Judge David J. Cowan, Case BP063500 2022-08-25 Tentative Ruling

Please notify Dept. 1’s courtroom staff by email (SMCDept1@lacourt.org) or by telephone (213-633-0601) no later than 8:30 a.m. the day of the hearing if you wish to submit on the tentative ruling rather than argue the motion. If you submit on the tentative, you must immediately notify the other side that you will not appear at the hearing. If you submit on the tentative and elect not to appear at the hearing, the opposing party may nevertheless appear at the hearing and argue the motion. Please keep in mind that appearing at the hearing and simply repeating the arguments set forth in the papers is not a good use of the court’s time or the parties’ time.

The Court issues an Order to Show Cause Re: Why Trial on Phantom Income Tax Issues Should Not Be Bifurcated, set for hearing on September 29, 2022 at 8:30 a.m. in Department 1.

Beneficiary and Former Trustees shall file separate Responses to the OSC Re: Bifurcation by September 15, 2022 addressing (1) what discovery is necessary to properly litigate phantom tax issues and how long this discovery is likely to take; (2) what expert testimony (if any) Beneficiary and Former Trustees intend to offer regarding tax liability; (3) whether the parties will stipulate to reopen discovery via stipulation and/or an unopposed motion, or whether any motion to reopen discovery will be disputed; (4) whether the parties are willing to stipulate to an expedited briefing schedule for a motion for summary adjudication, since the time for Former Trustees to file such a motion has long passed due to Beneficiary raising phantom income tax issues mid-trial; and (5) whether a bifurcated trial is necessary to adequately address phantom income tax liability issues without undue prejudice to Beneficiary or Former Trustees, particularly given the offset issue raised by FTI and absence of analysis of the Trust’s income streams by Patel/Deloitte.

The parties are ordered to make a good faith effort to meet and confer regarding the issues identified above (particularly as to the discovery needed, the time needed for that discovery, and the availability of an expedited motion for summary judgment, and the time needed to prepare for trial) before preparing their Responses to the OSC Re: Bifurcation.

On December 23, 2021, Beneficiary and Former Trustees filed a Joint Stipulation Re: Tower Grove Trial Dates providing that the first phase of trial would pertain to the value of Tower Grove, the second phase of trial would pertain to the amount of damages from Former Trustees' breach of trust and Former Trustees' defenses, and the third phase of trial would pertain to attorney's fees and costs incurred in connection with the Tower Grove litigation.

On March 10, 2022, Former Trustees and Beneficiary each filed Supplemental Briefs Re: Offers of Proof for Lost Profits. Beneficiary argued for the first time that the Court should consider damages to the Trust based on tax payments on “phantom income” accruing on the loans to Dickens after his default.

On March 24, 2022, the Court requested additional briefing from the parties regarding damages, to be filed on April 4 and April 11, 2022. As relevant here, the Court observed that the phantom income tax liability “issue was not timely raised in any prior briefing” and found “it is too late for Beneficiary to now introduce this issue,” concluding it “is outside the scope of the trial.” The Court indicated “determination of this issue may require evidence regarding Former Trustees’ and FTI’s handling of these ‘phantom tax’ liabilities and the propriety of payments thereon, which are collateral issues for purposes of this surcharge trial.” The Court explained that it would not “be appropriate to now reopen discovery and reorient the trial around this belatedly raised issue.”

On May 31, 2022, the Court issued its Interim Ruling on OSC Re: Scope of Valuation Phase Testimony and Issuance of OSC Re: Scope of Trial. In this Interim Ruling, the Court addressed various procedural and substantive objections by Beneficiary to past rulings and proceedings, as well as issues concerning the admissibility of certain lay and expert witnesses’ testimony for valuation of Tower Grove. As relevant here, the Court questioned “why the [phantom income tax] issue was so belatedly raised given that FTI allegedly paid taxes on phantom income from its appointment in 2013 through the foreclosure date in 2019,” particularly given the parties’ “asserted common interest in this litigation.”

On June 21, 2022, Former Trustees filed Motion in Limine No. 9 seeking to exclude any evidence and argument that Tower Grove is unmarketable.

On July 14, 2022, the Court issued its Final Ruling on the OSC Re: Scope of Trial, OSC Re: Scope of Valuation Phase Testimony, and Motion in Limine No. 9. As relevant here, the Court set an OSC Re: Phantom Income Tax for October 13, 2022, ordering FTI to “file its initial Brief concerning its treatment of phantom income tax liability by August 31, 2022” and Former Trustees to respond “by September 30, 2022.” The Court also “tentatively set[] a hearing for August 25, 2022 on Former Trustees’ Motion in Limine to exclude undisclosed testimony concerning phantom income tax liability.”

The Court expressed several concerns with this theory, including that “Beneficiary did not address FTI’s knowledge of its phantom income tax payments made between 2013 and 2019.” The Court found it “striking that Beneficiary did not attempt to address FTI’s years of knowledge of phantom income tax payments.” Indeed, “despite the Court and Former Trustees pointing out the issue several times, Beneficiary has never attempted to explain why FTI kept him in the dark on this issue.”

On August 3, 2022, Former Trustees filed Motion in Limine No. 10 seeking to exclude evidence or argument concerning phantom income tax damages.

On August 18, 2022, Former Trustees filed a Reply in support of Motion in Limine No. 10 and evidentiary objections.

On August 19, 2022, Beneficiary filed a Request for Judicial Notice of FTI's Response.

On August 22, 2022, Former Trustees filed an Objection to the Request for Judicial Notice of FTI's Response.

“‘Although not expressly authorized by statute, [a motion in limine] is recognized in decisions as a proper request which the trial court has inherent power to entertain and grant.’ [Cite.] The purpose of the motion ‘is to avoid the obviously futile attempt to 'unring the bell' in the event a motion to strike is granted in the proceedings before the jury.’ [Cite.] The scope of such motion is any kind of evidence which could be objected to at trial, either as irrelevant or subject to discretionary exclusion as unduly prejudicial.” (Clemens v. American Warranty Corp. (1987) 193 Cal.App.3d 444, 451.) “Motions in limine are ordinarily directed at particular items of evidence, rather than at a plaintiff's entire case.” (Id.) They “are designed to facilitate the management of a case, generally by deciding difficult evidentiary issues in advance of trial.” (Amtower v. Photon Dynamics, Inc. (2008) 158 Cal.App.4th 1582, 1593.)

