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Steamboat Capital Management, LLC v. Lowry

Court of Appeals of Texas, First District

November 21, 2017


         On Appeal from the 80th District Court Harris County, Texas Trial Court Case No. 2008-74262

          Panel consists of Chief Justice Radack and Justices Keyes and Caughey.


          Sherry Radack Chief Justice

         Appellees, R.K. Lowry, Jr., L-Falling Creek LLC, Russell A. Chabaud, R-Rac Wimbledon, LLC, John P. Moffitt, J-Jason LLC, Russell A. Chabaud, Trustee of the Russell G. Chabaud 1999 Investment Trust, R-Russell Wimbledon, LLC, Russell A. Chabaud, Trustee of the Ashley Chabaud 1999 Investment Trust, R-Ashley Wimbledon, LLC, Russell A. Chabaud, Trustee of the Audrey Chabaud 1999 Investment Trust, R-Audrey Wimbledon, LLC, LMC Recovery Fund, LLC, Union Gas Funding I, L.P., Rana Holdings, LLC, Westy I LLC, and Mogi, LLC, sued numerous defendants, [1] including appellants, Jay A. Johnston ("Johnston") and Steamboat Capital Management, LLC ("Steamboat"), for breach of fiduciary duty, negligence, fraud, conspiracy, and, in the alternative, breach of contract, complaining of tax-reducing investment strategies, involving both foreign distressed debt and digital options contracts on foreign currency, that they alleged were marketed to them through a scheme to defraud them out of millions of dollars in fees and that resulted in severe penalties being imposed against them by the Internal Revenue Service ("IRS").

          In two issues in this interlocutory appeal, [2] Johnston and Steamboat challenge the trial court's orders denying their special appearances. We affirm the trial court's order denying Johnston's special appearance. We reverse the trial court's order denying Steamboat's special appearance and render judgment granting the special appearance and dismissing the claims against Steamboat.

         Background [3]

         Among their claims in their fifth amended petition, appellees alleged that a group of defendants, the "Strategy Defendants, " which was comprised of Gramercy Advisors, LLC and various forms, [4] Johnston (a Gramercy principal), and Steamboat (a "Gramercy-related entity") (collectively referred to in the petition as "Gramercy"), along with other defendants not parties to this appeal, [5] acted "jointly and in concert" to develop, promote, sell, and implement certain investment strategies as a part of a conspiracy to commit fraud. Appellees alleged that the "Strategy Defendants" represented that they had designed proprietary tax-advantaged investment plans that would provide substantial returns on investments and minimize tax obligations. Appellees asserted that the Strategy Defendants knew, or should have known, that the investment strategies would not, and could not, yield the tax advantages claimed and knew that federal authorities were investigating the legality of similar "abusive tax shelters." Appellees alleged that the defendants did not disclose the investigation in order to "extract millions of dollars in fees and commissions" from them. And, after appellees, relying on the Strategy Defendants' representations, entered into the investment strategies and claimed certain losses on their year 2000 to 2005 tax returns, the IRS subjected them to costly audits and substantial penalties, interest, and back-taxes.

         Specifically, appellees alleged that Gramercy, along with BDO Seidman LLP ("BDO"), [6] sold them the investment strategies at issue. In September 2000, BDO representatives, Randy Moorman and Paul Shanbrom, [7] requested a meeting with appellees Lowry and Chabaud, along with their accountant, Newt Vannaman, [8] to educate them on BDO's expertise and services. After Lowry and Chabaud signed non-disclosure agreements, BDO told them that it had developed several investment strategies to meet their financial, investment, and tax needs. BDO described the strategies as having "significant tax benefits because they took advantage of certain loopholes contained in the [tax] code with respect to partnerships, " that were "completely legal and valid."

         One such investment strategy involved foreign distressed debt.[9] Shanbrom told Lowry and Chabaud that they could invest in foreign distressed debt, and, after executing the proprietary strategy, could legally take a loss on the debt through the application of certain partnership tax rules. Shanbrom and Moorman reassured Lowry and Chabaud that "all of the big accounting firms were implementing similar types of tax-advantaged investment strategies." Shanbrom asserted that he had personally implemented the strategy and provided information regarding other BDO clients that had implemented the strategy. Shanbrom emphasized that Gramercy had expertise and a "reputation as a leader" in providing clients with distressed-debt investments, and he recommended that Lowry and Chabaud engage Gramercy to assist BDO in the implementation of the strategy. Shanbrom also encouraged Lowry and Chabaud to invest an additional $15, 000, 000.00 with Gramercy in unrelated investments, which would diversify their portfolios. According to Shanbrom, these unrelated investments would strengthen Lowry's and Chabaud's "position[s]" in the event that the IRS audited their returns. After the meeting, Shanbrom and Moorman advised Lowry and Chabaud that if they wished to implement the distressed-debt strategy for the 2000 tax year, they should make investments with Gramercy by November 2000.

