How Deep the Rabbit Hole Goes in Preserving Investors’ Interests Against the Defense of Tax Estoppel

And I am, whatever you say I am. If I wasn't, then why would I say I am?

These words of one of the great American lyricists echoed the cold reality that confronted many investors who reasonably relied upon their corporate venture’s representations in tax documents before the investors’ relations with the corporate management of their venture soured. The mistaken belief that representation or performance was reality persisted in the realm of commercial relations in the guise of the affirmative defense of tax estoppel. That is until recently.

Tax estoppel is the stuff of nightmares, nights forgotten to celebration, or both, if one has sparred on both sides of that defense, for business and commercial litigators. For those unfamiliar, tax estoppel, like estoppel of the collateral and promissory varieties, refutes or defeats a party’s desired position in litigation based upon some prior representation. The prior representation in the case of tax estoppel is any previously filed tax document.

The fundamental assumption of tax estoppel is that a party to litigation has sworn to the truth of the contents of his tax document based upon his firsthand knowledge of the representations in all materials relied upon to prepare the tax document no matter their sources. The seminal case on tax estoppel is Mahoney-Buntzman. Mahoney-Buntzman v. Buntzman, 12 N.Y.3d 415, 418-19, 422-23 (2009). The Mahoney-Buntzman Court wryly opines that “[a] party to litigation may not take a position contrary to a position taken in an income tax return.” Id. at 422.

Mahoney-Buntzman is a matrimonial matter. The husband in that case negotiated an agreement under which he would treat a buyout of his corporate interests as personal income, executed that agreement, received the buyout, and prepared the couple’s joint tax return consistent with that agreement. The husband then tried to argue in his divorce proceeding that the buyout he negotiated to be personal income and reported to be personal income when he prepared the couple’s tax return somehow was definitely not personal income classified as marital property.

Supreme Court said, “not so fast.” The Court of Appeals agreed.

Courts left without specific direction on this point wrestled with if and how to apply Mahoney-Buntzman’s blanket pronouncement on tax estoppel in the corporate context. Corporate contexts are complex. They can be convoluted. They can become contentious.

Investors and managers sometimes quarrel. Investors depend upon managers of their corporate ventures as the sole source of information about their interests and investments even when investors and managers are embroiled in litigation.

Some appeared to endorse a legal fiction that managers prepared and provided all information that investors required to file their personal tax returns during a moment of fleeting amicability no matter how toxic or antagonistic the investor-corporate dynamic grew before or during litigation.

Some feared that investors could be estopped from challenging adjustments to their membership interests once the investors’ accountants filed a tax return that relied upon corporate management’s representations of attributable income if those representations internally correlated to an otherwise unnoticed or unreported dilution of investors’ interests.

Would that not be as nonsensical as citing items on a tax return as proof of not just the price paid as recorded on a vendor-prepared receipt but the appraised value of the purchased item?

Another’s representations about you need not reflect the truth of you even if you repeat those representations. The tone of the esteemed laureate from Detroit intimates as much. Courts began to erode a broad application of tax estoppel in the corporate realm, particularly involving direct disputes between investors and corporate management.

Observers knew Mahoney-Buntzman was always in an unhappy marriage with investors’ rights.

No appellate court had dared tumble down the rabbit hole far enough to pronounce unequivocally that tax estoppel had no place where corporate management attempted to evidence dilution of investors’ interests by citation to items in investors’ tax returns whose values appear only because of corporate management’s own potentially self-serving statements. That is until this summer.

The Fourth Department in McGuire seized upon such an opportunity. McGuire v. McGuire, __ A.D.3d ___ (4th Dept 2021). McGuire involves an investor-corporate dispute related to tens of causes of action, among them is a claim of improper dilution of investors’ interests. Corporate management raised tax estoppel as an affirmative defense in an effort to defeat the investors’ claim.

McGuire addresses corporate management’s invocation of the doctrine of tax estoppel. “[T]hat doctrine does not apply because the relevant documents were not prepared by plaintiffs, but rather by a third party at the direction of [venture], which is managed by defendant.” Id.

The Fourth Department prescribes the red pill for all future courts that consider tax estoppel.

Washed away should be any legal fiction that investors and corporate management who are now adversaries work or have worked together amicably and objectively in preparing and providing tax documents. No longer may corporate management hope to stave off claims of impropriety with reference to items in tax returns that corporate management either provides or advises investors or their agents present in the investors’ tax returns.

“It would distort the doctrine of tax estoppel beyond recognition to conclude that plaintiffs are precluded from taking a position contrary to a tax document…which was, in effect, prepared by their opponents.” McGuire, __ A.D.3d. at __.

The Fourth Department heard Mr. Mathers’ skepticism.

Investors in New York are free to challenge corporate management’s adjustments to their interests even when investors previously have filed tax documents that reasonably and necessarily rely upon information that corporate management has prepared and provided.

Aaron M. Griffin practices with the Litigation Practice Group of Underberg & Kessler LLP. He focuses his litigation practice on commercial litigation and public-interest law. He recently was selected as one of Super Lawyers’ 2021 Upstate New York Rising Stars in Business Litigation.

If you have any questions regarding this article, or if you have any other Litigation concerns, please contact the Underberg & Kessler attorney who regularly handles your legal matters or Aaron M. Griffin, the author of this piece, here or at (585) 258-2882.