“What in limine motions are not designed to do is to replace the dispositive motions prescribed by the Code of Civil Procedure. It has become increasingly common, however, for litigants to utilize in limine motions for this purpose. . . . These nontraditional in limine motions can result in a court's dismissing a cause on the pleadings. [Cites.] Some courts have also used the in limine process to examine the sufficiency of the evidence.” (Id. at 1594.) “Nontraditional” or “dispositive” motions in limine “circumvent procedural protections provided by the statutory motions or by trial on the merits; they risk blindsiding the nonmoving party; and, in some cases, they could infringe a litigant's right to a jury trial. [Cite.] Adherence to the statutory processes would avoid all these risks” and avoid “unnecessary reversals.” (Id.) Despite the “obvious drawbacks to the use of in limine motions to dispose of a claim, trial courts do have the inherent power to use them in this way.” (Id. at 1595.)

Former Trustees seek an order precluding Beneficiary from offering evidence or argument concerning damages arising from tax payments on “phantom income,” i.e., interest accruing on unpaid loans to Dickens. Former Trustees argue Beneficiary failed to timely disclose phantom income tax liability as a category of damages before the close of discovery. Former Trustees offer three arguments supporting exclusion.

First, Former Trustees argue permitting this damages theory "during trial and well after the close of discovery" would result in "'trial by surprise. (Motion, p. 12-13.) Second, Former Trustees argue Beneficiary bears the "burden to show that he could not have learned of this information through the exercise of ordinary 'diligence'" before the close of discovery, relying on CCP sec. 2024.050(b)(2) and Cottini v. Enloe Med. Ctr. (2014) 226 Cal.App.4th 401. (Motion, p. 13-14.) Finally, Former Trustees argue introduction of a new damages claim would result in "extreme and obviou prejudice at trial, relying on CCP sec. 2023.030(c).

In response, Beneficiary argues phantom income tax evidence should not be excluded because he did not “intentionally withh[o]ld the information” and Former Trustees would not be “genuinely ‘surprised’ by the evidence.” (Opposition, p. 7.) Beneficiary argues Former Trustees were not “genuinely ‘surprised’” by the phantom income tax issue because Former Trustees’ “counsel, including counsel at Loeb & Loeb, have known about the issue since inception in 2004.” (Opposition, p. 7.) Beneficiary also argues Former Trustees “really are saying . . . that the facts are undisputed and . . . they have no defense on the merits for the damage flowing from taxes paid on phantom interest income—i.e., that, if the evidence is considered, they will lose” at trial.[1] (Opposition, p. 3.)

Former Trustees argue CCP sec. 2023.030(c) permits imposition of an evidence sanction precluding evidence and argument relating to phantom income tax liability because this was not disclosed as a theory of damages before trial. (Motion, p. 14.) Section 2023.030 controls the imposition of “sanctions against anyone engaging in conduct that is a misuse of the discovery process.” Subdivision (c) authorizes “an evidence sanction . . . prohibiting any party engaging in the misuse of the discovery process from introducing designated matters in evidence.”

Here, Former Trustees have not established any “misuse of the discovery process” under CCP sec. 2023.010.[2] Former Trustees argue evidence may be excluded “if a party willfully withholds responsive material in discovery.” (Motion, p. 14 (citing Deeter v. Angus (1986) 179 Cal.App.3d 241, 254-55; Thoren v. Johnsten & Washer (1972) 29 Cal.App.3d 270, 273-74).) Indeed, “absent unusual circumstances, such as repeated and egregious discovery abuses, two facts are generally prerequisite to the imposition of a nonmonetary sanction. There must be a failure to comply with a court order and the failure must be willful." (Lee v. Lee (2009) 175 Cal.App.4th 1553, 1559; Mitchell v. Superior Court (2015) 243 Cal.App.4th 269, 272 (evidence sanctions for discovery nondisclosures are available “if the omission was willful or a violation of a court order compelling a response.”))

Though willfully withholding information may support sanctions, Former Trustees have not made any showing that Beneficiary “willfully” withheld any information during discovery, and do not argue Beneficiary violated any court order to produce information concerning phantom income tax liability. Instead, Former Trustees argue FTI was “on notice (or should have been on notice) of these alleged damages at least as early as July 2019,” and argues FTI’s knowledge is imputed to Beneficiary. (Motion, p. 13.) In effect, Former Trustees seek evidence sanctions on the grounds that Beneficiary, through FTI, should have known about phantom income tax damages earlier.

This is not a legally permissible basis for evidence sanctions under CCP sec. 2023.030(c). Evidence sanctions must be supported by willful misconduct and/or violation of a court order. A mere lack of diligence in discovery is, by definition, not a “willful” omission. Though a trial court may “exclud[e] evidence based on a willfully false discovery response,” exclusion is not supported by “mere failure to supplement or amend an interrogatory answer that was truthful when originally served.” (Biles v. Exxon (2004) 124 Cal.App.4th 1315, 1324; compare Motion, p 8 (arguing Beneficiary “had several opportunities to ‘update’ his interrogatory responses,” but failed to “disclose any alleged phantom income tax damages”.))

Even assuming arguendo that Beneficiary should have discovered these phantom income tax payments sooner, there is no evidence he knew of phantom income tax payments when he responded to Former Trustees’ interrogatories in 2021, and hence no evidence he willfully withheld information. (Rangel v. Graybar Electric Co. (1977) 70 Cal.App.3d 943, 949 (an interrogatory answer failing to identify witness did not support evidence sanctions “[i]n the absence of stronger evidence of wilful omission”))

The Court finds the case Beneficiary relies upon, R & B Auto Center v. Farmers Group, Inc. (2006) 140 Cal.App.4th 327, instructive here. In that case, the trial court granted a motion in limine to exclude testimony from three witnesses concerning sales of “inapplicable” lemon law coverage to car dealerships, finding the witnesses undisputedly “were not identified during the discovery process.” (Id. at 357 (citing Thoren, supra, 29 Cal.App.3d at 274).) However, the party offering these witnesses “stated that it did not discover the three witnesses in question until after the discovery cutoff date,” denying any “deliberate concealment” of the witnesses. (Id.)