         On November 7, 2000, appellees Lowry, Chabaud, and Moffit, along with their accountant, Vannaman, attended a meeting in Houston with Shanbrom and Moorman, of BDO, and Johnston, a principal at Gramercy. According to appellees, Shanbrom and Johnston discussed the steps of the distressed-debt strategy and reiterated that it was a "completely legal tax-reducing strategy." Shanbrom emphasized that BDO felt so confident about the strategy that it would represent appellees in any IRS audit. Shanbrom and Johnston further told appellees that R.J. Ruble, [10] who was "the recognized expert with respect to distressed-debt strategies" and a partner in the law firm of Sidley Austin, LLP, [11] would issue an independent opinion letter, confirming the propriety of the distressed-debt strategy. Shanbrom and Johnston advised appellees that the independent nature of the opinion letters would "provide the required legal support to confirm the propriety of the strategy and overcome any IRS challenge and, equally as important, would provide absolute penalty protection." Shanbrom and Johnston recommended that appellees undertake a distressed-debt strategy to be implemented over a five-year period, beginning with tax year 2000, and represented that BDO and Gramercy would handle the design and implementation of the distressed-debt strategy.

         Appellees further alleged that, pursuant to BDO and Gramercy's advice and instructions, they executed a consulting agreement with BDO and investment management agreements with Gramercy. Appellees asserted that, unbeknown to them, BDO and Gramercy had an independent agreement to share in the fees generated from appellees.

         Appellees asserted that, in 1999 and 2000, almost a full year before BDO and Gramercy recommended the investment strategies at issue, the IRS had issued general notices to taxpayers, stating that these types of investment strategies constituted illegal and abusive tax shelters. Appellees alleged that the Strategy Defendants were aware of these notices and not only did not disclose the information to appellees, but told them the opposite.

         In 2000, Gramercy, BDO, and Sidley Austin, acting pursuant to an undisclosed arrangement with Lehman Brothers Commercial Corporation, planned and executed a tax strategy involving the purchase and sale of digital options on foreign currency (the "2000 Digital Options Strategy"). They advised several appellees, including Lowry, Chabaud, and Moffit, to make certain investments that would "substantially reduce or eliminate" their tax liabilities, and they assured appellees that the strategy was legitimate and in accordance with all applicable tax laws, rules, regulations, published court decisions, and common law doctrines. They told appellees that Sidley Austin would issue an independent opinion letter that would enable them to satisfy IRS auditors as to the propriety of the tax returns. Appellees asserted that the Sidley Austin letters, which did not mention the IRS notices, represented "canned" opinion letters that had no actual basis in law. In reliance on the representations, appellees engaged in the strategy and then claimed long-term capital losses on their year 2000 federal tax returns.

         Subsequently, pursuant to collective advice from the Strategy Defendants, appellees formed the LMC Recovery Fund, LLC ("LMC Fund") and entered into the "2001 Distressed-Debt Strategy." Appellees made certain capital contributions into the LMC Fund. Specifically, the Gramercy Local Markets Recovery Fund, LLC, along with certain Brazilian and Bulgarian companies, contributed distressed-debt instruments to the LMC Fund. Appellees then purchased additional interests in the LMC Fund, and the LMC Fund then sold a portion of the distressed debt, generating losses. Appellees then claimed these losses on their 2001 federal tax returns. Again, Sidley Austin provided appellees with an opinion letter advising that the transactions were legal. And, BDO prepared a 2001 federal tax return for the LMC Fund and provided appellees with copies of the return. In 2002, appellees engaged in a similar investment strategy.

         In the "2003 Distressed-Debt Strategy, " Lojas Arapua S.A. ("Lojas"), a Brazilian company, contributed certain distressed-debt instruments to MPATRN, LLC, a Delaware limited liability company. MPATRN then contributed distressed-debt instruments to the LMC Fund, in exchange for a membership interest. Appellees then purchased additional interests in the LMC Fund, and the LMC Fund sold a portion of the distressed debt, generating losses. Again, the Strategy Defendants advised appellees that they could properly claim the losses on their 2003 federal tax returns, and they did so. In January 2004, law firm De Castro[12]issued opinion letters to appellees, characterizing the losses realized as "ordinary, " stating that there was a "greater than 50 percent likelihood" that the tax treatment would be upheld if challenged by the IRS, and asserting that the investors "would not be subject to" certain penalties by the IRS. Appellees asserted that the Strategy Defendants were aware, and intentionally failed to disclose, that the IRS, based on applicable statutes, regulations, and established and controlling case law, "would conclude that the 2003 Distressed-Debt Strategy" was an illegal and abusive tax shelter. Moreover, the Strategy Defendants affirmatively advised appellees to the contrary. Appellees asserted that they lost a "significant amount of money in carrying out the 2003 Distressed-Debt Strategy"; they paid "significant fees to the 2003 Strategy Defendants"; and they were assessed substantial back taxes, interest, and penalties as a result of their participation in the 2003 Distressed-Debt Strategy. Appellees engaged in similar investment strategies again in 2004 and 2005.

