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“Gimme Shelter” is one of the greatest of a lot of great Rolling Stones songs (made greater by Merry Clayton’s gut-wrenching contribution). And, of course, “Gimme Shelter” is a cliché often trotted out in discussions of tax shelters. We’re not going to do that here. Instead, Financial Strategy Group, PLC v. Continental Casualty Co., Case No. 14-6296 (6th Cir. Aug. 4, 2015), puts us in mind of that other great Stones song, “You Can’t Always Get What You Want.” Because in Financial Strategy, the U.S. Court of Appeals for the Sixth Circuit reminded us that you can’t get liability insurance to guarantee your work product—especially when your work product produces illegal tax shelters.
Financial Strategy Group (“FSG”) prepared tax returns for two different groups of clients. Both groups were convinced by financial and tax advisors that they could reduce their tax bills by buying and selling distressed debt through limited liability companies (“LLCs”) that had been formed for that purpose. In both cases, FSG prepared tax returns for the LLCs, and the clients used information from those returns in their individual returns.
Both groups of (now former) clients later sued FSG, alleging that the preparation of the LLCs’ tax returns had been “the final step in implementing the … tax shelters.” The clients alleged that FSG knew, when it prepared the returns, that “federal authorities were investigating the legality of similar ‘abusive tax shelters,’” and that the IRS was likely to impose on the plaintiffs “substantial back taxes, interest, penalties, and other damages.”
FSG duly filed a claim under a professional liability insurance policy issued by Continental Casualty. But Continental refused to defend or indemnify FSG, on the ground that the policy excluded coverage for any claims “based on, arising out of or in connection with the design, recommendation, referral, sale or promotion” of illegal tax shelters.
FSG sued Continental, and the district court dismissed the lawsuit for failure to state a claim.
On appeal, FSG argued that the exclusion did not apply, because the disputed tax shelters had been designed, recommended and sold before FSG prepared their tax returns. The Court of Appeals made short work of that argument:
“FSG’s act of including a proposed loss on a tax return was itself a suggestion to claim the loss. Thus, regardless of when the shelters here were sold, FSG’s actions in preparing the LLCs’ returns amounted to a recommendation to proceed with them.
Even if preparing the returns constituted a “recommendation” within the meaning of the exclusion, FSG argued that this fact still would not bar coverage, because, under Tennessee law, an insurer must defend a policyholder if the underlying complaint “contains a single claim for which the policy provides coverage.” FSG argued that its clients’ complaints “contain at least some claims to which the exclusion does not apply.”
The Sixth Circuit considered four such claims, and it found that the exclusion barred all of them. The clients alleged, for example, that FSG had injured them by giving advice about their individual tax returns—the kind of advice a professional liability policy for tax preparers would usually cover. The court found, however, that the substance of the advice brought the exclusion into play:
“[T]he … complaint … alleges that FSG instructed the … clients to use illegal tax shelters, that FSG advised the … clients that the tax shelters were legal, and that FSG proposed tax returns that claimed losses from the shelters. That conduct amounts to the recommendation of illegal tax shelters, so the exclusion applies to it.
The court reached the same conclusion about allegations that FSG had improperly advised its clients to sign their individual returns, had advised them that the returns complied with professional and legal standards, and had failed to advise them that the returns did not comply with applicable law.
Finally, FSG argued that coverage was required under Tennessee’s “concurrent causation” doctrine, which mandates coverage if the loss is the result of two causes—one covered, one excluded. According to FSG, the underlying complaints alleged that the clients’ tax problems had been caused by both (1) the design, recommendation and sale of illegal tax shelters (excluded) and (2) the preparation of their individual tax returns (covered).
The court declared “that distinction is illusory,” because FSG’s tax-preparation activities “amount[ed] to the recommendation of illegal tax shelters.”
Although traditional barriers to coverage for faulty workmanship claims in the construction industry are often breached, courts are also finding new applications for the old principle that a liability insurer does not guaranty the quality of an insured’s work.
Financial Strategy stands for a related principle: liability insurance does not cover a professional whose services are the endpoint of a course of excluded, wrongful conduct in which the professional participates. Where a policy excludes coverage for work involving illegal tax shelters, the insured must steer clear of them entirely.