Audited Through the Courts: The Troubling Trend in Flase Claims Act, Class Action and Municipal Litigation

AUDITED THROUGH THE COURTS:
The Troubling Trend in False Claims Act,
Class Action, and Municipal Litigation
David C. Blum, Partner
Levenfeld Pearlstein, LLC
2 N. LaSalle St., Ste. 1300
Chicago, IL 60602
312.476.7557
dblum@lplegal.com
1
1
Adam P. Beckerink, Counsel
Reed Smith LLP
10 S. Wacker Dr., 40th Fl.
Chicago, IL 60606
312.207.6400
abeckerink@reedsmith.com
TAXPAYER’S FEDERATION OF ILLINOIS
16th Annual Illinois
State & Local Tax Conference
September 17, 2015

Overview
• Qui Tam Actions/State False Claims Acts
• Class Action Exposure for Over-Collection
• Efforts to Legislatively Confine Vendor
Exposures
• The ABA Model Act
• MTC Uniformity Project
• Class Action Consumer Fraud Damages for
Over-Collecting
• Municipal Litigation

Federal Court and Qui Tam Actions
• Qui Tam Actions
• Are brought by an informer, under a
statute that establishes a penalty for the
commission or omission of a certain act;
• Provide that such penalties may be
recovered in a civil action;
• Awards a part of the penalty to the
“whistleblower” who brings the action (with
the remainder going to the state or some
other institution).

Federal Court and Qui Tam Actions
• Federal False Claims Act first enacted in 1863
• Crack down on suppliers in the Civil War
• Provides for private enforcement actions against those alleged
to have defrauded the federal government
• 31 USC §§3729-3733
• Prohibits any person from defrauding the government by false
claims, records, or statements
• Excludes allegedly fraudulent tax claims

State False Claims Acts
• Approximately 30 jurisdictions have False Claims Acts
• Some states restrict their FCA provisions to Medicaid and/or
contractor/type “frauds”.
• A number of state FCA statutes contain explicit “tax bars”
prohibiting qui tam actions for allegedly false tax claims (e.g.,
CA, DC, HI, MA, NM, NYC, NC, TN, VA). Some states impose a
tax bar only with respect to income tax matters (e.g., IL, IN, RI).
• A number of states do not appear to restrict the action to a
particular subject matter (e.g., DE, FL, VN, NH, NJ).
• In 2010, New York became the first state to explicitly authorize
the application of its FCA to tax claims.

Types of Qui Tam Actions
• Traditional False Claims Actions
• False claims for payment from the state
• Reverse False Claims Actions
• False statements to avoid or reduce
payments to the state
• Reverse false claims actions give rise to
Qui Tam actions for tax.

Elements of Qui Tam Actions - Generally
• Defendant made or used a false statement
• To avoid or reduce payment owed to the state
• Defendant knew or should have known
statement was false
• “Knowledge” can be actual, but also includes
deliberate ignorance or reckless disregard.
• Specific intent to defraud not required.
• Legal dispute as to interpretation of law should
negate scienter.

Elements of Qui Tam Actions - Generally
• Proper relator
• Direct and independent knowledge
of false statement
• It cannot be merely “publicly
available” information
- relator must be “original source”

Timeline of a Qui Tam Action
• The relator (plaintiff) investigates
• Direct and independent knowledge of false
statement
• No publicly available knowledge unless relator
is original source and gathers evidence
• The relator (plaintiff) gives notice to the
Attorney General
• The relator files the complaint under seal

Timeline of a Qui Tam Action
• The Attorney General investigates and:
• Intervenes and:
- (1) takes over case,
- (2) dismisses case,
- (3) dismisses to pursue alternate State remedy, or
• Does not intervene and allows the relator to
proceed
• The complaint is unsealed and summons
issued to the defendant(s).

Typical Qui Tam Actions
• Sales & Use Tax Collection
• Lawsuits against remote or internet sellers
(e.g., Diamond litigation):
• Direct mail and online retailers
• Investigate nexus, returns, affiliates
• Shipping & handling charges
• Liquor license Cases
• Lawsuit against Sprint Nextel Corporation
(New York) for failure to charge sales tax on
100% of charges for flat rate wireless plans.

Typical Qui Tam Actions
• Unclaimed Property
• Lawsuits for failing to remit unused amounts
on prepaid calling cards.
• Actions against MetLife and Prudential for
allegedly failing to turn over unclaimed life
insurance funds.
• Possible Future Actions
• Corporate income tax (state permitting).

