HENRY v. MONAGHAN (1995)

INTRODUCTION

This appeal requires that we venture into the murky milieu of the statute of limitations applicable to attorney malpractice.   Although there has been a spate of appellate review in the past five or six years, the focal points in this area have been reduced to two decisions:  ITT Small Business Finance Corp. v. Niles (1994) 9 Cal.4th 245, 36 Cal.Rptr.2d 552, 885 P.2d 965 (hereafter ITT ) and Laird v. Blacker (1992) 2 Cal.4th 606, 7 Cal.Rptr.2d 550, 828 P.2d 691 (hereafter Laird ).   At the time of judgment here, the California Supreme Court had not yet decided ITT and thus the trial court relied on the holding of Laird in making its ruling.   While this appeal was pending, the Supreme Court decided International Engine Parts, Inc. v. Feddersen & Co. (1995) 9 Cal.4th 606, 38 Cal.Rptr.2d 150, 888 P.2d 1279 (hereafter IEP ), addressing the statute of limitations issue in the context of accountant malpractice.

The original posture of this case also presented an issue of the statute of limitations applicable to accountant malpractice.   However, appellant Albert J. Henry (Henry) and the accountant defendants have settled the matter and have stipulated the judgment be reversed.   In accord with Neary v. Regents of University of California (1992) 3 Cal.4th 273, 10 Cal.Rptr.2d 859, 834 P.2d 119, we accept the stipulation.¹  In the absence of any problem apparent in the record or objection to the settlement by a nonparty, we find no extraordinary circumstances warranting denial of a stipulated reversal.   Further, there is no possibility the stipulated reversal will adversely affect the interests of nonparties or the public or erode public confidence in the judiciary.  (Id. at p. 284, 10 Cal.Rptr.2d 859, 834 P.2d 119.)   Accordingly, we limit our discussion in this appeal to the issue raised by the attorney defendants.

ISSUE PRESENTED

When does actual injury, caused by the negligent tax advice of attorneys, occur so as to commence the running of the applicable statute of limitations?   Although the appellate briefs frame other issues, our decision will necessarily dispose of those ancillary matters.

FACTUAL AND PROCEDURAL BACKGROUND

In 1978, Henry became a shareholder, officer and executive employee of IMED Corporation (IMED).   The attorney defendants ² are alleged to have constituted the general counsel for IMED in 1982.   Between 1979 and 1982 Henry received a substantial number of IMED shares through its employee incentive plan.   In 1982 IMED was acquired by Warner–Lambert Company.   As part of the acquisition IMED redeemed a portion of Henry's stock options and the remainder was sold to Warner–Lambert.

The attorney defendants, in particular Kevin P. Monaghan (Monaghan), were responsible for structuring the IMED/Warner–Lambert transaction to insure the proceeds from the redemption and sale of IMED stock options would be entitled to long-term capital gain tax treatment.   In 1982 and 1983 the accountant defendants were Henry's personal accountants and for those years prepared his federal and state income tax returns.   They advised him that the proceeds of the sale of his stock options ($8,636,552.50) were subject to long-term capital gain treatment and Henry's tax returns reflected that advice.

In 1983, the Internal Revenue Service (IRS) commenced an audit of Henry's 1982 income tax return.   In 1984, Henry retained a law firm (not a party here) to represent him in connection with the audit.   By letter dated January 23, 1984, Henry told Monaghan he had retained counsel to represent him regarding the part of the audit dealing with the tax treatment of his IMED stock options.   On July 31, 1984, Henry was informed in writing by the attorneys representing him in the audit that the monies he received for his stock options in 1982 was ordinary income not subject to capital gain treatment.

Between the years 1984 and 1990, Henry paid various attorneys and accountants for advice and representation concerning the audit, extended the IRS statute of limitations regarding additional tax assessments and was aware that the main focus of the audit was the treatment of the stock options sale proceeds.   In a letter dated June 6, 1990, an IRS examiner informed Henry “it is the government's position that under [Internal Revenue Code] section 83 and the regulations thereunder, the sale of the unexercised stock options resulted in ordinary income and not long-term capital gain.”   This correspondence advised Henry the examiner was proposing $6,862,450 in additional taxes, interest and penalties.