The Court of Appeal concluded it “was error” to grant the motion in limine, explaining that evidence should not be excluded due to “mere failure to supplement or amend an interrogatory answer that was truthful when originally served.” (Id. at 358.) The Court of Appeal found the trial “court abused its discretion in excluding the testimony of these three witnesses, and thus excluding nearly all of the evidence that would have shown the alleged pattern and practice underlying the unfair competition claim.” (Id.)

R & B Auto indicates evidence should not be excluded as inconsistent with prior responses to interrogatories where those responses were “truthful when originally served.” Beneficiary provided responses to interrogatories, and then amended those responses, but no evidence has been provided suggesting Beneficiary’s original and amended responses were anything other than “truthful when originally served.” Moreover, granting this Motion in Limine would clearly dispose of Beneficiary’s claim to phantom income tax damages—which is a disfavored (but not strictly disallowed) use of motions in limine. (See Amtower, supra, 158 Cal.App.4th at 1595 (recognizing “obvious drawbacks to the use of in limine motions to dispose of a claim.”))

In turn, Former Trustees argue R & B Auto is distinguishable because the case “does not address the statutory requirements of 'diligence' and 'lack of prejudice' in [section] 2024.050 and related case law." (Reply, p. 10 fn. 7.) CCP sec. 2024.050 does not require Beneficiary show diligence here because he does not seek to reopen discovery. (CCP sec. 2024.050(b)(2) (trial court must consider the “diligence of the party seeking the discovery or the hearing of a discovery motion”)) The Court returns to this issue below. To the extent Former Trustees argue R & B Auto did not consider “lack of prejudice,” it is unclear what Former Trustees mean; they failed to adequately develop this argument. Generally, Beneficiary is not required to demonstrate introduction of this evidence will not be prejudicial; rather, it is Former Trustees’ burden as the moving parties to demonstrate that permitting this evidence will be prejudicial. The Court returns to the issue of prejudice below.

Next, Former Trustees argue it does not matter whether evidence was “willfully” withheld because they would still be “genuinely surprised” at trial, relying on Campain v. Safeway Stores, Inc. (1972) 29 Cal.App.3d 362, 366. Former Trustees argue the phantom income tax evidence would be surprising, and thus unduly prejudicial, because they were “deprived of the opportunity to: (i) take written discovery on this new damages claim; (ii) depose fact or expert witnesses with respect to the alleged phantom income taxes; (iii) designate an expert on this tax issue; and (iv) move for summary adjudication as to this damages claim.” (Reply, p. 4.) Former Trustees argue the Court should not allow Beneficiary to belatedly expand the scope of this trial, relying on Duchrow v. Forrest (2013) 215 Cal.App.4th 1359, wherein the Court of Appeal found error in permitting mid-trial amendments to a complaint that introduced “new and substantially different issues” which were “not included in the original pleadings.” (Id. at 1380.)

Campain is distinguishable. In that case, the plaintiff received an interrogatory asking whether she was “making any claim for loss of wages, earnings or earning capacity as a result of the accident alleged in your complaint,” and the plaintiff “answered, ‘No.’” (Campain, supra, 29 Cal.App.3d at 365.) This “‘set at rest’ the issue of loss of earnings and future earnings,” and the defendant did not conduct further discovery into the issue. (Id.) But at trial, the “first evidence [the plaintiff] offered related to her prospective employment at the time of the accident and her plans for future employment.” The defendant “objected . . . that loss of earnings and future earnings was no longer an issue,” but the trial court “permitted [the plaintiff] to testify” regarding loss of income.

On appeal, the defendant argued that “it was denied a fair opportunity to prepare to meet the issue of loss of earnings and future earnings because it had been advised in pretrial discovery that [the plaintiff] was no longer claiming damages for loss of earnings and future earnings.” The Court of Appeal agreed, finding “[p]rejudice to [defendant] is apparent” where the defendant “was genuinely surprised, and consequently unprepared to meet [plaintiff’s] claim for loss of earnings and future earnings when that issue was injected into the trial, and that this surprise prejudiced its defense.”

Campain is distinguishable on its facts—in that case, the defendant specifically asked whether the plaintiff would be seeking a certain category of damages, and the plaintiff affirmatively denied she would be seeking those damages. During a jury trial, the plaintiff submitted evidence of the very damages she denied she would seek. The Campain plaintiff did not argue she was unaware of lost earnings at the time she answered the defendant’s interrogatory, but Beneficiary here denies he was aware of phantom income tax payments when he answered Former Trustees’ interrogatories and there is no evidence contradicting Beneficiary’s position. To the extent Former Trustees rely on Campain to show that evidence sanctions can be imposed under CCP sec. 2023.030(c) to avoid “genuine surprise” at trial, the case does not support that conclusion—there is no analysis of whether discovery sanctions are available to address surprises at trial.

There is also a meaningful difference between introducing evidence of lost earnings midway through a jury trial after affirmatively representing that such evidence would not be produced (as in Campain) and introducing newly discovered evidence of tax payments during a bench trial after months of detailed briefing over whether such evidence should be admitted (as here). Here, the parties have had ample opportunity to explain to the Court why this category of damages should or should not be considered; by contrast, the plaintiff in Campain surprised the defendant by showing the jury evidence that she stated she would not offer.

Moreover, for reasons discussed below, the Court is requesting the parties address whether it would be proper to bifurcate trial on phantom income tax issues so that the parties can conduct discovery and pre-trial motion practice otherwise made impossible by Beneficiary’s belated introduction of this category of damages. There is no indication the Campain parties considered a bifurcated trial as to lost earnings, or that this was possible under the circumstances of that case. Thus, Campain is not on point here.

Duchrow, supra, 215 Cal.App.4th 1359 is also distinguishable. In that case, an attorney filed a lawsuit against a former client to recover attorney’s fees. Midway through trial, after the former client cross-examined the attorney, the attorney “moved to amend the complaint to conform to proof” by increasing the requested damages from “around $44,000” to over $355,000. (Id. at 1373.) The trial court allowed the amendment over the former client’s objection and the jury ultimately entered a verdict for the attorney “in the amount of $140,056.95.” (Id. at 1376.)

