, 404 Ill. App. 3d at 914. Also, the consulting agreement said: " 'BDO's Services hereunder do not include, and BDO assumes no responsibility whatsoever for, any legal and/or tax opinions regarding any strategies that may be implemented, and has advised the Client to retain a law firm for legal and/or tax opinions on any strategies or transactions they [sic] enter into.' " Id. at 897.

¶ 17 Thus, the consulting agreement specifically excluded investment advice and tax advice from BDO's promised performance. Those exclusions were significant for purposes of arbitrability, because, according to the various counts in plaintiffs' complaints, BDO's bad investment advice and bad tax advice (or the bad tax advice of law firms with which BDO was in cahoots) were the proximate causes of plaintiffs' damages. BDO advised Khan that he could make money in the "investments" (id. at 895), whereas, in reality, the "investments" were structured so as to ensure that he would lose money (id. at 898-99). BDO assured him that if he lost money in the "investments," he could claim tax losses (id. at 895), and BDO sent him to supposedly independent but actually compromised law firms to obtain confirmation of this falsehood through " 'pre-wired' " legal opinions (id. at 900). Plaintiffs' allegations that BDO gave Khan this bad investment advice and bad tax advice (or that BDO deceptively referred him to coconspiring lawyers, by which BDO became liable for their bad tax advice) were outside the scope of the arbitration clause because (1) the consulting agreement specifically excluded those activities from BDO's contractual performance and

(2) the arbitration clause covered only claims " 'aris[ing] in connection with the performance or breach of this agreement' " (id. at 897). Id. at 916, 919. Of all the claims in plaintiffs' complaints, which consisted mostly of tort claims, the arbitration clause covered only those for breach of contract. Id. at 895. And bad investment advice and bad tax advice could not possibly be a breach of the contract between plaintiffs and BDO, given the disclaimers in the consulting agreement.

¶ 18 B. The Statutes of Limitations and Statutes of Repose (Khan II)

¶ 19 In the judgment that we reversed in Khan II, the trial court held that the statute of limitations in section 13-205 (735 ILCS 5/13-205 (West 2008)) barred the actions against the Deutsche Bank defendants and that the statute of limitations in section 13-214.2(a) (735 ILCS 5/13-214.2(a) (West 2008)) as well as the statute of repose in section 13-214.2(b) (735 5/13-214.2(b) (West 2008)) barred the actions against Grant Thornton.

¶ 20 We first will recount the trial court's analysis regarding the Deutsche Bank defendants, followed by the reasons we gave in Khan II for disagreeing with that analysis. Then we will recount the trial court's analysis regarding Grant Thornton, followed by our reasons for disagreement.

¶ 21 1. The Trial Court's Analysis Regarding the Deutsche Bank Defendants

¶ 22 Section 13-205 (735 ILCS 5/13-205 (West 2008)) is a five-year statute of limitations, which applies to actions for common-law fraud and other tortious misrepresentations. Chicago Park District v. Kenroy, Inc., 78 Ill. 2d 555, 560-61 (1980) (quoting then section 22 of the Limitations Act (Ill. Rev. Stat. 1975, ch. 83, ¶ 23)). The statute provides: "[A]ll civil actions not otherwise provided for[] shall be commenced within 5 years next after the cause of action accrued." (Emphasis added.) 735 ILCS 5/13-205 (West 2008).

¶ 23 Regardless, though, of when a cause of action accrues, the discovery rule postpones the running of the statute of limitations until the date when the plaintiff knows, or reasonably should know, that the injury has been wrongfully caused. Khan II, 408 Ill. App. 3d at 596. This is not to say that the statute of limitations waits until the plaintiff knows, or reasonably should know, the full extent of the wrongfully caused injury. Id. Rather, the statutory period begins running just as soon as the plaintiff becomes aware, or reasonably should become aware, of the existence of some wrongfully caused injury. Id.

