Battle of the Estoppels

May 17, 2021

In an earlier post, we wrote about a fascinating law firm limited liability partnership dispute culminating in a thoughtful post-trial decision by Erie County Commercial Division Justice Timothy J. Walker. Capizzi v Brown Chiari LLP involved two separate, full-blown litigations and bench trials more than a decade apart on the same issue: whether the law firm’s named partners were true “equity” partners of the firm. The legal significance of this issue was that if the firm’s named partners were true “equity” partners, then each had the power to unilaterally withdraw from and dissolve the partnership under Section 62 (1) (b) of the Partnership Law because the partnership lacked an agreement otherwise prohibiting withdrawal.

What made the Capizzi litigation unconventional was that Capizzi took essentially opposite positions as defendant in the first lawsuit and plaintiff in the second. In the prior lawsuit, Frascogna v Brown, Chiari, Capizzi & Frascogna, LLP, Capizzi opposed the position of his former law partner, Frascogna, who argued that he was true equity partner and dissolved the law firm as a matter of law when he formally withdrew from the firm. Capizzi lost that lawsuit, the Court concluding that all four of the original partners including, including Capizzi, were equity / general partners of the firm with the power to dissolve it unilaterally. After losing that lawsuit, the three remaining partners, including Capizzi, re-formed the firm under the same terms as the original.

Years later, Capizzi took the opposite position he took and lost in the first litigation, arguing that he was a true equity / general partner of the firm, and that his unilateral withdrawal from the firm caused its dissolution under Partnership Law § 62 (1) (b). In support of his position, Capizzi relied upon years of tax returns filed by the law firm and its name partners which he said showed that all three were general partners of the firm.

This unique fact pattern was the perfect setup to implicate multiple legal “estoppel” doctrines at once, namely, collateral estoppel, judicial estoppel, and tax estoppel. As we noted in our prior article, Justice Walker’s post-trial decision relied upon two of these doctrines – collateral estoppel and tax estoppel – to rule that Capizzi’s former partners, Brown and Chiari, were estopped from contesting Capizzi’s status as an equity / general partner of the firm due to the post-trial holding in the original Frascogna partnership litigation and the filing of tax documents stating that Capizzi was a general partner.

Last week, in Capizzi v Brown Chiari LLP, ___ AD3d ___, 2021 NY Slip Op 02956 [4th Dept May 7, 2021], a Rochester-based appeals court issued a decision affirming Justice Walker’s post-trial decision. Interestingly, though, the appeals court affirmed on different grounds that those relied upon by the lower court, suggesting that the higher court may have had some concerns with the lower court’s collateral and tax estoppel holdings. With Capizzi as a springboard, we’ll take a closer look at the doctrines of collateral estoppel, judicial estoppel, and tax estoppel as applied in business divorce cases.

Collateral Estoppel

“Under the doctrine of collateral estoppel, a party is precluded from relitigating in a subsequent action or proceeding an issue clearly raised in a prior action or proceeding and decided against that party or those in privity, whether or not the tribunals or causes of action are the same” (Reynoso v Ahava 750, LLC, 185 AD3d 1074 [2d Dept 2020] [quotations omitted]).

Collateral estoppel “applies only if [1] the issue in the second action is identical to an issue which was raised, necessarily decided and material in the first action, and [2] the party to be bound had a full and fair opportunity to litigate the issue in the earlier action” (Jaber v Elayyan, 191 AD3d 964 [2d Dept 2021] [quotations omitted]).

“The party seeking the protection of collateral estoppel bears the burden of proving that the identical issue was necessarily decided in the prior proceeding and is decisive of the present action,” and conversely, “the party against whom preclusion is sought bears the burden of demonstrating the absence of a full and fair opportunity to contest the prior determination” (id. [quotations omitted]).

Applying these rules, the lower court in Capizzi ruled that Capizzi’s former partners, Brown and Chiari, were “collaterally estopped from challenging issues conclusively determined against them in the Frascogna Action,” including that “Brown, Chiari, Capizzi & Frascogna LLP was a partnership with four equity partners, one of whom included Capizzi.” The appeals courts, however, did not address the collateral estoppel holding, choosing instead to affirm the lower court’s decision under the traditional multi-factor test for determining partnership formation, a standard we have written about many times.

