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November 15, 2004.

GOLDENBERG ROSENTHAL, LLP, et al., Defendants.

The opinion of the court was delivered by: RICHARD HOLWELL, District Judge


This litigation is the result of a business relationship that started out well but ended badly. The relationship between Shared Communications Services, Inc. ("SCS"), a telecommunications firm, and its accountant, Goldenberg Rosenthall, LLP ("GR"), began in 1995. Although SCS had once been satisfied with the services GR provided, by September 2001, that satisfaction had eroded and SCS refused to pay outstanding GR invoices. Following unsuccessful and ultimately acrimonious settlement negotiations, SCS filed suit on September 28, 2001, asserting six claims against GR: conversion, replevin, professional negligence or malpractice, billing fraud, breach of contract, and breach of fiduciary duty.*fn1 The conversion claim is asserted also against David Gruber, a partner at GR. GR, for its part, asserts counterclaims to recover for the invoices that SCS refused to pay.*fn2 A bench trial was held from December 1 to December 4, 2003. This opinion contains the Court's findings of fact and conclusions of law, as well as a summary of the prior proceedings in this action.

Prior Proceedings

  This action was originally filed on September 28, 2001, in New York state court. On November 2, 2001, defendants removed the action to the United States District Court for the Southern District of New York. Upon removal, the action was assigned to the Honorable John S. Martin, United States District Judge for the Southern District of New York. On July 23, 2003, the action was reassigned to the Honorable Shira A. Scheindlin, United States District Judge for the Southern District of New York. On November 12, 2003, the action was transferred to this Court. At the time of transfer to this Court, the case was ready for trial, with the parties already having submitted a joint pretrial order and Judge Scheindlin having substantially decided the motions in limine.

  The Court held a bench trial from December 1 to December 4, 2003. The Court heard testimony from GR partners, former partners, and associates, including Jerry Kalick, Jerome Kotzen, David Gruber, Brad Johnson, and Thomas Earley. The Court also heard testimony from Paula Brown, founder and chief executive officer of SCS, as well as from plaintiff's expert witness Martin Davidoff and defendants' expert witness David Scherf. After trial, the parties submitted designations and counter-designations from the deposition transcript of Lloyd Persun, a lawyer SCS hired to help resolve its tax liability. Finally, in early February 2004, plaintiff and defendants filed post-trial memorandums. Findings of Fact

  SCS, a Delaware corporation founded by Brown in 1983, sought to offer commercial building tenants a wide range of telecommunications services by entering into contracts with owners of buildings, thus allowing tenants to have access to state-of-the-art equipment and services for a single monthly charge without capital outlays. In pursuit of that goal, SCS took over a number of contracts (mostly in the Philadelphia area) and established five subsidiary operating companies, one for each location covered by the contracts: SCS of 1800-80 JFK Blvd., Inc. ("SCS of 1800"); SCS of ESR, Inc.("SCS of ESR"); SCS of Walnut Hill Plaza, Inc. ("SCS of Walnut Hill"); SCS of Devon Square, Inc. ("SCS of Devon"); and SCS of New York, Inc. ("SCS of NY"). (Tr. at 506-07, 577.) SCS owned all of the stock of each subsidiary and invoices for accounting services rendered to the subsidiaries would be sent by accounting firms to SCS, who would pay those invoices on behalf of the subsidiaries. (Tr. at 577-78.)

  From 1990 until March 1995, SCS became embroiled in debilitating litigation that depleted its operating resources and caused it to neglect its financial affairs and record keeping. Compounding these financial difficulties, SCS found the services of its accounting firm at the time, Ernst & Young LLP, to be wanting. SCS decided that the large-firm culture of Ernst & Young LLP was not well suited to a small company like SCS, which had only three or four employees (none of whom was a bookkeeper or accountant) and did not have a general ledger or other formal set of books. (Tr. at 511-12, 606-08.) Thus, once the litigation was concluded, SCS decided to retain a different accounting firm to get its financial house in order after years of neglect. (Tr. at 510.) On the recommendation of a local Philadelphia attorney, Brown met with Kotzen, a partner at GR, on March 16, 1995. (Tr. at 514.) Brown explained SCS's situation to Kotzen, expressing concern that SCS may be facing penalties and interest from the years of neglect. (Tr. at 514-15.) Kotzen assuaged Brown's concerns and Brown, on behalf of SCS and its subsidiaries, agreed to retain GR. (Ex. 81; Tr. at 514-15, 518.)

  Although the relationship between SCS and GR began as a limited one — at first, GR was only to prepare a report, financial statements, and income tax returns for 1994, not to audit the financial records and statements, Ex. 81 — the relationship soon blossomed into an expansive one, with GR serving almost all of SCS's accounting needs. (Ex. 95.) Indeed, SCS was sufficiently content with GR's services to continue giving work to Kotzen, who in turn directed a team of GR accountants, even after Kotzen retired from GR in 1998. (Tr. at 198.)

