SEGAL et al v. STRAUSSER ENTERPRISES, INC. et al
Filing
339
MEMORANDUM/OPINION THAT THE STRAUSSER DEFENDANTS' MOTION TO COMPEL PRODUCTION OF TAX RETURNS OF MR. SEGAL AND THE TRUST IS DENIED. SIGNED BY MAGISTRATE JUDGE HENRY S. PERKIN ON 8/8/13. 8/8/13 ENTERED AND COPIES E-MAILED.(ky, )
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SEGAL et al v. STRAUSSER ENTERPRISES, INC. et al
Doc. 339
IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
__________________________________________
:
KENNETH SEGAL, et al
:
:
CIVIL ACTION NO. 07-4647
Plaintiffs
:
:
vs.
:
:
STRAUSSER ENTERPRISES, INC., et al
:
:
Defendants
:
__________________________________________:
MEMORANDUM
Henry S. Perkin, M.J.
August 8, 2013
This matter is before the Court following the remand Order of the Honorable
James Knoll Gardner dated March 22, 2013. See Docket No. 329. A hearing was conducted
before the undersigned on April 11, 2013 for reconsideration of whether the tax returns of
Plaintiffs Kenneth Segal and the Karen and Kenneth Segal Descendant’s Trusts are discoverable.
In conjunction with the Hearing/Argument Scheduling Order, the parties were directed to submit
argument briefs concerning the foregoing issue. Defendants Strausser Enterprises, Inc.’s and
Gary Strausser’s Memorandum of Law in Support of Motion to Compel Production of Tax
Returns of Plaintiffs Ken Segal and the Karen and Kenneth Segal Descendants Trust was filed on
April 9, 2013. See Docket No. 332. Plaintiffs’ Argument Brief in Opposition to the
Discoverability of Plaintiffs’ Tax Returns was also filed on April 9, 2013. See Docket No. 331.
Having conducted the hearing and having considered the contentions of the parties,1 as well as
1
This Court has also considered the responses of counsel for Defendant to two questions posed by
the undersigned during the April 11, 2013 hearing, which responses are memorialized in a letter to the undersigned
dated April 24, 2013. Copies of this letter were provided to counsel for all parties.
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the remand Order of Judge Gardner, this Court is prepared to rule on this matter.
FACTUAL HISTORY
Plaintiffs, Kenneth Segal (“Segal”), Adam Segal, as trustee for and on behalf of
the Karen and Kenneth Segal Descendents Trust (“Trust”), and Segal and Morel, Inc. (“S&M”)
initiated this action on November 5, 2007 by filing a four-count civil Complaint against Strausser
Enterprises, Inc. (“SEI”), Gary Strausser (“Strausser”) and SEI’s attorney, Leonard Mellon
(“Mellon”). The Complaint alleges four state-law claims: tortious interference with contract
(Count I), tortious interference with prospective contractual relations (Count II), malicious
prosecution under the Dragonetti Act, 42 Pa.C.S.A. §§ 8351-8354 (Count III), and abuse of
process (Count IV).
According to the Complaint, this action arises from purchase agreements whereby
plaintiff S&M contracted to purchase several parcels of land from defendant SEI. SEI retained
certain limited rights of first refusal to repurchase some of the parcels under specific
contractually defined circumstances.2
2
According to the Complaint and the documents attached thereto, two agreements granted rights of
first refusal to SEI. The June 11, 2002 Agreement provided, in pertinent part, as follows:
[S&M] acknowledges that Phase II is a four-year build out and agrees to
aggressively market the purchased properties to homebuyers. Should [S&M] be
unable to market the properties sucessfully, absent any government imposed
moratorium, building an average of 20 units per year over a four (4) year period,
it hereby agrees to give [SEI] a right of first refusal to take back the approved
and improved lots at the same price continued [sic] herein.
See Complaint, Exhibit B, June 11, 2002 Agreement at § 5.17.4. The April 25, 2003 Agreement provided, in
pertinent part, as follows:
Should [S&M] decide to sell all or some of the lots [S&M] hereby agrees to give
[SEI] a right of first refusal to take back the approved and improved lots.
See Complaint, Exhibit D, April 25, 2003 Agreement at § 5.17.4.
2
S&M subsequently assigned all rights and obligations arising under the purchase
agreements and subsequent amendments to several limited liability companies (the “S&M
LLCs”) of which plaintiff Segal and the Trust are the only members. Plaintiffs allege that on
December 21, 2005, Segal and the Trust (collectively the “Segal sellers”) contracted to sell their
interests in the S&M LLCs to K. Hovnanian Pennsylvania Acquisitions, LLC (“Hovnanian”), by
way of a sales agreement that took several months to negotiate and finalize (“the Hovnanian
agreement”).