Defenses to Qui Tam Actions
• On the Merits
• No collection obligation (e.g., no
nexus) or obligation to pay
• Ambiguous law or regulatory
guidance – i.e., no scienter.
• Reliance on sound legal theory

Defenses to Qui Tam Actions
• Procedural Defenses
• Improper parties
• Relator not an “original source” of the information
• Conflicts between FCA and other areas of law (e.g.,
state constitution/tax provisions).
• Failure to state claim: no actual knowledge, no false
statement, no claim submitted to state.
• Government (already) had knowledge (e.g., prior
sales tax audit).

Qui Tam Liability
• Liability “per occurrence”
• Possible treble damages, plus “reasonable”
attorney’s fees and civil penalty.
• Civil penalty generally between $5,000 and
$10,000 per false claim.
- What is the false claim, the sale or the monthly return?
• Whistleblower generally awarded between
15% and 30% of the state’s recovery.

False Claims Act - Illinois
• Illinois False Claims Act (“FCA”) allows
whistleblowers (Relator) to bring qui tam actions
against taxpayers for false sales/use tax claims but
not income tax.
• Taxpayers found liable under the FCA are subject to
treble damages of the tax deemed owed or not paid,
plus a statutory penalty of between $5,500 and
$11,000 for each “false” claim.
• Taxpayers found liable are also required to pay for
the costs and attorney’s fees of bringing the action.

• Whistleblower Rewards
• Up to 30 percent of the recovered
proceeds.
• A whistleblower who planned or
initiated the false claim may even
recover an award provided that the
person is not convicted of a crime for
the false act.

• Whistleblower Protections
• A strengthened immunity provision and added
protections from retaliation encourage current and
former employees, contractors, or agents to
become whistleblowers.
• Employees, contractors, and agents are protected
from retaliation for transmitting any information for
the purpose of investigating, filing, or potentially
filing an action under the FCA, even if the
transmission “violate[s] a contract, employment
term, or duty owed the employer or contractor.”

• Elements Needed to Establish Liability
• Must show that the taxpayer “knowingly”:
• Presented or caused to be presented, a false or
fraudulent claim for payment or approval;
• Made, used, or caused to be made or used, a
false record or statement material to a false or
fraudulent claim;
• Made, used, or caused to be made or used, a
false record or statement material to an obligation
to pay or transmit money or property to the state
or a local government.

• “Knowingly”
• Means something more than actual
knowledge.
• Also includes acting in deliberate
ignorance or reckless disregard of the
truth or falsity of information.

False Claims Act – Illinois
• Disagreeing with Agency Guidance
• Liability may attach if a taxpayer takes a
reporting position that contravenes
published agency guidance, even if the
taxpayer has a good faith basis to
believe the guidance is incorrect, in
excess of the Department’s authority, or
unconstitutional.

• Not Limited to Fraud
• FCA specifically provides that there does not
have to be any showing of any intent to
defraud the government.
• The qui tam plaintiff or government must
simply prove the taxpayer made a claim that
it “knew” was incorrect.

• Other Considerations
• 10 year statute of limitations
• Taxpayer secrecy does not apply
• Conspirator liability, including tax
professionals
• Voluntary Disclosure may not protect from
liability

• Potential Defenses
• “Mere” negligence, not intentional
• Ambiguous law or regulatory guidance
• Reliance on sound legal theory
• Government knowledge
- e.g., prior audits or uniform industry practice
• Pending “civil action”

• Potential Defenses (cont’d)
• Public disclosure
• Who’s an appropriate whistleblower?
• Voluntary disclosure?
• State and Federal Constitutional
violations

• Recent Illinois Legislation – Amendment to Illinois False Claims Act:
Senate Bill 1828/House Bill 2803 (Introduced Feb 20, 2015)
• Senate Revenue Committee held a subject matter hearing on the
Illinois False Claims Act on September 9, 2015
• Amends 740 ILCS 175/4 (Illinois False Claims Act) by adding
subsection (e)(5):
• No court shall have jurisdiction over a civil action that relates to
or involves a false claim regarding certain tax acts administered
by the Illinois Department of Revenue (“DOR”), unless the
action is brought by the Attorney General.

Recent Illinois Legislation (cont’d):
Senate Bill 1828/House Bill 2803
• Amends 740 ILCS 175/4.5, which establishes several restrictions
upon actions for false claims relating to tax:
• The DOR shall have the sole authority to bring an administrative
action and the AG shall have the sole authority to bring a judicial
action for a false claim pertaining to taxes administered by the
DOR.
• Includes additional provisions concerning reporting,
enforcement, and payment of rewards.
• An award may be appealed exclusively to the Illinois Court of
Claims within 30 days of determination.