  Brown and Kotzen had discussed the cost of GR's services during their initial meeting, Tr. at 515-18, but no rate structure was ever formally agreed upon. Throughout their relationship, Kotzen never explained to Brown how the invoices were calculated, Tr. at 120, and SCS and GR never signed any kind of formal contract or retainer agreement, including any contract or agreement that governed the exact rates charged for GR's services. (Ex. 81.) Nevertheless, SCS received invoices on a regular basis from GR for services rendered to SCS and its subsidiaries, which invoices set forth the names of the accountants who worked on the SCS account, the hours the accountants worked, the rates they charged, and a general description of the tax matter on which they worked. (Ex. 92, KKK.) SCS paid all invoices issued prior to April 2000.*fn3 (Ex. 94, KKK.)

  Despite the dutiful payment by SCS, GR did not perform its accounting tasks without some mistakes. In particular, there were four areas in which GR committed errors. The first area concerns Pennsylvania's Public Utility Realty Tax ("PURTA"), which is an assessment on realty owned by public utility companies. (See Dep. of Lloyd Persun, October 1, 2003, at 210-211 (hereinafter "Oct. Dep.").) SCS, through its accounting firm, would typically file an annual corporate report indicating that no tax was owed because SCS owned no realty. In 1995, after GR had been retained, SCS of 1800 received a notice from the Pennsylvania Department of Revenue ("the State") stating that no annual corporate report had been filed. (Ex. 30.) This notice was forwarded to GR. In February 1996, SCS of 1800 received another notice from the State, this one explicitly stating that an additional $11.45 of PURTA tax for 1994 must be paid within 45 days. (Ex. 32.) The striking information in that notice was not the amount due, but rather that any tax was due at all. That notice was forwarded to GR, as well. (See id.) In response to the February 1996 notice, Earley, a GR accountant working under Kotzen's leadership, wrote a letter, dated February 21, 1996, informing the State that SCS of 1800 "does not own any realty of any kind and never has." (Ex. 33.) The letter explained that SCS of 1800 had filed its PURTA tax returns as part of a larger filing pursuant to an amnesty program meant to cover the years that SCS was tied up in litigation and that the returns showed SCS of 1800 not liable for any PURTA taxes.*fn4 (See id.)

  The problem with Earley's letter response was that it did not comport fully with either of the two proscribed ways to contest PURTA liability. To properly contest liability, a complainant could either pay the tax and apply for a refund or file a petition for reassessment. (See Oct. Dep. at 213.) It is possible that the State would treat a letter such as Earley's as a petition for reassessment, but it was also possible that such a letter, since it was not formally a petition for reassessment, would not be treated as a petition for reassessment. (See id.)*fn5

  Apparently, the State did not treat Earley's letter as a petition for reassessment because, in May 1996, SCS of 1800 received another notice, stating:
"In February you received a notice assessing your pro-rata share of Additional 1994 PURTA tax due. Our records indicate that you did not respond or remit payment of the tax within the 45 days prescribed by law." (Ex. 34.)
Approximately one month later, in response to the May notice, Early again wrote a letter, similar to the first, informing the Pennsylvania Department of Revenue that SCS of 1800 "has never owned any real estate and has never been liable for this tax." (Ex. 35.) This time, however, Earley's letter garnered a letter in response from the State. The State explained that SCS of 1800, SCS of ESR, SCS of Walnut Hill, and SCS of Devon did not file PURTA reports for 1994 and therefore the companies were liable for PURTA taxes. (Ex. 36.) The letter further explained that, in order to contest the liability, "each company must [first] satisfy these assessments to avoid further enforcement action," then the companies could appeal the assessments. (Id.)

  Fortunately, this issue dissipated after GR provided the State with copies of the PURTA tax returns that were filed as part of a larger filing pursuant to an amnesty program. (Ex. 37.) Neither SCS nor any of its subsidiaries have ever paid the assessed 1994 PURTA tax and no PURTA liability was assessed against SCS or its subsidiaries after 1994.

  The second area where GR erred pertains to the filing of sales tax returns. As noted earlier, SCS and its subsidiaries had neglected their filing responsibilities during the litigation and in fact had failed to file sales tax returns from October 1991 through July 1995. GR filed those returns for SCS of 1800 in September 1995. (Ex. 2.) However, GR miscalculated the monthly returns and had to file amended returns as part of an amnesty program the State offered between October 13, 1995, and January 10, 1996. (Ex. 6.)

  This sales tax issue was further complicated by an audit of SCS of 1800 that the State conducted in 1995 and GR's response to the results of the audit. The State's audit concluded that SCS of 1800, with the filing of the returns, had satisfied its sales tax obligations, but levied a penalty of $47,447.50 for the late filing of the state sales tax and $7908.00 for the late filing of the local sales tax. (Ex. 13.) Those figures amounted to 50 percent of the total sales tax SCS of 1800 owed — unusually large penalties, Tr. at 257-58 — and reflected the auditor's frustration in dealing with SCS of 1800, which repeatedly cancelled appointments with the auditor, before GR was retained. (Ex. H.)*fn6 However, GR bumbled the appeal of those penalties.

