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People ex rel. Schad v. My Pillow, Inc.

Court of Appeals of Illinois, First District, Fourth Division

June 15, 2017

THE PEOPLE ex rel. SCHAD, DIAMOND & SHEDDEN, P.C., Plaintiff-Appellee,
v.
MY PILLOW, INC., Defendant-Appellant.

         Appeal from the Circuit Court of Cook County Nos. 12 L 7874, cons. with 12 L 6782 Honorable Thomas R. Mulroy Judge Presiding.

          PRESIDING JUSTICE ELLIS delivered the judgment of the court, with opinion. Justices McBride and Burke concurred in the judgment and opinion.

          OPINION

          ELLIS PRESIDING JUSTICE.

         ¶ 1 This case requires us to consider matters of first impression arising under the Illinois False Claims Act, including whether damages paid by defendant prior to final judgment should be included in, or credited against, the amount of "damages" to be trebled under the Act and whether a law firm serving both as client and attorney may recover statutory attorney fees under the Act.

         ¶ 2 Relator, Stephen B. Diamond, P.C., formerly Schad, Diamond & Shedden, P.C. (relator), brought this qui tam action, on behalf of the State of Illinois, under the Illinois False Claims Act. 740 ILCS 175/1 et seq. (West 2012). Relator alleged that defendant, My Pillow, Inc. (My Pillow), knowingly failed to collect and remit use taxes on merchandise sold at craft shows in Illinois and on Internet and telephone sales to Illinois customers, as required by State law.

         ¶ 3 After a bench trial, the circuit court found in favor of relator as to the claims regarding Internet and telephone sales. The court awarded relator treble damages and attorney fees totaling $1, 383, 627.

         ¶ 4 We affirm the judgment in favor of relator. The evidence was sufficient to demonstrate that My Pillow acted in reckless disregard of its obligation to collect and remit use taxes on its Internet and telephone sales. The damages found by the trial court were supported by the evidence, and the trial court properly included, within the amount of damages to be trebled, those tax payments made by My Pillow before final judgment. We reverse that portion of the attorney-fee award that granted fees to relator for legal work performed by its own attorneys but otherwise affirm the fee award. We remand to the circuit court only for a recalculation of the attorney-fee award.

         ¶ 5 I. FALSE CLAIMS ACT

         ¶ 6 The Illinois False Claims Act (Act), formerly known as the Whistleblower Reward and Protection Act, allows the Attorney General or a private individual to bring a civil action on behalf of the State for false claims. See, e.g., State ex rel. Pusateri v. Peoples Gas Light & Coke Co., 2014 IL 116844, ¶ 16; see also 740 ILCS 175/1, 4 (West 2008). The Act closely mirrors the federal False Claims Act originally enacted in 1863. Scachitti v. UBS Financial Services, 215 Ill.2d 484, 506 (2005); see also 31 U.S.C. §§ 3729 through 3733 (2000). Both acts provide for qui tam actions brought by citizens seeking to reveal fraud against the government. People ex rel. Schad, Diamond & Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999, ¶ 30.

         ¶ 7 Thus, in construing the Act, Illinois courts have relied on federal courts' interpretation of the Federal False Claims Act for guidance. See id. (and cases cited therein); accord United States ex rel. Geschrey v. Generations Healthcare, LLC, 922 F.Supp.2d 695, 702 n.4 (N.D. Ill. 2012) (court's reasoning on false claim under Federal False Claims Act applied equally to state act, because "Illinois courts interpreting the state act look to interpretations of the similarly worded federal [act]").

         ¶ 8 Relator's claim is based on section 3 of the Act. 740 ILCS 175/3 (West 2012). Section 3 states, in relevant part, that a person is liable under the Act when he "knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the State, or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the State." 740 ILCS 175/3(a)(1)(G) (West 2012). For purposes of section 3, the term "knowingly" means that a person, "with respect to information: (i) has actual knowledge of the information; (ii) acts in deliberate ignorance of the truth or falsity of the information; or (iii) acts in reckless disregard of the truth or falsity of the information." 740 ILCS 175/3(b)(1)(A) (West 2012). "[N]o proof of specific intent to defraud" is required. 740 ILCS 175/3(b)(1)(B) (West 2012).

         ¶ 9 This case concerns a unique form of false claim involving the failure to collect and remit use taxes on the sale of merchandise in Illinois under the Retailer's Occupation Tax Act (ROTA) (35 ILCS 120/1 et seq. (West 2012)) and the Use Tax Act (35 ILCS 105/1 et seq. (West 2012)). "ROTA and the Use Tax Act are complementary, interlocking statutes that comprise the taxation scheme commonly referred to as the Illinois 'sales tax.' " Kean v. Wal-Mart Stores, Inc., 235 Ill.2d 351, 362 (2009). "[B]ecause of the impracticality of collecting the tax from individual purchasers, the burden of its collection is imposed upon the out-of-state vendor." Brown's Furniture, Inc. v. Wagner, 171 Ill.2d 410, 418 (1996).