Recent False Claims Act Cases
• Chimney Rock Winery, LLC et al. v.
Constance Beard
• Violation of Commerce Clause
• Violation of Internet Tax Freedom Act
• Violation of the Separation of Powers
Clause

• Chimney Rock Winery, LLC et al.
• Department’s position » pick-up option then
shipping not taxable – “separable” from
underlying sale. Kean and Private Letter
Rulings
• Illinois Attorney General either not reviewing
claim or disagreeing with the Department’s
position

• Chimney Rock Winery and Miner Family Winery (Individual matters)
• Private Letter Rulings stating – Department’s position » pick-up
option then shipping not taxable – “separable” from underlying
sale. Kean
• Motions to Dismiss to be heard by Circuit Court on September
2, 2015
• August 28, 2015, Department issues proposed amendments to
Sections 130.410 and 130.415 – clarify the existing law and
regulations
• August 31, 2015, after knowing the Department’s position for
several months, Illinois Attorney General represents it will
review all current proceedings for pick-up option

False Claims Act
• Should FCAs be Applied to Tax?
• Upends protections for taxpayer rights,
including historical right to privacy in tax
matters.
• May discourage use of voluntary disclosure
programs.
• Incentivizes collection of transaction taxes,
which may expose taxpayers to class-action
consumer fraud lawsuits.

False Claims Act
• Should FCAs be Applied to Tax? (Cont’d)
• Removes tax administration decisions from
taxing authorities.
• Leads to disparate treatment among
taxpayers.
• Taxpayer deprived of essential gov’t function.
• Contravenes well-established procedures
designed to ensure efficient resolution of tax
disputes.

Qui Tam Actions – Retailer Liability Risks
• Unclear statutes and a lack of guidance can create
liability risks for retailers.
• If collect too much tax
• Class Action Law Suit
• If collect too little tax
• Risk of audit
• Qui Tam
• Costs of litigation far exceed actual tax cost or the cost of
an audit by the state
• Public relations impact

Class Action Basics
• Federal Class Actions
• Elements to Certify a Class:
• Standing
• FRCP Rule 23(a) Requirements (must meet all four):
• Numerosity
• Commonality
• Typicality
• Adequacy of Representation
• FRCP Rule 23(b) Requirements (must meet one of three):
• Individual Adjudication would Result in Prejudice
• Injunctive or Declaratory Relief
• Common Questions of Law or Fact
• State Class Actions

Class Action Law Suits
• Examples of Customer Liability Actions Against Retailers:
• Applications of coupons
• Jurisdiction rate assignments
• Sourcing conventions
• Product/Service taxability
• Case Examples
• Lauren Minniti v. Pizza Hut of America Inc., CACE14023335 (2015)
(sales tax on delivery charges).
• Chang Wong v. Whole Foods No. 1:15-CV00898 (2015) (tax on in-
store coupons); see also, Chang v. Target (same)
• Schojan v. Papa Johns No. 14-CA-003491 (2014) and Tucker v. Papa
Johns No. 3:14-CV-00618 (2014) (tax on delivery charges)
• Shaun Brandewie et al. v. Wal-Mart Stores Inc. et al., 1:14-cv-00965
(2014) (allegedly “shortchanged” customers by applying lower sales tax
rates to refunds).

Class Action Law Suits
• Vendors often can defend against the
actions because they used due diligence
and remitted funds to the jurisdiction – but
not without costs.
• State governments can also face class
action lawsuits.

Kean v. Walmart
• Kean bought a trampoline on walmart.com for $23.33
plus $7.97 shipping and $2.74 sales tax (Sept. 2006).
• Alleged sales tax should have only been imposed on
trampoline and not shipping and handling.
• One month later (October 2006), Kean filed a multistate
class action in Cook County Circuit Court alleging:
• Consumer fraud and deceptive business practices;
• Unjust enrichment; and
• Injunctive relief – creation of a “class protest fund”
• Nov. 2006 filed a TRO and preliminary injunctive relief

Kean v. Walmart
• From Walmart’s perspective, they collected and remitted the tax,
which is now held by the state.
• So if money is owed to plaintiffs, the state should refund it…
• IDOR then intervene as party defendants and among other things,
filed a motion to dismiss plaintiffs’ case.
• Nov. 2009, Illinois Supreme Court rules that Walmart correctly
charged and collected sales tax on shipping charges – no refund.
• Key take away:
• One customer, with no sales tax experience or inside knowledge,
dragged Walmart through the courts for years, causing it to incur
sizable legal bills and no good way out. Plaintiff deprived taxpayer and
the state of the efficient administration of an essential government
function.