¶ 24 According to the trial court, the earliest harm that the Deutsche Bank defendants wrongfully caused and of which the Khans reasonably should have been aware was the $1,275,000 they paid Deutsche Bank for " 'brokering ' " the foreign-currency transactions. Id. at 592, 596. Once the Khans became aware, or once they had notice, that the IRS would disallow the claimed losses, it should have been apparent to them that they had been misled into paying this $1,275,000. Id. at 596. The court found that when the Khans hired a tax attorney in May 2003 to represent them in an IRS audit, they should have discovered that their payment of the $1,275,000 to the Deutsche Bank defendants had been wrongfully caused, because their tax attorney, in the exercise of due diligence, should have discovered the IRS notices rejecting the type of tax-advantaged "investment strategies" that the coconspiring defendants had foisted on the Khans. Id. at 596. Because the Khans filed their complaint in July 2009, more than five years after May 2003, the court held that the five-year period of limitation in section 13-205 barred their claims against the Deutsche Bank defendants. Id. at 597. (For purposes of its analysis, the court used what appeared to be the longest applicable statute of limitations. The court ruled out the 10-year statute of limitations in section 13-206 (735 ILCS 5/13-206 (West 2008)) because the court regarded plaintiffs' contract claims as disguised tort claims and, according to case law, one could not lengthen the time for filing suit by dressing up a tort claim as a contract claim. Khan II, 408 Ill. App. 3d at 597.)

¶ 25 2. Our Disagreement With the Trial Court's Analysis

Regarding the Deutsche Bank Defendants

¶ 26 We disagreed with the trial court's analysis regarding the Deutsche Bank defendants because, first, in return for the transaction fees that plaintiffs paid the defendants, plaintiffs were promised either a profit from the "investments" or, alternatively, a tax loss and, second, regardless of any ominous rumblings from the IRS, plaintiffs were not deprived of their tax loss until the IRS actually took it away from them by imposing an assessment. Presumably, in the contemplation of the parties, the payment of $1,275,000 to the Deutsche Bank defendants would have been worthwhile if, despite the immediate failure of the "investment" (or, rather, because of it), plaintiffs were able to claim a tax loss. See id. at 607 ("Until the IRS disallows the loss and, consequently, assesses the deficiency along with the interest and penalties, the fees that plaintiffs paid to defendants are not yet a waste, because plaintiffs have not yet been deprived of the contemplated benefit of their bargain, namely, the alternative benefit of a tax loss."). In short, Plan B was just as acceptable as Plan A. The notices that the IRS sent out to the general public did not deprive plaintiffs of their claimed tax loss. Plaintiffs would not actually lose their tax loss until, in their specific case, the IRS finally and definitively took it away through an assessment or until plaintiffs settled with the IRS-a point we gleaned from Federated Industries, Inc. v. Reisin, 402 Ill. App. 3d 23 (2010), and International Engine Parts, Inc. v. Feddersen & Co., 888 P.2d 1279 (Cal. 1995). Those authorities taught that a misadvised taxpayer in plaintiffs' position would not suffer actual damages, and consequently a cause of action would not accrue, until the earliest of two events: (1) the IRS made an assessment against the taxpayer (the final step of the IRS's assessment process, not to be confused with an earlier step, the issuance of a notice of deficiency), or (2) the taxpayer agreed with the IRS to pay additional taxes, penalties, or interest that the taxpayer would not have had to pay but for the tax advisor's bad advice. Khan II, 408 Ill. App. 3d at 602. (We should emphasize that, unlike us, the trial court did not have the benefit of Federated. The First District issued its decision in Federated after the trial court filed its decision.)

¶ 27 In addition to citing and discussing Federated and Feddersen, we pointed out the danger of an unjust result if an action for bad tax advice had to be filed before the claim was truly ripe. If a taxpayer had to file an action against the allegedly negligent tax advisor before the IRS made an assessment or before the taxpayer agreed to pay the IRS an additional amount, a fiasco could unfold. The plaintiff could win a money judgment against the tax advisor, and then, for whatever reason and against all expectation, the IRS could let the deadline go by for filing an assessment-with the unjust result that the taxpayer would get to keep the tax as loss well as the money judgment premised on the now-problematic theory that claiming the tax loss had caused the taxpayer pecuniary harm. Id. at 601.

ΒΆ 28 The harm from underpaying one's federal income taxes-the hammer-was an IRS assessment or, alternatively, a settlement with the IRS. Requiring the taxpayer to file a claim before that harm happened was tantamount to requiring the taxpayer to file an unripe claim. Consequently, we concluded that the trial court had erred in ...


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