         ¶ 10 The gist of relator's complaint is that My Pillow was required to collect and remit use taxes to the State but failed to do so. This specimen of false claim is known as a "reverse false claim, " in that the defendant is not alleged to have obtained money fraudulently from the government but, rather, to have failed to pay money duly owed. See, e.g., People ex rel. Beeler, Schad & Diamond, P.C. v. Relax the Back Corp., 2016 IL App (1st) 151580, ¶ 19 (reverse false claim is where material misrepresentation is made to avoid paying money owed to government); State ex rel. Beeler Schad & Diamond, P.C. v. Ritz Camera Centers, Inc., 377 Ill.App.3d 990, 996 (2007) ("[t]he reverse false claims provision was added to provide that an individual who makes a material misrepresentation to avoid paying money owed to the Government would be equally liable under the Act as if he had submitted a false claim to receive money" (internal quotation marks omitted)).

         ¶ 11 II. BACKGROUND

         ¶ 12 My Pillow is a Minnesota corporation involved in the sales, marketing, and distribution of pillows. The company was founded in 2004 by Mike Lindell, who is the company's chief executive officer. Lindell says he sewed the first pillows himself by hand. By 2009, the company had between 5 and 20 employees.

         ¶ 13 Beginning in 2010, independent contractors began selling My Pillow's products at craft shows in Illinois and throughout the country. Between April 2010 and July 2012, My Pillow sold its products at 44 craft shows in Illinois. It is no longer disputed that My Pillow collected use tax on its craft show sales and remitted all the tax to the Illinois Department of Revenue (IDOR). (Relator alleged otherwise at trial, but the court ruled in favor of My Pillow on the craft-show use taxes, and relator does not challenge that ruling on appeal.)

         ¶ 14 In June 2010, My Pillow began selling its products through the Internet. My Pillow did not collect sales or use tax on Internet or telephone sales to Illinois purchasers. Relator began its investigation of My Pillow in August 2011.

         ¶ 15 In October 2011, Lindell created and launched a detailed infomercial, for which he paid a marketing company close to $200, 000. In 2011, as a result of the infomercial, the company expanded impressively. Monthly sales increased from $200, 000 to $10 million. The number of employees grew from 20 in October 2011 to 500 in a very short period of time. By February 2013, My Pillow had 650 employees.

         ¶ 16 My Pillow registered to do business in Illinois in July 2012. On July 13, 2012, relator filed its initial complaint under the Act, claiming that My Pillow failed to collect and remit Illinois use tax on merchandise sold at craft shows in Illinois and on its Internet sales and telephone sales to Illinois customers. Relator filed an amended complaint on October 31, 2012. The State declined to intervene, and the amended complaint was unsealed on January 15, 2013.

         ¶ 17 Relator filed a second amended complaint on February 26, 2013. My Pillow was served with process in March 2013.

         ¶ 18 In November 2013, My Pillow began to collect and remit use tax on Internet and telephone sales. My Pillow amended its sales and use tax returns, i.e., the IDOR Form ST-1s, and paid a total of $106, 970 in taxes it owed to Illinois on Internet and telephone sales for 2012 ($61, 218) and 2013 ($45, 752).

         ¶ 19 Relator filed a third amended complaint on April 28, 2014. In its third amended complaint, relator alleged in count I that, although My Pillow collected tax on craft show sales, it did not remit the tax to IDOR. In count II, relator alleged that My Pillow failed to collect and remit use tax on website and telephone sales.[1]

         ¶ 20 A two-day bench trial began on September 22, 2014. Four witnesses testified at trial: Lindell, Nicole Oestrich, Stephen Diamond, and David Kim.

         ¶ 21 Lindell testified that, in April or May 2010, he asked an accountant, who had been doing his tax returns for 30 years, whether he had to charge sales tax on Internet sales. According to Lindell, it was his understanding that he would have to charge sales tax on Internet purchases within Minnesota but not on those that were shipped out of state. Lindell, however, never sought his accountant's advice or consulted with anyone about the collection, remittance, or payment of Illinois sales and use tax.

         ¶ 22 Lindell testified that, in July 2013, he told an employee, David Boyd, to begin collecting tax on Internet and telephone sales. Boyd did not follow Lindell's directions, and Lindell fired him for insubordination in November 2013. Lindell also testified that My Pillow contacted its customers and collected tax on Internet and telephone sales to Illinois customers for the prior years.