The Court of Appeal reversed the trial court's order granting leave to amend a complaint, finding the attorney had "offered no reason for the delay in seeking the amendment," which prejudiced the former client because it "changed the relevant facts and the theory of liability, significantly increasing the damages requested." (Id.) In considering "whether to allow [an] amendment," the trial court must "consider a number of factors: 'including the conduct of the moving party and the belated presentation of the amendment.'" (Id. at 1377.) Trial courts should generally not permit amendments which introduce “new and substantially different issues” or prejudice “the rights of the adverse party.” (Id. at 1378.) “[E]ven if a good amendment is proposed in proper form, unwarranted delay in presenting it may—of itself—be a valid reason for denial.” (Id.)

The attorney in Duchrow waited nearly three years to move to amend his complaint “on the fourth day of a five-day trial” based on facts already known to him (the terms of his retainer agreements) and did not attempt to explain the delay. (Id. at 1379-1380 (finding “Duchrow had all of the necessary information” for his new theory “[b]efore filing the complaint”).) Moreover, by seeking to amend the complaint mid-trial, the attorney prevented the client from conducting discovery into new issues (e.g., whether there was good cause for withdrawal and the reasonableness of hours claimed), including preparing expert testimony if necessary.

Duchrow is distinguishable on its face to the extent it concerns amendments to pleadings rather than exclusion of evidence. The same standards do not apply to motions in limine and motions to amend pleadings. Mere “unwarranted delay in presenting [an amendment] may . . . be a valid reason for denial” even if the proposed amendment is legally sound, while evidence generally may not be excluded on a motion in limine unless it is “unduly prejudicial”—which is not established by bare delay. In Duchrow, the attorney’s failure to explain his belated request to amend was reason enough for the Court of Appeal to reverse and remand. Moreover, unlike in this case, the attorney in Duchrow “had all of the necessary information” to support the proposed amendment before he even filed the original complaint years before trial. (Id.) Here, there is no evidence that Beneficiary was actually aware of phantom income tax issues at the time he filed his Consolidated Objections in 2018 (though, for reasons discussed below, he arguably should have inquired further into tax issues arising from the Tower Grove transaction). Hence, Duchrow applied different law (controlling mid-trial amendments to pleadings) to different facts (an amendment based on information long known to the plaintiff), and is distinguishable here.

Finally, Former Trustees argue Beneficiary has not carried his burden to show that he could not have diligently discovered the phantom income tax payments before the close of discovery. Former Trustees rely on CCP sec. 2024.050(b)(2), which requires the trial court to consider “the diligence of the party seeking discovery” in determining whether to grant or deny a motion for “leave to complete discovery proceedings,” “have a motion concerning discovery heard, closer to the initial trial date, or to reopen discovery after a new trial date has been set.”

On its face, CCP sec. 2024.050(b) is not applicable here; no party has moved to “complete discovery proceedings,” “reopen discovery,” or belatedly decide discovery motions. Rather, Former Trustees move to exclude Beneficiary’s evidence and argument relating to phantom income tax liability. Further, CCP sec. 2024.050(b)(2) requires the Court consider the “diligence of the party seeking the discovery,” and Beneficiary is not “seeking the discovery” here. On the contrary, Former Trustees argue they are unprepared to meet Beneficiary’s claims without further discovery. Hence, CCP sec. 2024.050(b)(2) does not require Beneficiary to show diligence in opposing this Motion.

In sum, Former Trustees’ Motion in Limine failed to support exclusion of Beneficiary’s phantom income tax evidence, and therefore is DENIED. Former Trustees primarily relied on authority concerning evidence sanctions (which require willful misconduct not shown here) and diligence as a prerequisite for reopening discovery (which Beneficiary does not seek, and so he is not subject to a requirement to show diligence). Former Trustees also argued they would be unduly prejudiced because they would be surprised at trial; the Court was unpersuaded mere surprise supported exclusion given the nature of this trial.

There is no apparent dispute that trial of phantom tax issues necessitates further discovery. Beneficiary acknowledges the need “to conduct discovery” because Former Trustees did not previously depose Beneficiary’s tax expert, Bina Patel, though Beneficiary asserts they “had ample opportunity to depose Ms. Patel.” (Opposition, p. 8.) Beneficiary “has no objection” to a deposition of Patel, arguing this can be “completed . . . before the next hearing in October” and arguing any delay will not be excessive because “this trial has been filled with long pauses for further briefing and discovery.” (Opposition, p. 8 fn. 3.) Former Trustees also argue they would need to conduct “targeted fact and expert discovery [as] to those alleged damages,” though argue the need for discovery demonstrates some risk of prejudice at trial (Motion, p. 14.)

The Court therefore recognizes that denying this Motion, and thereby permitting evidence and argument concerning phantom income tax, will likely prompt a motion to reopen discovery so that Former Trustees can adequately prepare for trial. However, it is unclear to the Court what discovery is required and how long this discovery will take. By extension, it is unclear whether phantom income tax issues can be reasonably included in this trial—a concern the Court has previously expressed—or whether a bifurcated trial would be necessary to avoid prejudice. (3/24/22 Ruling, p. 10 (expressing inclination to not “reopen discovery and reorient the trial around this belatedly raised issue.”)) Moreover, by raising these issues mid-trial, Beneficiary prevented Former Trustees from timely pursuing a motion for summary adjudication before trial—which is prejudicial—and it is unclear whether Beneficiary would be willing to remedy this prejudice by stipulating to an expedited schedule for a motion for summary adjudication limited to phantom tax issues.

Hence, the Court issues an Order to Show Cause Re: Why Trial on Phantom Income Tax Issues Should Not Be Bifurcated, set for hearing on September 29, 2022 at 8:30 a.m. in Department 1. Beneficiary and Former Trustees shall file separate Responses to the OSC Re: Bifurcation by September 15, 2022 addressing:

(1) What discovery is necessary to properly litigate phantom tax issues and how long this discovery is likely to take;

(2) What expert testimony (if any) Beneficiary and Former Trustees intend to offer regarding tax liability;

(3) Whether the parties will stipulate to reopen discovery via stipulation and/or an unopposed motion (see In re Marriage of Boblitt (2014) 223 Cal.App.4th 1004, 1025 ("the only means provided . . . for reopening discovery is a motion for leave of court"));

(4) Whether the parties are willing to stipulate to an expedited briefing schedule for a motion for summary adjudication, since the time for Former Trustees to file such a motion has long passed due to Beneficiary raising phantom income tax issues mid-trial (CCP sec. 437c(a) (permitting trial court to modify certain timelines for motion for summary judgment "for good cause" shown));

(5) Whether a bifurcated trial is necessary to adequately address phantom income tax liability issues without undue prejudice to Beneficiary or Former Trustees, particularly given the offset issue raised by FTI and absence of analysis of the Trust’s income streams by Patel/Deloitte, as discussed further below.