On January 24, 1991, the IRS issued a “30–day letter” informing Henry he had 30 days to file a protest.   On March 15, 1991, an administrative protest was filed on Henry's behalf.   On August 26, 1991, Henry received a statutory notice of deficiency (the “90–day letter”) informing him he had 90 days to file a petition in the tax court.   Henry filed a petition and the matter is presently pending in the tax court.³

Henry filed his complaint for malpractice, indemnity and declaratory relief against the attorney and accountant defendants on December 20, 1991.   The defendants successfully moved for summary judgment on the ground the action was barred by the applicable statutes of limitations.   This appeal followed.

DISCUSSION

The statute of limitations for attorney malpractice contained in Code of Civil Procedure 4 section 340.6, subdivision (a) provides in part:

“An action against an attorney for a wrongful act or omission other than for actual fraud, arising in the performance of professional services shall be commenced within one year after the plaintiff discovers, or through the use of reasonable diligence should have discovered, the facts constituting the wrongful act or omission, or four years from the date of the wrongful act or omission, which ever occurs first.   In no event shall the time for commencement of legal action exceed four years except that the period shall be tolled during the time that any of the following exist:

“(1) The plaintiff has not sustained actual injury;  ․”

Monaghan contends that at various times, beginning with the IRS audit and no later than the June 6, 1990, letter from the IRS examiner, Henry had “discovered” any malpractice, thus triggering the one year statute of limitations for the commencement of the attorney malpractice action.   Because Henry's complaint was not filed until December 20, 1991, he argues, the action is barred.   With some exceptions, Henry does not deny he had knowledge consistent with “discovery” under the statute.   Instead, he claims he has suffered no “actual injury” within the meaning of section 340.6, subdivision (a)(1) because the tax court has issued no decision on the claimed tax assessment and an adverse decision is necessary before it can be determined he suffered “actual injury.”

In Laird, supra, 2 Cal.4th 606, 7 Cal.Rptr.2d 550, 828 P.2d 691, the Supreme Court addressed the issue of whether the judgment against the plaintiff or the finality of the appeal therefrom constituted “actual injury” and concluded “the limitations period of section 340.6 commences when a client suffers an adverse judgment or order of dismissal in the underlying action on which the malpractice action is based․”  (Laird, supra, 2 Cal.4th at p. 609, 7 Cal.Rptr.2d 550, 828 P.2d 691.)   The Court disagreed with plaintiff's position “that actual injury should be defined in terms of monetary amount and that a successful appeal negates the client's ability to file a malpractice action.   To the contrary, although appellate review may correct judicial error, and thus reduce the client's damages, an appeal does not necessarily exonerate the attorney, nor does it extinguish the client's action against him for negligence in the conduct of trial․”  (Id. at p. 614, 7 Cal.Rptr.2d 550, 828 P.2d 691, reviewed and reaffirmed in ITT, supra, 9 Cal.4th 245, 36 Cal.Rptr.2d 552, 885 P.2d 965;  italics added.)

In ITT, supra, 9 Cal.4th 245, 36 Cal.Rptr.2d 552, 885 P.2d 965, a lender sued its attorney for malpractice based on the preparation of insufficient loan documents resulting in the lender's having to litigate the efficacy of the documents in a proceeding brought by the debtor.   That proceeding was ultimately settled for less than the value of the loan.   The malpractice action was filed within two months of the settlement but more than two years after the commencement of the adversary proceeding.   The trial court granted summary judgment in favor of the defendant attorney on the ground the action was time-barred.   The Court of Appeal reversed the summary judgment, concluding the statute of limitations in “transactional malpractice” cases does not begin to run until there is a settlement or trial court judgment of the third party action.  (Id. at pp. 248–249, 36 Cal.Rptr.2d 552, 885 P.2d 965.)