         ¶ 23 Nicole Oestrich was the My Pillow employee who filed its Form ST-1 with IDOR. Both Lindell and Oestrich testified that the independent contractors at the craft shows collected tax on the products they sold and either remitted the tax at the shows or gave it to My Pillow to remit with its monthly Form ST-1.

         ¶ 24 Stephen Diamond testified regarding relator's investigation of My Pillow and the discovery obtained from My Pillow.

         ¶ 25 Relator's attorney, David Kim, testified regarding relator's investigation of My Pillow. He also testified as to relator's damages calculations.

         ¶ 26 The trial court found that My Pillow did not violate the Act with respect to the craft shows, because relator failed to meet its burden of proving that My Pillow did not remit all of the taxes it received from the 44 craft shows it attended from April 2010 through July 2012. But the court found in favor of relator on its claims concerning My Pillow's Internet and telephone sales. The court found Lindell was not credible and further found that, "based on all the evidence, My Pillow knowingly violated [the Act] because it recklessly disregarded its obligation to remit tax on Internet and telephone sales."

         ¶ 27 The court reserved ruling on damages until after the matter had been fully briefed. The court awarded relator treble damages and attorney fees totaling $1, 383, 627. This calculation came from computing the damages, trebling them, and adding penalties, for an amount of damages-the proceeds of the action-of $889, 637. Then the court subtracted the $106, 970 in taxes My Pillow paid prior to trial for a final amount of damages of $782, 667. To this number, the court added attorney fees, expenses, and costs of $600, 960 for a total award against My Pillow of $1, 383, 627.

         ¶ 28 Of that amount, relator received $266, 891 in damages (30% of the proceeds of the action, or $889, 637) and attorney fees in the amount of $600, 960.

         ¶ 29 III. ANALYSIS

         ¶ 30 A. Standard of Review

         ¶ 31 After a bench trial, our standard of review is whether the order or judgment is against the manifest weight of the evidence. Reliable Fire Equipment Co. v. Arredondo, 2011 IL 111871, ¶ 12. We also review an award of damages made after a bench trial under the manifest-weight standard. 1472 N. Milwaukee, Ltd. v. Feinerman, 2013 IL App (1st) 121191, ¶ 13. A trial court's judgment is against the manifest weight of the evidence "only if the opposite conclusion is clearly evident or if the finding itself is unreasonable, arbitrary, or not based on the evidence presented." Best v. Best, 223 Ill.2d 342, 350 (2006). Under the manifest-weight standard, we give deference to the trial court as the finder of fact because it is in the best position to observe the conduct and demeanor of the parties and witnesses. Id. Accordingly, we will not substitute our judgment for that of the trial court. Id. at 350-51.

         ¶ 32 B. Issues on Appeal

         ¶ 33 My Pillow raises several issues on appeal. First, My Pillow challenges the trial court's finding that My Pillow violated the Act, claiming that it could not possess the requisite scienter because the issue of whether My Pillow had an obligation to collect and remit tax on its Internet and telephone sales is a disputed legal issue. My Pillow next argues that the circuit court erred in calculating damages where it (1) trebled amounts paid prior to trial and (2) awarded relator damages for periods prior to its investigation. My Pillow additionally contends that the court erred in awarding attorney fees because relator is a pro se litigant who cannot recover its own attorney fees. My Pillow's final argument is that, because relator did not prevail on any claims related to craft shows, the trial court erred in awarding attorney fees for legal work related to craft shows.

         ¶ 34 1. Whether My Pillow Acted With Reckless Disregard

         ¶ 35 We first address My Pillow's argument that it could not possess the requisite culpable state of mind of "knowingly" violating the Act, because the underlying issue of whether My Pillow had an obligation to collect use taxes on its Internet and telephone sales was, itself, a disputed legal issue. To reiterate, section 3, relevant to this lawsuit, defines "knowingly" as acting "in reckless disregard of the truth or falsity of the information." 740 ILCS 175/3(b)(1)(A)(iii) (West 2012).

         ¶ 36 My Pillow is referring to the constitutional requirement that before a state may impose a sales tax on an out-of-state company's sale within the state that company must have a "substantial nexus" with the state. See Quill Corp. v. North Dakota, 504 U.S. 298 (1992); Brown's Furniture, Inc. v. Wagner, 171 Ill.2d 410, 421 (1996). My Pillow is arguing here that the initial question of whether My Pillow owed a duty to collect and remit use taxes in Illinois at all-whether a "substantial nexus" existed-is a disputed and complicated legal question, and thus, My Pillow could not possibly have acted with reckless disregard of its obligation to collect and pay sales taxes. The reasoning, in essence, is that one cannot recklessly disregard an obligation when it is debatable whether that obligation exists in the first instance.