The parties are ordered to meet and confer in good faith regarding these issues before preparing their Responses to the OSC Re: Bifurcation. For context, the Court briefly addresses the capital gains tax offset issue identified by FTI and the Court’s own unresolved concerns regarding Patel’s conclusory account of the Trust’s tax expenditures.

The Court concludes the Order by briefly addressing Beneficiary’s failure to investigate the tax consequences of the Dickens loans despite knowledge of adverse tax consequences in other transactions negotiated by Former Trustees, FTI’s failure to inform Beneficiary of these payments for years even while Beneficiary was pursuing litigation against Former Trustees arising out of the Dickens loans, and the consequences of these omissions by Beneficiary and FTI—particularly the late introduction of phantom income tax issues mid-trial earlier this year.

It remains substantially unclear to the Court that phantom income tax issues can be efficiently litigated in this multi-phase trial; the late introduction of a new category of damages appears likely to delay resolution of Beneficiary’s claims to other damages, particularly if Beneficiary’s claims will require collateral litigation over the necessity and propriety of tax payments by Former Trustees and FTI. (See also 3/24/22 Order (“Former Trustees’ and FTI’s handling of these ‘phantom tax’ liabilities and the propriety of payments thereon, which are collateral issues…”)) The parties will have an opportunity to address the practicality of trying phantom tax issues in their responses to the OSC Re: Bifurcation.

Further, FTI acknowledges phantom taxes may serve as an offset for tax liability on future sale of Tower Grove. FTI states that tax payments on “phantom income would increase, and [have] increased, the Trust's basis in the Tower Grove property and might someday reduce future taxes payable if and when the Tower Grove property is sold." (FTI Response, p. 3.) However, FTI asserts the “impact [of that offset] is speculative" because "the increased basis only could reduce capital gains on a future sale of the property" and "it cannot be determined whether the higher tax basis will offset taxes and, if so, in what amount." (FTI Response, p. 3.) FTI presents multiple hypothetical sales of Tower Grove. (FTI Response, pp. 11-17.)

The Court is concerned by the prospect of windfall recovery for Beneficiary in obtaining damages for OID phantom income payments as well as tax offset from a future sale of Tower Grove. Assuming (as FTI contends) that the amount of that tax offset cannot now be determined due to uncertainty about the date and price point for a future sale of Tower Grove, this indicates it may be premature to determine the Trust’s damages from the phantom income tax payments as the benefit of said payments cannot be ascertained. The parties should address whether trial on phantom income tax damages can properly proceed before a sale of Tower Grove given the admitted potential for a significant capital gains tax offset arising from the Trust’s phantom income tax payments. It may be that this offset issue supports bifurcation of the phantom income tax issues for a later trial or denial of Beneficiary’s claims without prejudice—either of which would enable the Court to focus instead on the issues that were timely raised for this trial rather than tax issues raised mid-trial.

The Court is also concerned by the paucity of information regarding Deloitte’s management of phantom income tax liability. Though Patel alleges the Trust was required to pay taxes on accrued “phantom” income on the loans to Dickens, she offers no explanation why Deloitte elected to account for the Dickens loans using an accrual method rather than cash method where the former likely resulted in significant tax liability. The cash method contemplates recording income and expenses only when payments are actually received and paid, while the accrual method records income when invoiced and expenses when incurred on paper.

Where Dickens defaulted on all four loans and undisputedly did not pay back any money, such that no income was actually received, it is difficult for the Court to perceive any benefits from using the accrual method rather than the cash method. Rather, use of the accrual method appears to have generated tax liability on accrued (but unreceived) interest income. Given that Deloitte is a highly sophisticated tax firm, the Court considers it unlikely Deloitte chose to use the accrual method without any benefit where using the cash method would on its face avoid incurring tax liability on unpaid loans. Hence, the lack of explanation is troubling.

Moreover, the Court found Patel’s last Declaration “did not adequately address whether the Trust’s phantom income tax liabilities were used to offset tax gains from other transactions and thereby overall avoid tax liability” where the “Trust enjoys streams of income from several Trust-owned LLCs.” (7/15/22 Order, p. 30.) Without addressing distinct income streams, Patel reiterates her vague allegation that “the Trust’s total tax liability exceeded the amount of tax paid on the accrued interest income reported that year such that the amounts reported on the attached schedule necessarily reflect actual cash outflows.” (Patel Decl., para. 10.) The Court previously found this allegation “conclusory and lacking foundation,” and requested “further information regarding the Trust’s other income and potential offsets from phantom income tax liability to discern whether the Trust’s phantom income tax liabilities were used to offset other forms of income, effectively zeroing out losses.” (7/15/22 Order, p. 31.)

No new information has been provided, and in fact, the Patel Declaration filed on August 12, 2022 in support of this Motion is identical to the Declaration previously filed on June 24, 2022. Neither Declaration attempts to explain why Deloitte handled tax on the Dickens loans on an accrual rather than cash basis. Yet there was presumably some reason for this decision. The Court’s concerns regarding Deloitte’s management of phantom income tax remain unaddressed; these issues should be addressed in the Joint Trial Report as the Court is inclined to bifurcate trial on phantom tax issues if Beneficiary’s claims will require substantial litigation over Deloitte’s tax strategy.[3]

The denial of Former Trustees’ Motion in Limine does not mean that the Court’s concerns regarding Beneficiary’s discovery of this theory are resolved. The Court has repeatedly requested some explanation of why FTI failed or declined to inform Beneficiary of phantom income tax payments it made between 2013 and 2019 or earlier tax payments made by Former Trustees between 2004 and 2012. (5/31/22 Ruling, p. 23 (questioning “why the [phantom income tax] issue was so belatedly raised given that FTI allegedly paid taxes on phantom income from its appointment in 2013 through the foreclosure date in 2019,” particularly given the parties’ “asserted common interest in this litigation”); 7/14/22 Ruling, pp. 28-31, fn. 17 (“despite the Court and Former Trustees pointing out the issue several times, Beneficiary has never attempted to explain why FTI kept him in the dark on this issue.”))