         Subsequently, appellees received from the IRS certain "Notice[s] of Audit, " pertaining to their 2001 through 2005 tax returns, and, ultimately, the IRS imposed on them penalties, interest, and back taxes.

         Appellees asserted that, in each of the investment strategies, the Strategy Defendants and "other participants" conspired with one another to design, promote, sell, and implement the strategies for the purpose of receiving and dividing substantial fees collected from appellees.

         In their breach-of-fiduciary-duty claim, appellees alleged that the Strategy Defendants, as their accountants, financial and investment advisors, and attorneys, owed appellees a duty of honesty and care. Appellees asserted that the Strategy Defendants breached their fiduciary duties by advising them to engage in the investment strategies at issue and orchestrating their implementation, which generated "huge fees"; providing legal opinion letters that were not truly independent; and advising appellees to file tax returns in reliance on their advice. Appellees asserted that the Strategy Defendants knew, or should have known, that the IRS would likely consider the strategies at issue to be improper and illegal.

          In their negligence claims, appellees alleged that the Strategy Defendants, during the course of their representation of appellees, omitted material facts, negligently made numerous affirmative representations that were incorrect, improper, or false, and gave improper recommendations, advice, and opinions. Appellees asserted that the Strategy Defendants knew, or should have known, that their representations, recommendations, advice, and opinions were inaccurate and improper. As a result of appellees' reliance on the Strategy Defendants' advice and recommendations, appellees paid millions of dollars to the Strategy Defendants in investments and fees.

         In their fraud claims, appellees alleged 56 affirmative misrepresentations and intentional omissions of material fact by the Strategy Defendants. Appellees asserted that the enumerated misrepresentations were false when made, and the Strategy Defendants knew that they were false, but they made them with the intention that appellees rely on them in entering into the investment strategies. Further, appellees, in reasonable reliance on the Strategy Defendants' misrepresentations, paid substantial fees and amounts to execute the strategies and suffered injury.

         In their conspiracy claim, appellees alleged that the Strategy Defendants and other participants acted in concert to design, market, sell, and implement the distressed-debt strategies, which they knew constituted fraudulent and illegal tax shelters, by giving the false impression to appellees that they were legitimate business transactions. Further, the Strategy Defendants' conspiracy to commit fraud proximately caused appellees' damages.

         Appellees brought, in the alternative, a breach-of-contract claim against the Strategy Defendants, alleging that they breached their agreement to provide professionally competent advice. Appellees further sought a judgment declaring that the parties' agreement and contracts were unenforceable. Appellees sought disgorgement of all payments rendered to the Strategy Defendants and rescission of the parties' agreements.

         Gramercy, including Steamboat and Johnston, filed a combined special appearance, arguing that the Texas court lacked personal jurisdiction over them because they lacked sufficient contacts with Texas. In their amended special appearance, Gramercy asserted that appellees had "allege[d]-without any supporting concrete facts-three bases of jurisdiction." Namely, they alleged that Gramercy (1) had done and was doing business in the State of Texas, (2) had contracted with a corporation through their Texas offices, and either party was to perform the contract in whole or in part in Texas, and (3) had committed torts, in whole or in part, in Texas. Gramercy argued that it was BDO, and not Gramercy, who had advised appellees to engage in the investment strategies. As evidence, Gramercy proffered the affidavits of Robert Lanava, Gramercy's Managing Director for Operations, and Johnston.[13]

         Lanava testified that none of the Gramercy defendants, including Steamboat, is organized in Texas; rather, each has its principal place of business in either Connecticut or New York. In addition, the Gramercy defendants do not have offices or employees operating in Texas and do not have agency relationships or agreements with any co-defendant. Lanava asserted that the Gramercy defendants did not affirmatively solicit appellees' investments; rather, BDO referred appellees to Gramercy. Further, "[t]o the best of [his] knowledge, " appellees visited New York to meet with Gramercy to discuss the proposed investments. Gramercy exchanged emails and facsimile communications with appellees incident to the administration of their investments and sent periodic written communications for signatures. The distressed debt and emerging market debt that appellees acquired was located in Brazil and in the Russian Federation. Gramercy procured currency options for appellees through firms located in New York City. Gramercy did not prepare, review, or file tax returns for appellees.

