The Arizona Supreme Court has ruled that it doesn't violate due process for a Connecticut law firm to face a legal malpractice lawsuit in that state even though none of the firm's lawyers are licensed to practice in Arizona. Legal experts, however, said there is little chance that facing a lawsuit in another state will lead law firms to stop the practice of issuing opinion letters to out-of-state clients on tax shelters.
I covered the case in a piece for the Connecticut Law Tribune. Here's an excerpt:
The Arizona Supreme Court has ruled that a Connecticut law firm with no lawyers licensed to practice in Arizona can nevertheless be the target of a malpractice claim from two Grand Canyon State residents. But the ruling is not likely to curtail the practice of law firms writing opinion letters for out-of-state clients in tax matters, according to legal experts.
In exchange for a $50,000 fee, Bridgeport-based Pullman & Comley and partner D. Robert Morris prepared an opinion letter for Arizona plaintiffs Bill and Sue Beverage some 13 years ago. The letter opined that it would be legitimate under federal tax law for the Beverages to take advantage of a tax shelter known as a custom adjustable rate debt structure.
However, the Internal Revenue Service rejected the couple's tax return and their declaration of substantial losses related to the tax shelter. They ended up being assessed $3 million.
In a two-page opinion, Chief Justice Rebecca White Berch affirmed that the Connecticut defendants are subject to Arizona's specific jurisdiction—even though the firm does not have an office in Arizona and does not have any attorneys licensed to practice law there. Pullman & Comley now have to face claims of civil racketeering, fraud, breach of fiduciary duty, conspiracy, professional malpractice and negligent misrepresentation in Arizona.
Adam Chodorow, a professor who teaches tax law at Arizona State University Sandra Day O'Connor College of Law, said the Arizona Supreme Court decision won't cause firms to step away from issuing opinion letters on tax matters. Instead, he thinks firms are going to insert choice-of-forum clauses—which stipulate the court or jurisdiction in which any subsequent legal actions will take place—when they advise out-of-state clients about tax shelters.
"Any firm that wants to can insert a choice-of-forum clause in any contract with a client," Chodorow said, adding that such clauses are typically upheld by the courts. In this case, such a clause might have prevented Pullman from "getting stuck in court in Arizona."
Chodorow also said law firms that issue opinion letters are going to weigh the costs of potentially being sued by an unhappy clients in a far-off state against the benefits of the business they get from issuing opinion letters.
"I guarantee you, if the money is there, and the client base is there, they'll either accept the risk or assert the forum clauses," he said.
Stephen Utz, a professor at the University of Connecticut School of Law who teaches federal tax law and policy, said the case of Beverage v. Pullman & Comley highlights the risks involved in opinion letters.
As far as the IRS is concerned, taxpayers are still subject to tax penalties even if they have an opinion letter from a law firm stating that a certain investment, deduction or other financial maneuver is legal, Utz said.
"Some law firms don't do letters of this kind in order not to disappoint clients and not mislead them that something is going to be great" when it won't, he said.
Other law firms, however, not only give opinions on tax shelters but design them and market shelters, Utz said.
The IRS has made it more difficult for tax lawyers to give advice on tax shelters, Utz said. The agency has specific penalties for "material advisors," which may include lawyers, who don't report to the IRS when clients have consulted them about certain tax shelters, he said.
The penalties were "intended to be intimidating and to persuade some tax practitioners not to do this," Utz said.
Facing lawsuits in out-of-state jurisdictions over tax-shelter legal advice gone wrong is not what will dissuade law firms from doing this kind of legal work, Utz said. But, he added, penalties from the IRS will.