Since at least April 20, 2018, when Beneficiary filed his Consolidated Objections to Former Trustees’ Accountings, Beneficiary has alleged that Former Trustees engaged in transactions that resulted in unnecessary tax liability for the Trust. Though Beneficiary asserts he did not inquire into the tax treatment of the Tower Grove earlier (which the Court takes this as true in the absence of any contrary evidence), Beneficiary does not even attempt to explain why he made no inquiry. The absence of any investigation is difficult to explain given Beneficiary’s objections to Former Trustees’ handling of taxes in other transactions.

Specifically, Beneficiary alleges Former Trustees mismanaged a “real estate investment in Hawaii, known as the Kapolei investment,” when they “improvidently agreed to make a loan of up to $ 11 million to an entity called Kapolei Studios, LLC, which intended to lease real property located in Hawaii and develop it into sound stages and related facilities.” (4/20/18 Consolidated Objections, pp. 11-12.) Former Trustees allegedly knew “the investment's success depended on the highly speculative prospect that the State of Hawaii would amend its laws to allow certain tax benefits that would make a sound stage and movie studio a viable enterprise.” The Trust allegedly “ended up carrying an investment of $9.76 million” and has “been unable to recoup a single penny.” Strikingly, Beneficiary alleges the Trust “has paid millions of dollars in taxes on the ‘phantom income’ it is deemed to receive each year under the terms of the loan,” which “continues to be a drain on the Trust resources.”

Beneficiary also alleges the Former Trustees “allowed an attorney (Kenneth Ziskin) . . . to talk them into a complicated, convoluted estate tax scheme (a Graegin loan transaction)” using “an assetless shell entity created by Ziskin (and owned by the Ziskin family) for the sole purpose of serving as . . . a conduit for the transfer of funds, but otherwise contribut[ing] nothing.” (4/20/18 Consolidated Objections, pp. 14-15.) Beneficiary alleges this transaction was not approved by the IRS or a court “in the form [Ziskin] was proposing” and alleges the deal “depended upon acceptance of representations made to the IRS that, being charitable, were of dubious veracity.” Notably, FTI asserts "the Trust has recognized and paid income tax on over $100 million in phantom income in connection with the Graegin loan transaction undertaken by the Former Trustees.” (FTI Response, p. 2 fn. 1.) Whether FTI and Beneficiary’s assertions are accurate or not, they reflect awareness of phantom income tax issues in the Graegin transaction.

Thus, since at least April 2018, Beneficiary has known that Former Trustees made at least two loans with damaging tax consequences, and one incurred “phantom income” tax liability, but he made no inquiry into Former Trustees’ handling of taxes for the Tower Grove loans. Even taking as true Beneficiary’s assertions that he was unaware of the Tower Grove phantom taxes until March 2022, Beneficiary has not attempted to explain why he did not inquire into the tax consequences of the Dickens loans. This lack of explanation is striking given that Beneficiary and his sophisticated counsel knew of unnecessary tax liability in other transactions handled by Former Trustees.

It is difficult to understand why Beneficiary or his counsel would not attempt to determine whether any tax consequences flowed from several unpaid loans to Dickens totaling $200 million; though less than $20 million was actually disbursed under the Dickens loans, this still far exceeded the amount disbursed under the unpaid Kapolei loan, and hence Dickens’ default would have raised alarms concerning potential tax consequences. (12/2/21 Joint Stipulated Statement of Facts, para. 22-27, 30-32.). Beneficiary does not offer justification for not looking further into the issue between April 2018 and March 2022, merely asserting ignorance.[4]

Beyond Beneficiary’s knowledge of tax consequences in other mismanaged transactions, FTI knew about Former Trustees’ tax payments on phantom income accruing on the Dickens loans between 2004 and 2013. FTI was equally aware of phantom income tax payments it made as Successor Trustee between 2013 and 2019. Despite its common defense agreement with Beneficiary, FTI asserts Beneficiary “has never been involved or consulted in regard to Trust taxes” because Trust tax matters are “treated as confidential.”

In other words, FTI declined to inform Beneficiary of tax payments made on phantom income accruing on the Tower Grove-related loans to Dickens despite Beneficiary’s ongoing pursuit of litigation against Former Trustees arising out of the Tower Grove transaction. It is not enough for FTI to say it did not inform Beneficiary; it must explain why it chose to keep Beneficiary in the dark, which has (according to Beneficiary) prevented him from discovering these damages until March 2022. FTI’s lack of explanation is particularly concerning where, as Successor Trustee, FTI has duties “to take reasonable steps to enforce claims that are part of the trust property” and “to preserve the trust property.” (Prob. Code sec. 16006, 16010.) FTI’s failure to inform Beneficiary of (at minimum) its own phantom income tax payments between 2013 and 2019 interfered with Beneficiary’s timely identification of recoverable damages arising from the Tower Grove transaction.

In sum, Beneficiary plainly had reason to inquire about tax consequences of the Dickens loans—he knew that Dickens had defaulted on the loans and knew that Former Trustees’ other transactions resulted in objectionable tax liabilities for the Trust. In particular, Beneficiary knew that the defaulted Kapolei loan resulted in phantom income tax liability. FTI was also aware of the tax consequences of the Dickens loans. Despite paying taxes on phantom income accruing on these loans for several years and entering into a common defense agreement with Beneficiary, FTI chose not to inform Beneficiary. Beneficiary’s injection of novel phantom income tax issues mid-trial could have easily been avoided by simply asking FTI about negative tax consequences of the Dickens transactions, or by FTI volunteering this information, either of which could have occurred given the parties’ joint pursuit of litigation. Neither FTI nor Beneficiary address this communication breakdown.

Hence, in denying Motion in Limine No. 10, the Court is not justifying Beneficiary’s belated introduction of this category of damages—it is merely concluding that Former Trustees failed to establish sufficient legal grounds for exclusion of evidence relating to these damages. The Court will consider difficulties with trying claims for phantom income damages in connection with the OSC Re: Bifurcation.

Former Trustees filed evidentiary objections to the Declarations of Thomas Kenney and Bina Patel—three objections to the former and eleven objections to the latter. Former Trustees also filed an objection to Beneficiary’s Request for Judicial Notice of FTI’s Response to the OSC Re: Phantom Income Tax Liability.