  Earley filed a timely petition for appeal on October 25, 1996, but specified only the state tax penalty on the petition. (Ex. 13.) Although the local penalty was noted in the documents attached to the petition, the Board of Appeals was not obligated to review that penalty because it was not specified in the petition. The other flaw in the petition was that the amnesty program was the only ground raised for challenging the penalties. (See id.) Early wrote that the sales tax returns were filed pursuant to the amnesty program and that "[a]ll penalties were to be abated under this program." (Id.) However, the Notice of Tax Amnesty Program clearly stated that only taxes due before December 31, 1993, would be eligible for abatement. (Ex. 3.) Earley did not argue that the penalty should be abated because SCS of 1800 did not deliberately fail to file the returns. Such an argument had been successful in getting abated other penalties levied against SCS. (Ex. 8.)*fn7

  On March 26, 1997, the Board of Appeals issued a decision abating the state tax penalty through November 1993 in accordance with the amnesty program, but sustaining the remainder of the penalty. (Ex. 15.) The decision did not abate any of the local tax penalty. (See id.) Brown did not learn that the penalties were not fully abated until the time to appeal the Board of Appeals decision had expired.*fn8 (Tr. at 579.) In fact, Brown believed the penalties had been abated in their entirety, as she was told by Earley, see id., and thus never paid them. Brown finally learned of the unpaid penalties in 2000 when she had decided to sell a substantial portion of SCS of 1800's assets and a routine lien search was performed in connection with the asset sale. (Ex. 20.) The lien search revealed the unpaid penalties, Ex. 22, and Brown brought them to the attention of Kotzen. (Tr. at 534-35.)

  On November 17, 2000, Early wrote a letter to the Pennsylvania Office of the Attorney General. (Ex. 27.) In the letter, Early again stated his belief that the amnesty program should have abated all the penalties. (See id.) The letter also stated, for the first time, that the penalties should be abated because SCS of 1800's failure was accidental and the result of extenuating circumstances. (See id.) However, the Attorney General declined to grant relief to SCS of 1800.

  On March 13, 2002, Lloyd Persun, an attorney hired by SCS, wrote another letter to the Office of the Attorney General in a further effort to abate the penalties. (Ex. 29.) Ultimately, by July 2002, Persun was able to persuade the Attorney General to deem the penalties "uncollectible" and, although the State liens remained unsatisfied, to close the file on SCS of 1800, which had by then ceased operations.*fn9 (Ex. R.) Thus, the penalties have never been paid, though SCS did pay Persun approximately $6,000 for his work on this matter. (See Dep. of Lloyd Persun, September 16, 2003, at 177-78 (hereinafter "Sept. Dep.").) In addition, SCS was compelled to pay a second law firm, Montgomery McKracken, $13,311.58 to remove certain non-State liens asserted against SCS and its subsidiaries that were triggered by the outstanding sales tax penalties. (Tr. at 589-91; Ex. 142.) SCS paid a third law firm, Trujillo Rodriguez, $447.25 to remove a non-State lien that had been asserted against Brown individually based on the unpaid sales tax penalties. (Tr. at 592; Ex. 69.)*fn10 Finally, SCS paid a fourth law firm, Fischbein Badillo, $4,689.39, to act as SCS's general counsel and coordinate the work of the other law firms. (Tr. at 588-89; Ex. 71.)

  GR also committed errors in a third area, which involved the 1996 Business Privilege Tax. On March 18, 1996, GR forwarded to SCS of 1800 a Business Privilege Tax Extension Coupon for 1996 and directed SCS of 1800 to pay the State $2,500. (Ex. 41.) However, having filed for an extension, GR then never filed the return for the 1996 Business Privilege Tax. (Tr. at 453.) SCS of 1800 learned of the missing return on October 20, 1998, when it received a Code Enforcement Complaint from the Commonwealth of Pennsylvania. (Ex. 42.) SCS of 1800 forwarded this Complaint to GR and GR quickly prepared the appropriate tax return. (See id.; Tr. 453-54.) In its haste, GR forgot that SCS of 1800 had already paid $2,500 towards the 1996 tax. (Tr. at 454.) Fortunately, SCS of 1800 picked up on that omission in the first draft of the return and GR prepared a corrected return reflecting the fact that $2,500 had already been paid. (Tr. at 454; Ex. 43.) When the corrected return was filed, SCS retained a Philadelphia law firm (Ballard Spahr) to handle the proceedings with the Complaint and to clear the liens that stemmed from the missing tax return. For this work, SCS paid Ballard Spahr $1,983.30. (Tr. at 592-93; Ex. 70.)*fn11 Though the law firm was successful in resolving those issues, SCS of 1800 eventually was obligated to pay another $1,291 to the State because the previously filed corrected return was based on estimated figures, the exact figures not being available to GR at the time.*fn12 (Tr. at 476-78; Ex. 44.)

  The fourth area where GR faltered was in its handling of the gross receipts taxes from 1986 to 1996. The Pennsylvania Public Utilities Commission levies a tax on the gross receipts of all utilities providing telephone and telecommunications services in Pennsylvania. SCS believed that, since it was not a utility company, it was not subject to this tax. (See Sept. Dep. at 17-21.) Accordingly, GR submitted gross tax receipt returns for 1986 ...

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