Recent Illinois Cases
• Wong v. Target (Illinois Federal Court) – Coupon Case
• Bought an item for $10, used a $1 coupon, alleged he was
overcharged sales tax by applying tax on $10, not $9.
• Causes of Action: Consumer Fraud (unfair and deceptive acts and
practices), Common Law Fraud, and “Money Had and Received” (i.e.,
unjust enrichment)
• Damages Sought: (1) Compensatory damages ($0.02 in his case); (2)
Punitive damages of “at least equal to 1% of annual revenue of each of
defendant’s Illinois stores during each year the violations occurred;” (3)
attorney’s fees; and (4) such other relief court deems
• Wong v. Whole Foods (Illinois Federal Court)
• Largely identical to the Target case
• Case recently settled for an undisclosed sum.

Recent Cases
• Papa John’s International (Illinois & Florida)
• “Illegally” collected sales tax on delivery fees
• Consumer fraud, deceptive trade practices, etc.
• Florida case recently settled; Illinois still pending
• Pizza Hut (same)
• BJ’s Wholesale Club (Florida & Pennsylvania)
• “Illegally” overcharged and kept sales tax on items purchased
through discounts, coupons and other price reductions offers
(e.g., rebate coupon “dealer discount”)
• “Prospective class consists of many thousands, if not tens of
thousands, of BJ’s members who were improperly charged
under the guise of BJ’s collection of sales tax”

Recent Cases
• Walmart & Sam’s Club
• Pennsylvania
• Named plaintiff bought two cans of shaving gel with a buy one get
one free” coupon. Total purchase $2.97.
• Alleges Walmart overcharges sales tax in PA stores and Internet
sales and has “misappropriated millions of dollars…”
• Ohio
• Retailer shortchanged customers who returned items to different
stores by applying lower sales tax rates
• Breach of contract – violates terms of sale by refunding less than the
original purchase price
• Walmart seeks to remove to State Tax Commission from federal
court since they are exclusive arbiter of state tax refund claims.

Tax Collection Liability Litigation
• Class actions can be brought against the government
jurisdiction –
• Arizona Department of Revenue v. Bernard J. Dougherty,
29 P.3d 862: class action lawsuits against the State were
permitted in Tax Court.
• Granados v. County of Los Angeles, CA Court of Appeal,
Second District, No. B200812 (March 28, 2012): a
taxpayer can file a class action claim for refund of CA
local telephone users taxes paid. Before filing the claim
the plaintiff must first file a claim that contains the
information required by the Government.

American Bar Association Model Act
• Prepared by the Government Submissions and
Legislative Whitepapers Subcommittee with the
State and Local Tax Committee
• Paper balances conflicting of interests of sellers,
purchasers and state and local governments.
• Subcommittee drafted a model that would not
violate SSUTA but would provide an exclusive
remedy for a purchaser to obtain a refund of
over-collected tax.

• The paper outlines 15 Governing principles. Some
highlights include:
• Principle 6 – Sellers are, in collecting tax from purchasers, and
paying it over to the taxing jurisdiction, acting merely as agent
for the taxing jurisdiction. Accordingly, sellers should not be
subject to claims arising from or in any way related to an
overpayment by purchasers or liability to such purchasers or
anyone else other than a taxing jurisdiction revenue department,
regardless of the nature of the claim or cause of action
asserted, unless the party asserting the liability demonstrates
that in collecting the tax the seller acted with willful intent to
defraud the purchaser.

• Principle 9 – Any purchaser who has overpaid a tax should
be entitled to a refund if a timely and adequate claim is filed.
• Principle 11 – A taxing jurisdiction has a legitimate interest in
ensuring that duplicate refunds are not issued. Accordingly, a
taxing jurisdiction may establish procedures for that purpose.
• Principle 14 – A taxing jurisdiction has a compelling interest
in the fair and equitable interpretation of its transaction tax
laws and should be an indispensable party in any litigation
determining the proper application of those laws.

