Judge: Mark H. Epstein, Case: 23SMCV01911, Date: 2024-02-22 Tentative Ruling

Case Number: 23SMCV01911    Hearing Date: February 22, 2024    Dept: I

The demurrer to the cross-complaint is OVERRULED in part and SUSTAINED WITHOUT LEAVE TO AMEND in part.

Defendants filed tax returns on plaintiffs’ behalf.  Plaintiffs later learned that the tax returns failed to set forth the correct basis of certain securities leading to significantly larger tax liability than should have been reported.  Plaintiffs therefore sued defendants.  Defendants filed a cross-complaint against the cross-defendants—a law firm and a partner.  Cross-complainants contend that the law firm had also been retained by plaintiff to provide advice concerning the formation of certain entities but also to provide certain tax strategies to plaintiffs.  According to the cross-complaint, the law firm provided information to plaintiffs who forwarded that information on to cross-complainants, who relied thereon.  The cross-complaint alleges that the information so provided was not correct and that the problem tax returns were the result of that bad information.  Cross-complainants sue for indemnity, contribution, declaratory relief, and negligence.  Cross-defendants demur and cross-complainants oppose.

Central to the demurrer is the theory of duty.  Cross-defendants contend that a lawyer (and a law firm) owes no duty except to the client and to a third party beneficiary of the contract between attorney and client.  That is, generally speaking, a correct rule of law.  (Moore v. Anderson Zeigler Disharoon Gallagher & Gray (2003) 109 Cal.App.4th 1287.)  Here, cross-complainants are not the client; plaintiffs are the client.  Thus, the law firm owed no direct attorney-client duty to cross-complainants.  But what of the third party beneficiary theory?  That is a relatively narrow exception to the general rule that a lawyer’s duty starts and stops with the client.  Where there is a third party who everyone knows is intended to rely on counsel’s advice, then if the advice is improper, a tort can be alleged.  Thus, where a client asks for an opinion letter from a lawyer and everyone knows that the client intends to show the letter to an investor and that the investor will rely on it, if the opinion is negligently rendered the investor may sue.  (Lucas v. Hamm (1961) 56 Cal.2d 583.)  And that rule has been extended a bit so as to apply to a third party where the transaction was intended to benefit the third party, there was foreseeability of harm, certainty that the harm came to pass, a close connection between the lawyer’s conduct and the harm, moral blame, and imposing liability would prevent future harm, such as where the plaintiff is the beneficiary under a trust injured because the attorney negligently drafted the trust documents.  (Moore, supra, 109 Cal.App.4th at pp. 1294-1295.)

What the court cannot tell here is whether cross-complainants qualify.  The complaint is somewhat terse.  It alleges that cross-defendants provided information that cross-complainants needed in order to fill out the tax returns and that this information was given to cross-complainants (although the court is not sure if the allegation is that the information came indirectly from the client or directly from cross-defendants).  And there is the rub.  If cross-defendants knew that their advice and information was going to be given to the tax preparer who would rely on that advice at the time the advice was given, it could be enough.  But if that was not part and parcel of the contract between the law firm and plaintiffs, then it would not be enough.  Consider the following hypothetical.  Law firm L comes up with a tax structure that the firm believes will minimize taxes by characterizing something as a lease rather than a sale.  L provides that structure along with supporting information to income tax preparer P, who relies on that to prepare client C’s tax returns.  L knows that the structure will be given to P and that P will rely on it in preparing the returns.  However, the structure is faulty and will not achieve the intended tax savings.  P dutifully uses the information to prepare the tax return, making certain elections and calculations based on the structure and advice L gave.  The return is filed on C’s behalf.  Because of the erroneous structure, however, the IRS later disallows certain deductions and finds that C owes lots of money in back taxes, interest, and penalties even though had a proper structure been in place the deductions could have been properly taken.  When the IRS imposes the penalty, C sues P for not preparing the returns in such a way to minimize taxes notwithstanding L’s advice.  One could see how P might well have a cause of action against L for indemnity or perhaps contribution or perhaps negligence.  If, however, so far as L knew its job ended when it provided its advice to C, then it would be hard to understand how P might have a cause of action against L down the road, even if it was somehow L’s actions that led to the tax ruling.

The court cannot tell from the complaint whether or not cross-defendants are alleged to have known and understood that their information would be forwarded to cross-complainants and relied upon by cross-complainants in filing tax returns.  And, at the pleading stage, the court must construe the complaint in the light most favorable to the cross-complainant.  Frankly, the court suspects that cross-complainants’ theory will ultimately not hold up.  Reading between the lines, the cross-complaint seems to read more like a claim that the legal advice was poor and so it is really the lawyers’ fault that plaintiff paid too much in tax rather than that the lawyers provided negligently bad information to cross-complainants who relied on it to file a bad tax return and that cross-complainants were third-party beneficiaries.  But the court cannot indulge that suspicion now.  The court recites it only because the court suspects a summary judgment motion is coming down the pike following some pretty basic discovery, and it could well be that this case will not survive an evidentiary showing that cross-complainants were not true third party beneficiaries here.

And that is important.  Indemnity does not apply when there are simply two tortfeasors.  It arises only when the liability is joint and several such that one of them ought not be left holding the proverbial bag for the other.  But here, what is most likely being claimed in the cross-complaint is that it is not cross-complainants’ returns that caused the problem at all, but rather cross-defendants’ allegedly bad legal advice.  If such is the case, there is no indemnity.  What there is would be the ability for cross-complainants to allege that they are not liable at all for the injury, or that if they are liable, cross-defendants’ actions are such that their liability is not the total harm.  In other words, their claim would be that the liability is several, not joint and any judgment ought to be reduced by cross-defendants’ negligence as part of the verdict.  There is no indemnity (or contribution, for that matter) where the liability is several and not joint. 

The negligence cause of action stands or falls with contribution and indemnity.  If cross-complainants are third party beneficiaries, they may well be able to claim professional negligence.  And if not, then there is no duty of professional care owed to them and thus no cause of action.  (This is professional negligence or nothing.  There is no claim that cross-defendants hit cross-complainants’ car on the way to the IRS filing location and thus caused the filing to be late or incomplete because certain pages were lost in the wreckage.)

Finally, as to declaratory relief, the court tends to agree with the demurring defendants.  There is no need for a declaration here.  The issue will either be solved on the merits or the jury’s verdict will apportion the liability.  The demurrer is SUSTAINED WITHOUT LEAVE TO AMEND as to that cause of action.  It is OVERRULED in all other respects.  Cross-defendants have 30 days to answer.