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Sticks, Inc., An Iowa Corporation and Sarah Grant, A Single Person v. Michael Hefner

February 13, 2013


Appeal from the Iowa District Court for Polk County, Karen A. Romano, Judge.

The opinion of the court was delivered by: Potterfield, J.

Attorney for the plaintiffs appeals the district court decision imposing sanctions. REVERSED.

Heard by Vogel, P.J., and Potterfield and Doyle, JJ.

James Cook-attorney for the plaintiffs Sticks, Inc., and its owner Sarah Grant-appeals the district court's order imposing sanctions against him. Cook claims no sanction should have been imposed because he, on behalf of Sticks and Grant, urged a good faith extension of the existing case law following their first professional negligence suit against Michael Hefner and Hefner Financial, L.L.C. (collectively Hefner), who had been acting as Sticks' Chief Financial Officer. Cook also argues on appeal that if any sanction is to be imposed, the amount of the sanction determined by the district court violates the "American Rule" that the losing litigant does not ordinarily pay the victor's attorney fees, and is contrary to settled case law in Iowa. Because we find the district court abused its discretion in determining sanctions were warranted, we reverse the award of sanctions.

I. Background Facts and Procedure

This case arose after a jury returned a verdict in September 2009, finding Hefner liable for professional malpractice and breach of its fiduciary duty to Sticks and Grant. On October 9, the parties reached a compromised settlement of the verdict in the amount of $150,000, which was paid by check written to "Sticks, INC. & Sarah Grant" in satisfaction of the judgment.

In January 2010, both Sticks and Grant received an Internal Revenue Service (I.R.S.) Form 1099 Miscellaneous Income (Form 1099) from Hefner reporting each had received "other income" of $150,000 from Hefner. The next day, Cook contacted Hefner's trial attorney claiming the Form 1099s should not have been issued at all. He also told Cook he no longer represented Hefner.

According to Cook, the attorney stated he would pass on Cook's concerns to Hefner. Sticks, Grant, and Cook never contacted Hefner directly about the two Form 1099s.

During the next few days, Cook consulted with an expert, David Hove, who was familiar with Hefner and the 2009 malpractice litigation. The expert was a certified public accountant, with twenty-three years of experience as a tax accountant and four years experience as an IRS field agent. Cook, Grant, and Hove signed a letter*fn1 sent to the IRS Office of Professional Responsibility in February 2010, claiming the two Form 1099s were a "deliberate attempt to harass Ms. Grant and Sticks, Inc. because of the outcome of the lawsuit."

In March 2010, Sticks and Grant filed this lawsuit claiming professional negligence against Hefner, seeking compensatory damages for conduct described as "gross negligence, intentional acts, and professional malpractice" for "improper and invalid 1099-Misc income reporting" as well as seeking punitive damages and costs. The claim of Sticks and Grant was that Hefner's fiduciary duty to Sticks and Grant survived the first lawsuit, imposing on Hefner a greater responsibility in issuing the Form 1099s than another individual might owe. In its answer, Hefner counterclaimed pursuant to Iowa Rule of Civil Procedure 1.413(1) for sanctions "including legal fees and expenses and other amounts as are appropriate."

Hefner filed a motion for summary judgment in October of 2010, stating Sticks and Grant did not contact them regarding amending the Form 1099s and that the issuance of two forms was appropriate. It referred the court to affidavits of experts James Monroe and Bruce Cahill. The motion concluded with the statement, "This action is frivolous and sanctions should be awarded."

Sticks and Grant filed a resistance to the motion, including affidavits from two experts: Hove and another CPA named Stephen Thielking. Hove opined that Hefner knew through his work with Sticks and the first lawsuit that part of the settlement was to reimburse Sticks for expenses and was not taxable. He also stated that the IRS regulations regarding the preparation of Form 1099's were unclear where more than one recipient had received funds, but that the code requires reporting of payments to joint payees separately only if one of the payees is an attorney. His affidavit also included a statement regarding penalties imposed when improper returns forms are filed, and penalties which can be incurred when forms are fraudulent.

Thielking opined that joint payees frequently receive a single Form 1099 and that no exception existed to warrant the issuance of two in this case. He also opined that issuing two Form 1099s of $150,000 would be clearly misleading as it would represent the incorrect sum of $300,000. The resistance also stated that counsel for Sticks and Grant had contacted Hefner's counsel regarding the forms. It also argued that only thirty-five percent of the original judgment was a taxable event-$12,000 for the return of a consulting fee and $72,000 for punitive damages.

Hefner replied to the resistance of the motion for summary judgment, alleging the resistance was untimely, any communication with Hefner's former attorney regarding the forms did not constitute notifying Hefner, that Hefner did not need to analyze the parts of the settlement to determine what was taxable, that no code section prohibits the issuance of two Form 1099s, that the cases cited by Hove regarding fraudulent returns are distinguishable, and Thielking's affidavit was incorrect in stating the issuance of two Form 1099s doubled the amount reported. Hefner contended that Grant and Sticks' expert opinions were insufficient to generate a question of material fact, and its own experts had concluded there was no specific guidance from the Treasury Department addressing the issue in question. Hefner included in his reply that Grant and Sticks' expert opinions were insufficient to establish a breach of the standard of care in his profession.

The district court denied Hefner's motion in February of 2011, finding Grant and Sticks sufficiently had raised disputed issues of material facts. Judge Romano found "[t]he Plaintiffs, through counsel, requested to Defendant's counsel, that the Defendants withdraw or amend the 1099-MISC forms, to which the Defendants, through counsel, declined." The court summarized the Sticks and Grant's argument to be that [O]nly a portion of the settlement amount, if any, is taxable and the 1099-MISC forms should not have contained the entire $150,000.00" [and] . . . there ...

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