• Major provisions:
• Section 4 sets forth Purchaser Recourse provisions
• Purchaser’s relief is limited to a refund claim
pursuant to §5
• Seller should not be party to any action
• Section 5 sets forth Refund Procedures
• Purchaser may file a claim with the seller with time
limits (90 days) for response
• Purchaser may under certain circumstances file a
claim with the taxing jurisdiction

MTC Project on Class Action/False Claims
• MTC Sales Tax Uniformity Subcommittee formed
a drafting group (public and private sector
members) to address class action and false
claims issues
• December 2014 – Subcommittee proposed that
executive committee recommend states adopt
ABA Model Act
• MTC is working toward adopting a model similar
to the IRS.

Consumer Protection Violations?
• Kawa v. Wakefern Food Corporation, 24 NJ Tax
144 (App. Div. 2009)
• Class action not permitted
- Cited Streamlined and exclusive remedy
provisions in New Jersey Statutes
• Consumer fraud damages not applicable
because remedies governed by sales tax
laws

• Nava v. Sears, Roebuck and Co., Illinois Appellate Court, First
District, No. 1-12-2063 (July 29, 2013)
• Tax on coupon discounts for converter boxes erroneously
collected
• Customer brought suit under consumer protection act
• Also sought certification of a class action
• Trial court dismissed the case, but Appellate Court
reinstated and remanded the consumer protection act
claims
• Found that Sears was not statutorily authorized to
collect this tax

• Loeffler v. Target Corporation, Slip Opinions No. 5173972
(May 1, 2014)
• May a consumer in a sales tax transaction sue a retailer
under the consumer protection laws for allegedly
improperly collecting sales tax reimbursement on a
transaction the plaintiff contends is not subject to sales
tax? Target collected sales tax reimbursement from
consumers who purchased a cup of coffee “to go.”
• Held that the refund scheme created by California tax code
provides the exclusive remedy for a dispute over the
applicability of the state tax laws to retail transactions.

False Advertising Violations?
• Yabsley v. Cingular Wireless LLC, 176 Cal.App.4th 1156
• Did Cingular violate the CA False Advertising Law when it
advertised it would collect sales tax reimbursement on
sales of cellular phones?
• Under Regulation 1585, the retailer must pay sales tax
(and may collect sales tax reimbursement) on the full
unbundled price of the phone when it sells a cell phone
bundled with a service contract
• Court of Appeals agreed with the trial court that
regulations provide the same safe harbor for suits under
the UCL that statutes do. The class action was thus
dismissed.

Municipal Litigation
• Increase rise in Municipal (and related) Litigation
• Municipalities and other governmental authorities are
starting to “take matters into their own hands.”
• Problem:
- they do not afford taxpayers the same administrative options and
remedies that the State of Illinois offers.
- Issues resolved through costly litigation
- They may seek to tax something IDOR already found to be
nontaxable.
• Examples:
- RTA, et. al. v. Kankakee, et. al. (local sourcing of sales tax)
- Village of Bedford et. al. v. Expedia, et. al. (hotel occupancy tax)

Municipal Litigation (Cont’d)
• Who is in charge?
• RTA: “IDOR does not have exclusive nor primary
jurisdiction”
- Thus, even though IDOR is the statutory agent to audit on their
behalf, RTA and other municipalities assert they can also seek tax
from taxpayers that have already been audited by IDOR and find
taxability where none was found previously.
• Note, under ILCS 2505-475, the Department is
empowered to correct errors on distribution of taxes
between municipalities and counties.
• New Proposed Regulations to give Illinois counties and
cities enhanced information sharing from the state.

Summary
• There is an increased and troubling trend of tax liability
allegations and accusations from parties other than the
Department of Revenue and who typically have little
factual information and/or specific tax knowledge.
• Taxpayers are denied the opportunity of the efficient
governmental function and privacy afforded to them by
traditional audits and administrative appeal mechanisims.
• Third party litigation causes taxpayers to be audited in
the courts in a very expensive and public way –
oftentimes on a very narrow issue – that may already
have been audited and found to be nontaxable by IDOR.

Questions?
David C. Blum, Partner
Levenfeld Pearlstein, LLC
312.476.7557
dblum@lplegal.com
Adam P. Beckerink, Counsel
Reed Smith LLP
312.207.6400
abeckerink@reedsmith.com

Audited Through the Courts: The Troubling Trend in Flase Claims Act, Class Action and Municipal Litigation

More Related Content

What's hot

Similar to Audited Through the Courts: The Troubling Trend in Flase Claims Act, Class Action and Municipal Litigation

More from Levenfeld Pearlstein, LLC

Recently uploaded

Audited Through the Courts: The Troubling Trend in Flase Claims Act, Class Action and Municipal Litigation