Judge: Mark H. Epstein, Case: 19SMCV01265, Date: 2024-01-05 Tentative Ruling

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Case Number: 19SMCV01265    Hearing Date: March 27, 2024    Dept: I

The court is inclined to GRANT THE MOTION TO QUASH IN PART AND DENY THE MOTION TO QUASH IN PART.  This motion involves a subpoena upon NHH’s tax preparer.  Plaintiff, HIG, seeks certain tax records.  In Phase I of the case, the court concluded that the November Agreement did provide that HIG’s economic interest could be diluted if it failed to make a capital call, and that the dilution would be to a new percentage based upon the capital HIG had contributed as against the capital contributed by all those with an economic interest following the capital call rather than to zero, as defendants had suggested.  Thus, to know the proper new economic interest, it will be necessary to determine what HIG’s capital was (which is not hard to discern) and the total capital following the capital call.  To be clear, that is not the total capital as of the date of trial.  HIG received no further capital calls after the one at issue, and therefore the dilution will only be as to capital that was contributed contemporaneously (or perhaps nearly contemporaneously) with the capital call at issue.

The evidence in Phase I of the trial was that many things were informal as between the various parties.  Loans were made and acknowledged (and repaid) without paperwork, for example.  There is nothing illegal about that, but when it comes to the parties’ contract, they are bound by what they signed, not by any informal way of doing things.  So here it is important to know what the capital is and when it was contributed.  Mavaddat, who controls the remaining entities that have an interest in NHH (or at least did at the relevant time after Samara sold out), has or will testify, but that testimony may not be reliable in a formal accounting way.  For example, there may have been money infused into NHH, but if the money was in the form of a loan taken out by NHH, that is not of necessity a capital contribution, even if (perhaps) Mavaddat guaranteed the loan.  Conversely, if Mavaddat took out a personal loan and used the proceeds to make a capital contribution to NHH, that likely would count as a capital contribution.  Because of evidence adduced in Phase I of the trial, the court is not sure that it has 100% confidence in NHH’s books and records.  The parties acted with great informality and the number of errors (both sloppy and not) that NHH’s lawyer made that have been documented in the evidence.

To attempt to get a definitive answer to this question, HIG seeks certain tax documents.  As HIG notes, tax documents are submitted under penalty of perjury, and thus have a patina of extra veracity.  Further, given that they are filed with the IRS and there are criminal penalties as well as civil penalties for getting it wrong, there is more reliability placed upon them.  True, there is some evidence that the accountant simply filled in whatever numbers Mavaddat told him to write down.  But the court is not so convinced that the accountant was a mere scrivener that it will discount the tax documents.

The court does, of course, recognize that there is a qualified privilege for tax papers.  Because of the importance of encouraging honest filings with the taxing authorities, generally tax returns and supporting papers will not be produced in discovery.  However, the privilege is not without its limits.  (Schnabel v. Superior Court (1993) 5 Cal.4th 704.)  The privilege will not be upheld where there is an intentional relinquishment, the gravamen of the lawsuit is inconsistent with the privilege, or a public policy greater than confidentiality is involved.  Here, the court looks at two exceptions.  First, to the extent that NHH’s records purport to discuss HIG, HIG’s interest in knowing how it is being portrayed to the taxing authorities outweighs any interest NHH might have in keeping that information private.  But further, NHH (or its owners) have put this at issue.  Although perhaps not knowing it when NHH took the dilution action that it did, the proper dilution turns on capital, and this could be the only accurate way to get at that number.  Finally, HIG has an economic interest in NHH.  As such, it has certain rights under the various agreements to certain information.

Here, HIG seeks the K-1,the K-1 summary worksheets, reconciliation of partners’ basis worksheets, reconciliation of partners’ capital accounts worksheets, “Federal Statements,” analysis of partner’s K-1 current year increase or decrease worksheets, partner’s basis worksheets with shares of income, deductions, and the like, California statements, and the fist page of the returns, all for 2003 to the present.  The court agrees with HIG that documents pertaining to the capital, including schedules and worksheets, should be produced, and to that extent the motion is DENIED.  That is the K-1’s and worksheets as well as any forms or schedules containing the capital percentages or amounts for each partner or person with a capital account.  That applies to both federal and California returns.  On the other hand, the court does not agree that the first pages of the returns are required or statements as to distributions of income or loss paid out or other documents not pertaining to capital, and to that extent the motion is GRANTED.  The court also does not know what a “Federal Statement” is.  The production should span from the year before the year of the capital call to and including the year pertaining to which suit was filed and one year after that unless defendants intend to claim that relevant capital was contributed after that date, in which case the years will extend through that period. 

Because there was substantial justification on both sides, the requests for sanctions are DENIED.