Plaintiffs allege that the Segal sellers attempted to meet with the Strausser
defendants3 to discuss the sale of memberships in the S&M LLCs to Hovnanian, but that, in an
attempt to interfere with the sale to Hovnanian and to gain leverage by which to gain monetary
concessions from the Segal sellers, Strausser and other SEI representatives refused to meet with
the Segal sellers. The Complaint further alleges that on February 13, 2006, just two days prior to
closing on the Hovnanian agreement, SEI, through its attorney, defendant Mellon, filed a lawsuit
in the Court of Common Pleas of Northampton County, Pennsylvania to stop the transfer of the
properties based on a right of first refusal, as well as a notice of entry of lis pendens against the
property.
As a result of the lis pendens, plaintiffs allege that Hovnanian refused to proceed
with the closing. Plaintiffs aver that the Strausser defendants refused to withdraw the lis
pendens, and Hovnanian terminated the Hovnanian agreement because the Segal sellers were
Both of these agreements were executed by the seller, SEI, and buyer, S&M. More specifically,
the Court notes that Gary J. Stausser, as president for SEI, executed the agreements on behalf of SEI and Kenneth
Segal, as president for S&M, executed the agreements on behalf of S&M.
3
In this Memorandum, “Strausser defendants” refers to Strausser Enterprises, Inc. and Gary
Strausser.
3
unable to provide good title to the properties.
The Complaint alleges that the filing of the Northampton County lawsuit was
frivolous and in bad faith because defendants SEI, Strausser and Mellon all knew that the
purchase agreements had binding arbitration clauses; the transaction with Hovnanian did not
trigger the right of first refusal clauses; and the Strausser defendants lacked the financial ability
to exercise the rights of first refusal, even if properly triggered. In response to these allegations,
the Strausser defendants have asserted an “advice of counsel” defense and acknowledge that they
have waived any privilege protection that may have existed with respect to documents and
information concerning the advice relied upon in filing the Northampton County lawsuit
regarding rights of first refusal and the filing of the lis pendens.4
PROCEDURAL HISTORY
On March 28, 2011, the Strausser defendants submitted to the undersigned an
informal letter motion to compel discovery of the tax returns of Kenneth Segal and the Trust
from 2003 to 2009. By Order dated April 12, 2011, the undersigned denied the Strausser
defendants’ motion but added “if discovery discloses additional information pertaining to this
issue, broader discovery may be permitted in the future.” See Docket No. 204.
On December 6, 2011, the Strausser defendants provided this Court with a second
informal letter motion to compel discovery, which again requested an order compelling plaintiffs
to produce all tax returns of Mr. Segal and the Trust, this time from 2003 to 2010. The Strausser
defendants contended that the requested tax returns contain information necessary for them to
4
At the time of the filing of the Northampton County lawsuit and lis pendens, the Strausser
defendants were represented by Defendant Leonard Mellon. It is Mr. Mellon’s advice that the Strausser defendants
assert they relied upon in connection with the filing of the Northampton County lawsuit and lis pendens.
4
accurately investigate the extent and veracity of plaintiffs’ damages.
On January 3, 2012, after consideration of the issues, the undersigned granted the
Strausser defendants’ motion to compel discovery and ordered plaintiffs to provide them with the
requested tax returns. See Docket No. 257. Plaintiffs sought review of this Order by filing
Plaintiffs’ Petition to Reconsider the Order of Magistrate Judge Henry S. Perkin Dated January 3,
2012 on January 17, 2012. In so doing, plaintiffs requested that Judge Gardner reverse the
undersigned’s January 3, 2012 Order, and deny the Strausser defendants’ motion to compel
discovery.
On March 22, 2013, Judge Gardner granted plaintiffs’ petition for reconsideration
and remanded this issue to the undersigned for additional consideration concerning the
discoverability of plaintiffs’ tax returns using the two-prong test articulated in In re Sunrise
Securities Litigation, 130 F.R.D. 560, 578 (E.D.Pa. 1989) (O'Neill, J.). See Docket No. 329.
Judge Gardner’s Order also provides that the undersigned should consider all relevant
information including the following:
(1)
Whether plaintiffs complied with their promise, made in response to the
denial of defendants’ first motion to compel discovery filed March 28,
2011, to provide defendants with “a substantial amount of information
relating to their damages and/or to the financial condition of Plaintiffs
Segal and Morel, Inc. and the [Trust] that should enable [defendants] to
assess the extent and veracity of plaintiffs’ damages.”