Kenney alleges that "Former Trustees knowingly accepted the 100% seller financed sale and 100% accrual Tower Grove Notes knowing that such structure would generate OID phantom income" and that "Former Trustees and their tax lawyers were advised of this when the transaction was structured." Former Trustees argue this testimony is based on inadmissible hearsay (discussions with Patel) and secondary evidence (“Trust records turned over to FTIC”). Former Trustees also argue Kenney is speculating “as to what Former Trustees knew or did not know, and whether or not they were ‘surprised.’”

Former Trustees’ objections are well-taken and SUSTAINED. Kenney explicitly relies on out-of-court discussions with Patel and vaguely defined “Trust records” to support his assertion that Former Trustees knew the Tower Grove transaction would result in phantom income tax liability. No applicable hearsay exception has been identified for the out-of-court discussions Kenney had with Patel; though Kenney does not describe Patel’s statements, he appears to be relying on inadmissible hearsay to support his own conclusions. Further, Kenney does not identify the “Trust records” relied upon. To the extent Kenney asserts his review of “Trust records” showed “the Former Trustees paid [phantom income tax] throughout their tenure as trustees,” Kenney appear to be describing the contents of writings which could be admitted into evidence. (But see Evid. Code sec. 1523(d) (permitting oral testimony describing a writing which “consists of numerous accounts or other writings that cannot be examined in court without great loss of time, and the evidence sought from them is only the general result of the whole.”))

Kenney alleges “research into the tax aspects of the Tower Grove Sale transaction was not undertaken until after the Former Trustees earlier this year first suggested that the $23.75 million in sales proceeds from the 2004 Tower Grove Sale should be reduced by capital gains taxes presumably paid as a result of that, and it was at that point the Trust’s accountant . . . first discussed the tax paid on phantom income” with Beneficiary’s counsel. Former Trustees argue Kenney lacks “personal knowledge [as to] what research (if any) was conducted by Beneficiary, Beneficiary’s counsel/experts, and/or Deloitte into the tax aspects of the Tower Grove sale transaction, or when any such research was conducted by parties other than FTI.”

The Court agrees and SUSTAINS this objection; the Declaration lacks any allegations establishing Kenney’s personal knowledge of inquiries by other parties into tax consequences of the Tower Grove sale. Kenney asserts he has personal knowledge of Trust affairs because he has served as “the individual at FTIC principally responsible for our company’s services with respect to the Trust since January 2013, when FTIC was first appointed trustee ad litem of the Trust,” and “remain[s] principally responsible to this day.” But this does not suggest Kenney would have personal knowledge of whether and when non-FTI parties investigated the tax consequences of the Tower Grove deal. In particular, Kenney has not alleged any facts suggesting he would be personally aware of inquiries to Deloitte, which handles taxes for the Trust, concerning the Tower Grove deal.

Kenney alleges Beneficiary “and his counsel had no reason or ability to know about the tax on phantom income generated by the notes secured by Tower Grove until it was disclosed to counsel earlier this year” and argues “the fact that Beneficiary did not raise this issue until earlier this year . . . strongly supports the notion that he and his counsel did not know (as there would have been no reason to reduce damages).”

Former Trustees persuasively point out that "[n]othing prevented Beneficiary from simply asking FTI what taxes were paid for the Property as part of . . . investigation prior to the close of discovery,” but this merely indicates Kenney is wrong about Beneficiary’s “ability to know about the tax”—not that Kenney’s testimony should be excluded. Regardless, the Declaration lacks any facts indicating Kenney would have personal knowledge that Beneficiary “had no . . . ability to know about the tax on phantom income” from other sources (e.g., Deloitte itself).

The Court SUSTAINS Former Trustees’ objection to Patel’s allegation that “applicable tax law” required the Trust “to report interest income accruing on the loans to the Dickens entities, and to pay taxes based on the interest accruing each year.” Patel fails to identify any applicable tax law to support her legal conclusion that the Trust was required to report phantom income. Moreover, the Court is concerned whether her testimony on tax law would be admissible where Patel was not otherwise disclosed as an expert on tax issues. This concern is particularly pressing in light of “the prohibition against admission of an expert's opinion on a question of law,” such as the obligations of the Trust under “applicable tax law.” (Summers v. A.L. Gilbert Co. (1999) 69 Cal.App.4th 1155, 1178.)

The Court OVERRULES Former Trustees’ objection to Patel’s allegations regarding an email previously provided to the Court. The secondary evidence rule does not prohibit witnesses from describing writings otherwise admitted into evidence. (People v. Gonzalez (2021) 12 Cal.5th 367, 410 (“Gonzalez has cited no case in which the secondary evidence rule was applied when the writing itself was admitted into evidence”); People v. Son (2020) 56 Cal.App.5th 689, 696 (“Defendant has not pointed to any case in which the secondary evidence rule was applied even though the writing itself was admitted into evidence.”))

Where Former Trustees have offered the original email into evidence, the secondary evidence rule does not support exclusion of testimony explaining and interpreting that email. (Id. at 411 (secondary evidence rule was not violated where “the purpose of the detectives’ testimony was not to prove the actual words that were said in the video, but rather to give general context as to the subject matter . . . and explain the meaning of some of the terms the speakers used.”)) The Court did not find Patel’s contextualizing comments on the subject matter of that email to be improper legal argument or conclusion, or improper expert testimony.

The Court SUSTAINS Former Trustees’ objections to Patel’s allegation that Deloitte “determined that, for each year from 2004 through 2018, the Trust’s total tax liability exceeded the amount of tax paid on the accrued interest income reported that year such that the amounts reported on the attached schedule necessarily reflect actual cash outflows.” This allegation is vague, ambiguous, and conclusory, as discussed above. (See also 7/15/22 Order, p. 30-31.)

The Court OVERRULES Former Trustees’ objections to Patel’s allegation that she is “not aware of any way for the Trust beneficiary to know these facts related to the Hughes Entities’ tax reporting of the transaction without reviewing the tax returns and talking to me or the Trustees.” Patel alleges she “did not disclose this information . . . until very recently, when counsel called to inquire.” Former Trustees argue Patel lacks personal knowledge to testify that she is “not aware” of a path for Beneficiary to learn about phantom income tax issues; this argument is unpersuasive. Patel plainly has personal knowledge of whether she knows another way for Beneficiary to gain this information and whether and when she told Beneficiary’s counsel about phantom income tax issues. Patel’s testimony is not argumentative or speculative.