The Supreme Court affirmed the Court of Appeal.   Citing section 340.6, subdivision (a)(1), the Court recited the general rule that “a malpractice action accrues once [defendant's] former client ‘discovers' the malpractice, and is tolled until the client suffers ‘actual injury’ from the malpractice.   There must be a nexus between discovery and harm, and without both elements the filing of the malpractice action is premature.   Thus, discovery of the facts essential to the malpractice claim and the suffering of actual harm from the malpractice establish a cause of action and begin the running of the statute of limitations․”  (ITT, supra, 9 Cal.4th at p. 250, 36 Cal.Rptr.2d 552, 885 P.2d 965;  italics in original.)

The court in ITT then went on to review the most recent cases involving the legal malpractice statute of limitations, including Laird, and distinguished between attorney “conduct” in litigation resulting in an adverse verdict and “transactional malpractice.”   Having established that distinction, the court concluded:

“[I]n transactional legal malpractice cases, when the adequacy of the documentation is the subject of dispute, an action for attorney malpractice accrues on entry of adverse judgment, settlement, or dismissal of the underlying action.   It is at this point that the former client has discovered the fact of damage and suffered ‘actual injury’ due to the malpractice under section 340.6.   Therefore, in the present case, the statute of limitations of section 340.6 was tolled until the action contesting the documentation was concluded.”  (ITT, supra, 9 Cal.4th at p. 258, 36 Cal.Rptr.2d 552, 885 P.2d 965;  italics in original.)

In ITT, the malpractice action was based on the legal effect and sufficiency of loan documents.   Similarly here, Henry's malpractice action is based on the tax consequences of a sales transaction exposing him to claims by the IRS.   Thus, the malpractice alleged here is the “transactional” variety of ITT, rather than the “conduct” or “litigational” variety of Laird.   (See also McElroy v. Biddison (1995) 32 Cal.App.4th 1164, 1170, 38 Cal.Rptr.2d 804.)

In IEP, the Supreme Court addressed the “actual injury” issue with respect to an accountant's negligent preparation of tax returns and the plaintiff's subsequent dealings with the IRS.   In that case, the defendant accountant failed to file documents necessary for plaintiff's subsidiary to retain a certain advantageous tax status.   The IRS audited plaintiff's income tax returns and advised plaintiff the failure to provide the documents would result in loss of the subsidiary's status.   The IRS then issued a preliminary report stating it intended to disqualify the subsidiary from its status and impose tax deficiencies.   On May 16, 1988, the IRS assessed the deficiency.  (IEP, supra, 9 Cal.4th 606 at pp. 609–610, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)   That same day, the plaintiff signed appropriate forms acknowledging the deficiency assessment and agreeing to pay the taxes and penalties due.  (Id. at p. 613, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)

On May 15, 1990, plaintiff sued defendant for accountant malpractice.   Defendant successfully sought summary judgment on the ground the action was barred by the two-year statute of limitations of section 339, subdivision 1 and the Court of Appeal agreed.  (IEP, supra, 9 Cal.4th at pp. 610–611, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)

The Supreme Court reversed the Court of Appeal.   It first reiterated the rule that although a cause of action for professional negligence accrues “ ‘on discovery of the loss or damage suffered by the aggrieved party,’ ” the cause of action cannot be established until the client suffers damage or actual injury from the negligence.  (IEP, supra, 9 Cal.4th at p. 608, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)   The Court then held actual injury occurs, and thus the statute of limitations commences, when the tax deficiency is assessed by the IRS.  (Id. at p. 622, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)   The Court reasoned “[t]he deficiency assessment serves as a finalization of the audit process and the commencement of actual injury because it is the trigger that allows the IRS to collect amounts due and the point at which the accountant's alleged negligence has caused harm to the taxpayer.”  (Id. at p. 617, 38 Cal.Rptr.2d 150, 888 P.2d 1279;  italics in original.)   Thus, plaintiff's action was timely filed on May 15, 1990, because actual injury occurred no sooner than May 16, 1988, when the IRS made its deficiency tax assessment.  (Id. at p. 620, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)