         ¶ 37 We should clarify at the outset that My Pillow does not deny that it had a duty to collect and remit use taxes on the sales of its products in Illinois. That point was conceded. As we noted in the factual background, My Pillow began collecting and remitting use taxes in response to relator's lawsuit sometime in 2013 (and had intended to start in 2012). My Pillow's argument is that this liability was not sufficiently clear, during the relevant time period before it began to "voluntarily" collect and remit, for My Pillow to be found to have recklessly disregarded its tax obligations.

         ¶ 38 We do not quarrel with the proposition that the "substantial nexus" requirement is far from a clear requirement, especially in this digital age. We are instructed that the out-of-state vendor must have a "physical presence" in the taxing state. Quill Corp., 504 U.S. at 317; Brown's Furniture, Inc., 171 Ill.2d at 423. But what, precisely, a "physical presence" means these days has proven difficult to pin down.

         ¶ 39 The " 'slightest' physical presence within a state will not establish substantial nexus." Brown's Furniture, Inc., 171 Ill.2d at 423 (quoting Quill Corp., 504 U.S. at 315 n.8). On the other hand, the physical presence " 'need not be substantial.' " Id. at 424 (quoting Orvis Co. v. Tax Appeals Tribunal, 654 N.E.2d 954, 960-61 (N.Y. 1995)). Ultimately, "[l]eft unclear after Quill *** is the extent of physical presence in a state needed to establish more than a 'slight' physical presence." Id. at 423; accord Relax the Back Corp., 2016 IL App (1st) 151580, ¶ 22 ("the law on what constitutes sufficient physical nexus to justify collection of the use tax is far from clear"). It is a decision to be made on a case-by-case basis. Irwin Industrial Tool Co. v. Department of Revenue, 394 Ill.App.3d 1002, 1014 (2009), aff'd, 238 Ill.2d 332 (2010).

         ¶ 40 If the only question were whether this is a nebulous area of the law, My Pillow would win the debate, hands down. But the question is more subtle. The question is not only whether, under the facts of a specific case, the existence of a sufficient nexus is difficult or simple, but also what the company did to try to figure out the answer to that question. After all, if we are to determine whether a company acted in "reckless disregard" of its obligation to collect and remit taxes, it stands to reason that our focus, at least in part, must be on that company's conduct. This court previously recognized that, given the murky nature of use-tax law in this context, a company is not automatically deemed to have "knowingly" violated the False Claims Act (then the Whistleblower Reward and Protection Act) by failing to collect and remit use taxes on its Illinois sales, but rather "necessary factual determinations *** must be made regarding defendants' knowledge" in each particular case. Ritz Camera, 377 Ill.App.3d at 999.

         ¶ 41 Thus, though we agree with My Pillow that this area of use-tax law is imprecise, we must also consider My Pillow's conduct in this case before determining whether it acted in reckless disregard of its use-tax obligations in Illinois.

         ¶ 42 "Reckless disregard" under section 3 requires more than " '[i]nnocent mistakes or negligence.' " State ex rel. Schad, Diamond & Sheddon, P.C. v. National Business Furniture, LLC, 2016 IL App (1st) 150526, ¶ 33 (quoting United States v. King-Vassel, 728 F.3d 707, 712 (7th Cir. 2013)). It refers to "the failure ' "to make such inquiry as would be reasonable and prudent to conduct under the circumstances, " ' " a " ' "limited duty to inquire as opposed to a burdensome obligation." ' " Id. (quoting United States ex rel. Williams v. Renal Care Group, Inc., 696 F.3d 518, 530 (6th Cir. 2012), quoting S. Rep. No. 99-345, at 20-21 (1986)).

         ¶ 43 "Reckless disregard" under section 3 has been aptly described as " 'the ostrich type situation where an individual has buried his head in the sand and failed to make simple inquiries which would alert him that false claims are being submitted.' " Relax the Back Corp., 2016 IL App (1st) 151580, ¶ 27 (quoting National Business Furniture, 2016 IL App (1st) 150526, ¶ 33). "Thus, one acting in reckless disregard ignores 'obvious warning signs' and 'refus[es] to learn of information which [it], in the exercise of prudent judgment, should have discovered.' " Id. (quoting United States ex rel. Ervin & Associates, Inc. v. Hamilton Securities Group, Inc., 370 F.Supp.2d 18, 42 (D.D.C. 2005)).