(2)
Whether the information and documentation already supplied to
defendants by plaintiffs through previous discovery including, but not
limited to, the ledger books of S&M LLCs and Mr. Segal’s redacted
Schedules B and E to his personal tax returns, contain sufficient
information to adequately inform defendants of the extent and veracity of
plaintiffs’ damages.
(3)
Whether the “Tax Benefit Rule”, articulated in Randall v. Loftsgaarden,
5
478 U.S. 647, 106 S.Ct. 3143, 92 L.Ed. 525 (1986) can be extended to
apply to this case and preclude defendants from off-setting plaintiffs’
damages by the amount of tax benefits realized by plaintiffs resulting from
their continued investment in the S&M LLCs.
See Docket No. 329.
DISCUSSION
An individual has a privacy interest in his tax returns, thus, “public policy favors
nondisclosure of income tax returns.” Jackson v. Unisys, Inc., 2010 WL 10018 at *2 (E.D.Pa.
January 4, 2010) (Jones II, J.) (citing DeMasi v. Weiss, 669 F.2d 114, 119-20 (3d Cir. 1982)).
Accordingly, the correct standard to be applied to the discovery of income tax
returns is a two-part test: (1) the tax returns are relevant to the subject matter of the action; and
(2) there is a compelling need for the returns because the information contained therein is not
otherwise readily obtainable. In re Sunrise Securities Litigation, 130 F.R.D. 560, 578 (E.D.Pa.
1989) (O'Neill, J.). While the party seeking discovery bears the burden of proving relevance, the
party resisting discovery bears the burden of showing the information is available elsewhere. Id.
Plaintiffs aver, and the Strausser defendants do not contest, that they have already
produced voluminous documents to the Strausser defendants reflecting plaintiffs’ financial
condition, as well as the financial condition of the S&M LLCs, in order for the Strausser
Defendants to properly assess plaintiffs’ alleged damages. More specifically, plaintiffs have
produced the following: (1) the tax returns for S&M, Inc. and the S&M LLCs for 2004 through
2010 (as proof of such entities’ profits and/or losses over the requested period); (2) a complete
set of the internal financial statements and general ledgers for S&M, Inc. and the S&M LLCs by
month and year from 2006 to 2011 (as proof of the financial activities of these entities during the
6
requested period); (3) all balance sheets reflecting the profit, loss and gross revenues of S&M,
Inc. and the S&M LLCs; (4) reports identifying plaintiffs’ job costs for each home, townhome or
condominium sold by the S&M LLCs at Riverview; and (5) reports detailing sale prices and
costs incurred for each unit sold by the S&M LLCs at Riverview.
In addition, and subsequent to our prior ruling on this matter, we note that while
plaintiffs did not concede the relevance or discoverability of any portion of Mr. Segal’s and/or
the Trust’s tax returns, they did provide, in an effort to resolve this ongoing discovery issue, the
Strausser defendants with redacted copies of Schedules B (used to report interest/dividend
income) and E (used to report supplemental income or loss from partnerships, S corporations,
estates, trusts, etc.) that were affixed to Mr. Segal’s personal tax returns for the years 2006
through present. Plaintiffs advise that these portions of the returns have been redacted such that
they identify only income or losses passed through to Mr. Segal and/or the Trust from the S&M
LLCs, as well as any loan interest paid to Mr. Segal from these entities. The redacted Schedules
exclude financial information concerning Mr. Segal’s investments/income from entities unrelated
to this action.
Despite having received these portions of the sought-after tax returns, the
Strausser defendants continue to aver that their forensic accountant expert finds it necessary to
review the entire returns, including Schedules A (pertaining to itemized deductions) and C
(pertaining to profit or loss from business).5
Having been given the opportunity to present
5
Schedule A is used to figure your itemized deductions. In most cases, your federal income tax will
be less if you take the larger of your itemized deductions or your standard deduction. If you itemize, you can deduct
a part of your medical and dental expenses and unreimbursed employee business expenses, and amounts you paid for
certain taxes, interest, contributions, and miscellaneous expenses. You can also deduct certain casualty and theft
losses.
7
evidence at the hearing on this issue of necessity, however, I note that the Strausser defendants
failed to present any expert reports or testimony bearing on this issue. Relying solely on the
representations and argument presented by counsel for the Strausser defendants, which this Court
has thoughtfully considered, I am unable to conclude that the additional information sought is
necessary to analyzing plaintiffs’ claim of damages. Moreover, in response to the Court’s inquiry
at the hearing, plaintiffs have advised the undersigned through correspondence dated April 24,
2013 that to the extent they exist, Schedules A and C for the years 2006 through 2010 do not
identify any deductions arising from the subject matter in this action nor do they identify any
activity related to this action.
