Sann v. Mastrian, 2012 U.S. Dist. LEXIS 9107 (Jan. 26, 2012)
First, the plaintiff sued his business attorney for malpractice for failing to advise him that his company could choose S corporation status over C corporation status. He also claimed the attorney failed to provide any form of shareholder dispute resolution in the formation of his company, leading to a protracted dissolution proceeding in which the plaintiff lost all his shares in the company.
Second malpractice suit
When his attorney in that case failed to meet the deadline for disclosing his expert’s damages report, the case was dismissed. As a result, the plaintiff launched a second malpractice suit against his trial attorney. In this case, to prove what his damages would have been (but for the dismissal of the first malpractice action), the plaintiff enlisted a CPA expert to calculate the value of his former company. The expert also calculated the difference in tax liability that the company would have enjoyed as an S corporation rather than a C corporation. The defendant challenged both calculations under Daubert, claiming neither was reliable nor relevant.
In particular, after considering the three traditional valuation approaches, the plaintiff’s expert applied the income approach and based on a review of the company’s financial records, ultimately arrived at a value of just under $2.7 million. The defendant contended that this opinion was unreliable, because it was based on the "false" assumption that "the company had a buyer … who would have purchased [it] for this amount."
The court found the assertion to be meritless and misplaced. "Nowhere in his valuation of the company did [the plaintiff’s expert] assume that the company had a potential buyer as of the valuation date." Further, the expert’s report adequately explained the valuation approaches that he ultimately used to value the company and the financial information that he relied on.
Tax-impact damages were nonexistent
In calculating the potential economic damages to the company’s shareholders (including the plaintiff) that may have resulted from its formation as a C corporation rather than an S corporation, the expert assumed a sale at $2.7 million to determine the difference in tax liability. This opinion was purely speculative, the defendant argued, and didn’t fit the analytical "facts" of the case. The court agreed.
Finally, because the expert’s calculation of company value was under the income approach (as opposed to the market approach), "no tax liability adjustments need be made to the value [he] reached," the court explained. "Not only is the purported tax liability not likely to occur," the court added, "it is impossible for it to occur." The company had been dissolved without incurring any tax liability; in fact, the IRS had issued a refund. Accordingly, "in its role as gatekeeper," the court precluded the plaintiff’s expert from testifying to any tax-liability differences between the assumed sale of the company as a C corporation and as an S corporation, but permitted him to present his $2.7 million calculation of value.
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