         ¶ 44 For example, in National Business Furniture, 2016 IL App (1st) 150526, ¶ 7, the defendant was a Wisconsin company that sold furniture by phone, catalog, or the Internet and shipped its product to customers. Customers selected a shipping method, and a delivery charge was calculated at the completion of the purchase. Id. ¶ 8. The defendant did not collect and remit use tax on the shipping charges, but the relator (the same one as in this case) alleged that the defendant was in violation of Illinois law. Id. ¶¶ 10-11.

         ¶ 45 The evidence at trial showed that the defendant collected and remitted taxes on shipping charges in some states but not others, depending on the defendant's interpretation of the applicable state's laws and regulations, and that the defendant interpreted Illinois's administrative rule as not requiring the tax's imposition. Id. ¶¶ 13-14. The defendant subscribed to a publication that tracked changes in sales tax rules by state and used software that did the same. Id. ¶¶ 15-16. In addition, the Illinois Department of Revenue (IDOR) had conducted an "Illinois Sales Tax audit" for a one-year period, and the defendant opened up its books to IDOR. Id. ¶ 18. Those records included a document plainly showing that the defendant was collecting the use tax on the sale of merchandise but not on shipping. Id. ¶ 21. The former chief financial officer testified that he believed, at all relevant times, that the company was complying with Illinois tax laws. Id. ¶ 22.

         ¶ 46 At the close of trial, the circuit court found that the relator had failed to prove that the defendant acted with reckless disregard, that instead the defendant had reasonably relied on the IDOR audit and its own interpretation of the applicable Illinois administrative rule to determine that it owed no duty to collect use tax on shipping charges in Illinois. Id. ¶ 23. We affirmed, finding that the trial judge's findings were not against the manifest weight of the evidence. Id. ¶¶ 37-39. We reasoned that the relator failed to "prove that defendant ignored obvious warning signs, buried its head in the sand, and refused to learn information from which its duty to pay money to the State would have been obvious." Id. ¶ 39.

         ¶ 47 In Relax the Back, 2016 IL App (1st) 151580, ¶¶ 6-7, another recent case involving the same relator, the question was whether the defendant was liable for failing to collect and remit use taxes for catalog and Internet sales for its neck and back care products (chairs, massage products, books, and videos). The claim regarding Internet sales was rejected because the trial court determined that no use taxes were owed in the first instance due to a lack of sufficient nexus. Id. ¶ 13. But as to catalog sales, the trial court found a sufficient nexus to impose tax liability, based on evidence that defendant's franchises in Illinois distributed a thousand catalogs to customers in Illinois every year. Id. Thus, as to catalog sales, the trial court proceeded to the question relevant here, whether the defendant recklessly disregarded its obligation to collect and remit those use taxes. Id.

         ¶ 48 The evidence showed that the defendant's chief financial officer (CFO) consulted with an outside tax attorney, who concluded that the defendant lacked a sufficient nexus to Illinois and owed no duty to collect and remit use taxes. Id. ¶ 8. The CFO likewise consulted with a "sales tax specialist in accounting" who reached the same conclusion. Id. ¶ 9. The CFO testified that outside certified public accountants audited the defendant's financial statements annually, and he understood that they would not have approved the financial statements had they believed the company should be collecting use taxes. Id. ¶ 10. Finally, the defendants presented an opinion witness, a former bureau manager of the audit bureau of IDOR, who testified that the defendant's investigation of its Illinois tax obligations was reasonable. Id. ¶ 11.

         ¶ 49 The trial court found that the defendant's CFO " 'made an honest effort to determine whether or not any tax liability occurred as a result of its Internet operations.' " (Emphasis added.) Id. ¶ 13. The trial court noted, however, that the defendant's investigation of its tax liability concluded in 2004 or 2005, and that its new requirement to Illinois franchises to mail catalogs to Illinois residents (the act that gave it a "substantial nexus" and triggered its use-tax obligation) began in either 2005 or 2006. Id. ¶¶ 14-15. Thus, because the defendant failed to re-examine its potential tax liability regarding catalog sales after imposing that new "catalog requirement" on its Illinois stores, the trial court found that the defendant recklessly disregarded its use-tax obligation as to catalog sales and was liable under the False Claims Act. Id. ¶¶ 15-16.

         ¶ 50 This court reversed the judgment in the relator's favor on the catalog sales. Id. ¶ 30. We reasoned that a mistaken interpretation of a somewhat gray area of the law was not reckless disregard. Id. Though we acknowledged that the defendant "did not actively seek the opinion of the IDOR or reevaluate [its] use tax obligation in light of its catalog requirement, this failure to ensure ...


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