Why did the appeals court in Capizzi seem to have a different view than the lower court of collateral estoppel? Important clues lie throughout Capizzi’s respondent’s briefs, which you can read here and here.

Capizzi argued throughout his briefs that he did not make any inconsistent representations in the Frascogna case about his equity status (or lack thereof) in the legacy firm, Brown, Chiari, Capizzi & Frascogna LLP, because that firm and the successor firm, Brown Chiari LLP, were separate entities: in Capizzi’s words, “his testimony in the Frascogna lawsuit concerned an entirely different partnership.” By arguing that the two firms were “entirely different,” one could argue that Capizzi defeated the “identicality of issues” prong of the collateral estoppel standard, explaining the appeals court’s reluctance to rely upon the doctrine.

Judicial Estoppel

“Under the doctrine of judicial estoppel, also known as estoppel against inconsistent positions, a party may not take a position in a legal proceeding that is contrary to a position he or she took in a prior proceeding, simply because his or her interests have changed” (Re/Max of New York, Inc. v Weber, 177 AD3d 910 [2d Dept 2019] [quotations omitted]).

Judicial estoppel “rests upon the principle that a litigant should not be permitted to lead a court to find a fact one way and then contend in another judicial proceeding that the same fact should be found otherwise” (id. [quotations omitted]).

An important limitation on the judicial estoppel doctrine: “The doctrine applies only where the party secured a judgment in his or her favor in the prior proceeding” (id. [quotations omitted]).

In Capizzi, this rule of law proved dispositive of Brown and Chiari’s argument, the appeals court holding:

[W]e reject the contention of defendants that, based upon plaintiff’s past sworn statements, plaintiff is judicially estopped from taking the position that he is a partner in the firm [because] the elements of judicial estoppel are lacking. Although plaintiff previously took the position that he was not a partner in the prior firm, that position did not prevail. Even if it had prevailed, we conclude that plaintiff’s position here is not contrary to his position in the Frascogna litigation. Plaintiff testified at trial that he changed his opinion of his ownership status around the time of the formation of defendant firm based upon his understanding of the Frascogna decision. In our view, plaintiff acted reasonably in doing so.

(citations and quotations omitted).

Tax Estoppel

“Under the doctrine of tax estoppel, party to litigation may not take a position contrary to a position taken in a tax return” (Rizzo v Natl. Vacuum Corp., 186 AD3d 1094 [4th Dept 2020] [quotations omitted]).

Tax estoppel derives from the notion that courts “cannot, as a matter of policy, permit parties to assert positions in legal proceedings that are contrary to declarations made under the penalty of perjury on income tax returns” (Mahoney-Buntzman v Buntzman, 12 NY3d 415 [2009]).

In Capizzi, the appeals court chose not to adopt the lower court’s tax estoppel holding. Why? It is not entirely clear. According to the lower court, Brown and Chiari signed and filed the firm’s business returns each year, which included Schedules K-1 identifying Capizzi as a partner with a capital account in the same percentage as Brown and Chiari and as a guarantor of the firm’s credit, so Brown and Chiari were estopped from denying Capizzi’s status as owner of the firm.

Perhaps the appeals court found this evidence more equivocal than the lower court. Chiari’s principal brief did not address tax estoppel, but Brown’s principal brief addressed it at the very end, arguing that the tax returns were “not inconsistent” with Capizzi’s status as income partner and even if they were some evidence of ownership status, they were not “conclusive evidence” (citing e.g. Matter of Bhanji v Baluch, 99 AD3d 587 [1st Dept 2012] [“Flytime’s federal tax return for the year 2000, which indicated she was a 50% owner of the corporation was insufficient, without more, to satisfy petitioner’s burden, since corporate and individual tax returns, even when filed with government agencies, are not in and of themselves determinative”). It seems the appeals court credited this argument, relying upon the firm’s tax documents as but one factor among several in determining partnership status, but not the end of the analysis.

The Lesson

As we’ve written previously, lawyers and law firms tend to generate an outsized share of business divorce litigation, ironically because they often do not carefully document their business relationships. For the law partners in Capizzi, one might say (of course with the benefit of hindsight), that the lesson after the first litigation was quite obvious: draft a partnership agreement. In the wake of the prior Frascogna litigation, if Brown and Chiari truly intended for Capizzi to be only an “income partner,” no one was in a better position to protect themselves than themselves.