          Johnston testified that he is a Co-Managing Member of Gramercy Advisors, LLC; lives in Puerto Rico, previously resided in Connecticut; and has never lived in Texas or had offices or property in Texas. Johnston testified that he did not affirmatively solicit appellees; rather, BDO referred appellees to Gramercy:

[Appellees] invested in distressed Brazilian and certain Russian assets through Gramercy, and also separately invested in Gramercy's emerging market hedge funds. To the best of my recollection, I may have attended a single meeting in Texas in late 2000 with [appellees'] representatives and representatives of [BDO] prior to [appellees'] investments with Gramercy (I am not certain of the timing). To the best of my recollection, my participation was limited to a discussion of Gramercy's hedge fund operations; a description of emerging market distressed debt assets to be acquired by [appellees], and a general description of other financial and transactional aspects of the services that would be performed by Gramercy on [appellees'] behalf. I did not address the tax implications of any transactions conducted for [appellees], the anticipated IRS position with respect thereto, which I understand to be the subject of this action.
Following [appellees'] investments with Gramercy, I met with [appellees] in Texas on a few additional occasions at [appellees'] request. However, the purpose of these meetings was solely to update [appellees] with respect to their investments in Gramercy's hedge funds. These investments were unrelated to the transactions subsequently challenged by the IRS which, as I understand it, form the basis of the instant lawsuit.

         In their response to the special appearance, appellees disputed that Gramercy lacked sufficient minimum contacts with Texas. Specifically, they argued:

Gramercy made numerous purposeful contacts with the state of Texas directly relating to the actions complained of by [appellees] in this case. Gramercy willfully participated in a scheme to defraud [appellees], all of whom are Texas residents. Gramercy met face-to-face with [appellees] in Texas on numerous occasions to market, sell, and implement the tax-reducing investment strategies at issue in this case. Gramercy's role was much broader than merely executing investments strategies determined by others. Instead, Gramercy was actually involved from the beginning in every aspect of the tax-reducing investment strategies, including discussing the alleged tax benefits with [appellees] as part of the initial sales pitch in Texas. Contrary to Gramercy's position, Gramercy did, in fact, discuss the tax-advantaged nature of the strategies at Texas meetings and pitched the tax savings as one of the reasons for doing the deals. Those meetings alone subject Gramercy to jurisdiction in Texas. Gramercy also purposefully directed its activities at Texas by:
• Drafting, negotiating, and entering into numerous contracts with Texas-resident [appellees] related to the . . . investment strategies, which contracts contemplated a longterm relationship between the parties with performance occurring at least in part in Texas;
• Managing and holding partnership interests in several entities-some of which resided in Texas-that were involved in the tax-reducing investment strategies and selling partnership interests and distressed debt assets to Texas-resident [appellees];
• Directing and overseeing the preparation of tax returns . . . containing the tax losses generated by the . . . strategies for the benefit of Texas resident [appellees] and mailing and, in one instance, hand-delivering [them] to [appellees] in Texas;
• Earning millions of dollars from its purposeful actions in Texas through fees generated by investment management agreements with [appellees] and undisclosed kick-backs from consulting fees paid . . . to BDO;
• Sending regular, monthly account statements to [appellees] in Texas, setting up a secure website for [appellees] to view account information from Texas, and inviting [appellees] to participate in quarterly conference calls from Texas; and
• Marketing and selling tax-reducing investment strategies-similar to the ones sold to [appellees]-to other Texas clients.

         As evidence in support, appellees proffered the affidavits of appellees Lowry, Chabaud, and Moffitt, as well as that of their accountant, Vannaman, and attorney, David Deary. Generally, in the affidavits, appellees averred that, at the September 26, 2000 meeting, BDO representatives presented the distressed-debt strategy and recommended that appellees engage Gramercy to assist BDO. At a follow-up meeting on November 7, 2000, Johnston introduced himself as a principal with Gramercy, and "Johnston and Shanbrom [with BDO] worked together equally on the 'pitch' that was made to [appellees] during the meeting." Both Shanbrom and Johnston touted Ruble at Sidley Austin as the recognized expert on distressed-debt strategies. Shanbrom explained that an opinion letter from Ruble would shield appellees from liability with the IRS. And, Johnston reiterated that Gramercy had experienced good results from Sidley Austin on these types of transactions in the past. In addition, Shanbrom ...

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