The Court partially SUSTAINS Former Trustees’ objection to Patel’s allegations that “tax issues were discussed with, and approved by, the Removed Trustees and their representatives prior to when the applicable tax return was filed” and that “the Beneficiary would have been unaware of these issues until now.” Patel’s Declaration speculates as to what Beneficiary “would have been unaware” of without alleging facts showing Patel would have knowledge of that issue. The Court does not find the remaining allegations excessively vague or ambiguous.

The Court OVERRULES Former Trustees’ objection to Patel’s allegation that “tax issues and tax return reporting . . . were discussed with the Removed Trustees and their representatives, including counsel at Loeb & Loeb, prior to when the tax return was filed.” Former Trustees claim this testimony is vague and ambiguous; the Court does not agree.

The Court OVERRULES Former Trustees’ objection to Patel's allegation that she would often communicate with Former Trustees' counsel, Mr. Stolyar, about "information concerning taxes." The Court did not find this allegation vague or ambiguous, and Patel would have personal knowledge of whether she communicated with Mr. Stolyar. Patel also alleged that she "cannot confirm whether [Mr. Stolyar] did or did not inquire as t phantom income tax issues; Former Trustees state that Patel "admits she does not know whether she ever had any discussions with Mr. Stolyar regarding phantom income tax issues concerning Tower Grove." This is true, but not an evidentiary issue; Former Trustees appear to agree with Patel’s testimony on that point. To the extent Former Trustees argue this allegation is speculative, that argument is rejected; the allegation appropriately limited to matters within Patel's knowledge.

The Court OVERRULES the objection to Beneficiary’s Request for Judicial Notice of FTI’s Response and GRANTS that Request. “The court may in its discretion take judicial notice of any court record in the United States.” (Lockley v. Law Offices of Cantrell Green Pekich Cruz McCort (2001) 91 Cal.App.4th 875, 882.) “However, while courts are free to take judicial notice of the existence of each document in a court file, including the truth of results reached, they may not take judicial notice of the truth of hearsay statements in decisions and court files. [Cite.] Courts may not take judicial notice of allegations in affidavits, declarations and probation reports in court records because such matters are reasonably subject to dispute and therefore require formal proof.” (Id.)

Here, the Court is not taking “judicial notice of the truth” of FTI’s assertions and allegations in its response—merely taking notice of the fact that FTI made certain assertions. The Court rejects Former Trustees’ argument that FTI’s response is irrelevant to the Motion in Limine; FTI’s response and Former Trustees’ Motion both address Beneficiary’s knowledge of phantom income tax damages. To the extent Former Trustees contend they should be permitted an opportunity to prepare a response to FTI’s response before the Court takes judicial notice, the Court finds this is unnecessary. Judicial notice of the contents of FTI’s response generally supports Former Trustees’ position that Beneficiary did not diligently investigate phantom income tax damages before trial, though Former Trustees failed to show that this warrants exclusion of such damages, as discussed above. The Court will still have opportunity to consider Former Trustees’ response to FTI in connection with the OSC Re: Phantom Income Tax, and at that time can consider factual conflicts between Former Trustees’ and FTI’s responses.

The Court issues an Order to Show Cause Re: Why Trial on Phantom Income Tax Issues Should Not Be Bifurcated, set for hearing on September 29, 2022 at 8:30 a.m. in Department 1.

[1] This is not an accurate characterization of Former Trustees’ position. Moreover, Former Trustees’ Reply identifies several defenses that could have been asserted had Beneficiary disclosed this theory of damages sometime before trial. (Reply, p. 12.) For example, Former Trustees point out that FTI continued to pay taxes on the phantom income for several years after Former Trustees’ removal, on some level indicating Former Trustees’ payments prior to removal were not improper. The Court does not consider Beneficiary’s argument further.

[2] Misuses of the discovery process include persistently attempting to obtain information “outside the scope of permissible discovery” without justification, “[u]sing a discovery method in a manner that does not comply with its specified procedures” or “in a manner . . . that causes unwarranted annoyance, embarrassment, or oppression, or undue burden and expense,” “[f]ailing to respond or to submit to an authorized method of discovery,” making an unjustified and “unmeritorious objection to discovery,” making “an evasive response to discovery,” “[d]isobeying a court order to provide discovery,” unjustifiably and unsuccessfully “[m]aking or opposing . . . a motion to compel or limit discovery,” or failing to make a good faith effort to meet and confer where required. (CCP sec. 2023.010.)

[3] FTI’s Response attempts to support Patel’s contention that the Trust was required to report unpaid income. FTI asserts OID rules apply "to all debt instruments with accruing but unpaid interest albeit "with exceptions covering many routine transactions," though asserts "none of those routine exceptions apply" to the Dickens loans. Hence, FTI argues "all accruing interest on the Tower Grove Notes . . . was required to be recognized as income by the Trust on its income tax returns (even though not received).” (FTI Response, p. 2.) But unlike Patel, who was involved in Former Trustees’ tax strategy, there is no indication that FTI has knowledge of tax decisions made by Former Trustees between 2004 and 2012. As a result, even if FTI is legally correct about the Trust’s tax obligations (which the Court is not concluding at this time), it is unclear that Former Trustees were acting merely due to perceived tax obligations or whether they decided to report unpaid income for other tax benefits and offsets.

[4] Beneficiary denies constructive or inquiry notice of phantom income tax payments related to the Tower Grove transaction, arguing the “notion that FTI’s knowledge must be imputed to the Beneficiary is plainly false” because “the Beneficiary is not the Trust.” Beneficiary has not explained how the latter point supports the former; Beneficiary could still be on constructive notice of damages to the Trust even if he “is not the Trust” or even the Trustee. There is no dispute that Beneficiary and FTI had (or have) a common defense agreement. Status as the Beneficiary of the Trust does not prove (or even suggest) that Beneficiary lacked constructive notice of the phantom income tax payments. (See also Prob. Code sec. 16460(a) (statute of limitations on claim against trustee begins to run when beneficiary receives report providing “sufficient information so that the beneficiary . . . reasonably should have inquired into the existence of the claim.”))