Based on my review of the briefs submitted as well as my consideration of the
parties’ argument at the hearing, I conclude that the Strausser defendants have not made an
adequate showing that the remaining portions of the desired tax returns contain relevant
information not already contained within the documents that plaintiffs have already produced, or
which may be otherwise readily obtainable. While certain portions of the tax returns at issue may
be relevant to demonstrate loss, I conclude that the entire tax returns are not relevant. Schedules
B and E provided by plaintiffs in an effort to resolve this matter, as well as the production of
other documents containing financial information referenced above, appear to sufficiently
advance the issue as to plaintiffs’ claim of damages at this time. Accordingly, because I find that
Schedule C is used to report income or loss from a business you operated or a profession you
practiced as a sole proprietor. An activity qualifies as a business if your primary purpose for engaging in the activity
is for income or profit and you are involved in the activity with continuity and regularity.
See Schedule A (Form 1040), Itemized Deductions, http://www.irs.gov/uac/Schedule-A-(Form-1040),
-Itemized-Deductions, and Schedule C (Form 1040), Profit or Loss From Business,
http://www.irs.gov/uac/Schedule-C-(Form-1040),-Profit-or-Loss-From-Business (last visited August 7, 2013).
8
the Strausser defendants have failed to establish relevancy at this time as well as a compelling
need for the remaining portions of the tax returns, I must deny the Strausser defendants’ motion
to compel.
Finally, I must discuss the implications of the “tax benefit rule” as an additional
basis for denying the Strausser defendants’ motion to compel. In conjunction with their efforts,
the Strausser defendants have previously argued that Mr. Segal’s purported tax benefits are
related to plaintiffs’ potential damages and in an effort to test or challenge such alleged damages,
it is essential for them, and their expert, to review the tax returns at issue in order to properly
examine and challenge any potential damages model proposed by plaintiffs. Accordingly, it
appears that the Strausser Defendants argue in part that because Mr. Segal and the Trust have
allegedly realized tax benefits in the form of tax deductions and credits resulting from their
continued investment in the S&M LLCs, they are entitled to inspect Mr. Segal’s and the Trust’s
returns in order to assess plaintiffs’ damages.
Under the “tax benefit rule,” established by the United States Supreme Court in
Randall v. Loftsgaarden, 478 U.S. 647 (1986), “plaintiffs will be required to report any damages
recovered in [an] action as taxable income, resulting in a recapture of their tax benefits, and any
prior tax benefits will thereby be disallowed.” Cody v. Edward D. Jones & Co., 502 N.W.2d
558, 562 (S.D. 1993) (quoting Fullmer v. Wohlfeiler & Beck, 905 F.2d 1394, 1402 (10th Cir.
1990)). Simply put, application of the tax benefit rule ensures that plaintiffs receiving a damage
award will not obtain a double recovery in light of tax benefits or credits previously received.
Id.
Courts within this District have denied the discovery of tax returns in situations
9
where the party seeking such returns has argued that their discovery was warranted to learn of
“tax benefits” that might be offset against damages. For example, in Bove v. Worlco Data
Systems, Inc., No. 86-1419, 1987 U.S. Dist. LEXIS 422 at *2 (E.D. Pa. Jan. 21, 1987), the
defendants sought the production of the plaintiffs’ personal income tax returns, arguing that if
the plaintiffs’ participation in a limited partnership was motivated in part by tax planning, any
damages caused by the defendants’ alleged failure to fulfill their obligations must be reduced by
the tax savings that the plaintiffs gained as a result of the plaintiffs’ participation in the
partnership. Relying on Randall, the District Court concluded that the tax information sought
was irrelevant, id. at *4, and refused to compel production of the returns. Id. at *7. Relying
upon the foregoing cases as well as the information contained in plaintiffs’ brief on this issue, I
find that the “tax benefit rule” serves as an additional basis in which to deny discovery of the
remaining portions of the tax returns.6
For the foregoing reasons, we deny the Strausser defendants’ motion to compel.
An appropriate Order follows.
6
During the hearing on this discovery issue, I find that plaintiffs properly stated the “tax benefit
rule” and although the Strausser defendants appeared to recognize its implications, they continued to argue that any
tax benefits received by plaintiffs may be relevant as to a potential theory based on plaintiffs’ alleged failure to
mitigate. For example, the Strausser defendants argued that if plaintiffs withheld the sale of certain land in exchange
for favorable tax consequences, thereby failing to mitigate, any tax benefits received by plaintiff would be relevant to
a failure to mitigate theory. As I believe I indicated at the time of the hearing, this theory would be an issue for trial.
Nothing in this Memorandum or accompanying Order shall be construed as barring this potential mitigation theory at
the time of trial.
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