Although the Court in IEP addressed “actual injury” caused by an accountant's malpractice, its holding is instructive here.   The IRS has not yet assessed a tax deficiency against Henry and thus no actual injury has occurred.   Throughout the audit process, the statute of limitations was tolled because actual injury was still speculative and any deficiency assessment uncertain.  (See IEP, supra, 9 Cal.4th at p. 621, 38 Cal.Rptr.2d 150, 888 P.2d 1279.)   The examiner's letter of June 6, 1990, stated the government's position on potential liability only and the examiner's preliminary findings are “proposed findings that are subject to negotiation prior to any determination of tax deficiency.”  (Id. at p. 612, 38 Cal.Rptr.2d 150, 888 P.2d 1279;  italics in original.)   Unlike the plaintiff in IEP who consented to the deficiency assessment and thereby allowed the IRS to collect amounts due, Henry disagreed with the examiner's proposed findings at which time the IRS issued a 30–day letter and Henry filed a protest.   When no agreement was reached, the IRS issued a statutory notice of deficiency causing Henry to file his tax court petition.   Under Internal Revenue Code section 6213, subdivision (a), the IRS is prohibited from assessing any deficiency or attempting to collect any amount due until the decision of the tax court has become final.   Thus, there was no assessment against Henry at the time he filed his malpractice action.   Whether Henry suffered actual injury as a result of the alleged malpractice is contingent on the outcome of the tax court proceeding.   Accordingly, the one-year statute of limitations of section 340.6, subdivision (a) is tolled and the malpractice action was timely filed.⁵

The attorney defendants express concern that any tolling under the facts of this case would be contrary to the public policy underlying the statute of limitations.   However, the court in ITT rejected a similar argument:

“Moreover, there was no danger in the present case that tolling the malpractice statute of limitations until conclusion of the adversary proceeding would undermine the statute's goals of preserving evidence and notifying defendants.   ITT notified Niles that he should contact his malpractice insurer as soon as ITT realized it would have to defend the documentation prepared by Niles in the adversary proceeding.   Finally, it would be a waste of judicial resources to require both the adversary proceeding and the attorney malpractice action to be litigated simultaneously.   Had ITT prevailed in the adversary proceeding, the malpractice action would have been unnecessary.”  (ITT, supra, 9 Cal.4th at p. 257, 36 Cal.Rptr.2d 552, 885 P.2d 965.)

DISPOSITION

The summary judgment is reversed.   Henry shall recover costs on appeal against the attorney defendants;  Henry and the accountant defendants shall bear their own costs on appeal.

FOOTNOTES

FOOTNOTE.  

1.   Henry and the accountant defendants have also requested we accept their stipulation that the remittitur issue forthwith and that all parties bear their own costs on appeal.   In light of the fact other parties remain in the appeal, we deny the request to have the remittitur issue forthwith.   However, we accept the stipulation insofar as the parties have agreed to bear their own costs.

2.   Two law firms and a number of individual attorneys named in Henry's complaint were allegedly involved as counsel to IMED and/or Henry and allegedly provided legal advice upon which the claim of legal malpractice is based.   Because the specific identity of any firms or individual attorneys except Kevin P. Monaghan adds nothing to our decision, we decline to list them.

3.   Monaghan was a member of IMED's Board of Directors who also received stock options and the proceeds from the subsequent redemption and sale of those options.   Like Henry, Monaghan faced a deficiency assessment as a result of that transaction.   We take judicial notice that Monaghan's case has since been decided by the tax court.  (Cramer et al. v. Commissioner of Internal Revenue (U.S. Tax Ct.1993) 101 T.C. 225, 1993 WL 369030.)

FN4. All statutory references are to the Code of Civil Procedure unless otherwise specified..  FN4. All statutory references are to the Code of Civil Procedure unless otherwise specified.

5.   Even if the notice of deficiency dated August 26, 1991, constituted “actual injury” and thus commenced the running of the one-year statute of limitations, Henry's malpractice action, filed on December 20, 1991, was timely.

MIDLAM **, Associate Justice. FN** Assigned by the Chairperson of the Judicial Council.

WORK, Acting P.J., and BENKE, J., concur.