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Finderne Management Company, Inc. v. Barrett

September 9, 2008

FINDERNE MANAGEMENT COMPANY, INC., ROCQUE DAMEO AND DANIEL DAMEO, PLAINTIFFS-APPELLANTS/CROSS-RESPONDENTS,
v.
JAMES W. BARRETT, GERARD T. PAPETTI AND U.S. FINANCIAL SERVICES CORPORATION, DEFENDANTS-RESPONDENTS/CROSS-APPELLANTS, AND CIGNA FINANCIAL ADVISORS, INC., LINCOLN NATIONAL LIFE INSURANCE COMPANY, RONN REDFEARN, STEVEN G. SHAPIRO, TRI-CORE, INC., MONUMENTAL LIFE INSURANCE COMPANY, AND INTER-AMERICAN INSURANCE COMPANY OF ILLINOIS, BEAVEN COMPANIES, INC., CJA ASSOCIATES, INC. AND RAYMOND J. ANKNER, DEFENDANTS.



On appeal from the Superior Court of New Jersey, Law Division, Somerset County, Docket No. L-0851-99.

The opinion of the court was delivered by: Lihotz, J.A.D.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

APPROVED FOR PUBLICATION

Argued November 28, 2007

Before Judges Cuff, Lisa and Lihotz.

Plaintiffs Finderne Management Company, Inc. (FMC), Rocque Dameo and Daniel Dameo seek recovery of losses alleged to result from false and misleading representations by defendants James W. Barrett, Gerard T. Papetti and Papetti's company, U.S. Financial Services Corporation, (defendants or Barrett and Papetti). Defendants induced plaintiffs to establish what they represented was a "tax qualified," "419 annuity" by participating in a program known as the Employers Participating Insurance Cooperative (EPIC). EPIC purported to be a multiple employer welfare benefit plan and trust that provided employers with a tax-deductible vehicle to fund pre-retirement death benefits for owner-employees through the purchase of specific life insurance products, and allowed the individual insured to convert the insurance policy to obtain post-retirement benefits.

Six years after FMC commenced participation in EPIC, the Internal Revenue Service (IRS) audited the company and disallowed claimed deductions for two tax years. As a result of the IRS audit, plaintiffs paid additional taxes and interest deemed due. Thereafter, plaintiffs terminated participation in EPIC.

Plaintiffs' complaint asserts various misrepresentation claims, sounding in negligence and fraud.

They argue that defendants misrepresented the tax consequences of the benefit plans to induce plaintiffs to purchase life insurance. Plaintiffs allege that while [defendants] earned millions of dollars in commissions from the insurance sales, plaintiffs lost substantial sums of money because the IRS decided that plaintiffs' contributions were not tax deductible. Plaintiffs claim that defendants knew of the potential adverse tax consequences, and not only failed to tell plaintiffs, but affirmatively represented that the contributions would be tax deductible. [Finderne Management Co., Inc. v. Barrett, 355 N.J. Super. 170, 190 (App. Div. 2002), certif. denied, 177 N.J. 219 (2003) (Finderne I).]

The matter was tried to a jury. The trial judge entered an order of judgment molding the verdict and fixed liability against Barrett and Papetti, each in the amount of $36,734.60.

Plaintiffs appeal from numerous pre-trial and trial orders, asserting legal errors that warrant a new trial. Two specific arguments challenge the orders that dismissed plaintiffs' consumer fraud claims and limited the scope of damages. Also, in a permitted supplemental brief filed following entry of a trial court order upon our grant of a limited remand, plaintiffs challenge the denial of their motion to set aside the judgment under Rule 4:50-1(c).

Defendants Barrett and Papetti cross-appeal from the denial of their respective summary judgment motions and certain evidentiary trial rulings. Finally, defendants appeal from the post-trial denial of their request to award counsel fees following plaintiffs' rejection of a pre-trial offer of judgment. We affirm on all issues.

I.

FMC operates a Bridgewater trucking business and is owned by brothers Rocque Dameo and Daniel Dameo. Since 1977, Barrett, a Senior Account Executive at Cigna Financial Advisors, Inc. (Cigna) provided financial advice and sold life insurance to the Dameos. In the late 1980s, Barrett suggested the Dameos develop a business succession plan to consolidate their companies and to minimize estate taxes in the event of the death of either brother. The Dameos held significant wealth in the value of their business interests, but had "a very serious problem" with asset liquidity to pay anticipated death taxes in the event one brother passed away. Furthermore, the Dameos had terminated an existing retirement vehicle so they had no program to provide for retirement. The brothers agreed that additional estate planning strategies "such as retitling assets, new wills, new trusts, and some other financial planning" techniques were necessary to "reduce the estate tax[es] down to a meaningful level" and, in planning for their retirement, to provide a "seamless" transfer of the business to family members while affording them, as former owners, a sufficient stream of retirement income.

Barrett introduced the Dameos to Papetti who was a personal financial planner, licensed insurance agent, and certified public accountant. Together, Barrett and Papetti performed a comprehensive review of the Dameos' financial concerns, including available cash flow and the future "accumulation and preservation of . . . wealth." Defendants prepared and presented a comprehensive tax and estate planning analysis that made several planning recommendations.

Included among the recommendations was Papetti's proposal that FMC participate in EPIC. The EPIC plan was designed by defendant Ronn Redfearn and marketed through defendant Tri-Core, Inc. (Tri-Core). EPIC was presented as a multi-employer trust, funded by life insurance products purchased by the individual employers from designated insurance companies. Employers joined the trust by executing an adoption agreement. The employer paid annual contributions and deducted the sums as business expenses pursuant to 26 U.S.C.A. § 162.*fn1

Prior to retirement, a covered employee received death benefits through group term life insurance; following retirement, the employee could convert the term insurance interest to an individual universal life insurance policy.

EPIC's insurance benefits were provided through a program called Group Entry Age Reserve (GEAR), developed by Tri-Core, which served as the EPIC Plan Administrator. The key feature of GEAR was the conversion option available to employees who terminated participation in the plan. The employer's premium costs for the insurance were based on an employee's age when he or she "began [] employment, not [] retirement age." In this way, the universal life policy costs were lower than costs had the policy issued upon retirement.

The GEAR marketing materials tout the ease with which a participating employer funds the individual universal life insurance policies for its terminating employees, explaining that a portion of an employer's annual contributions are set aside in a rate stabilization reserve, which is used to pay the conversion costs charged when an employee retires. The insurance feature called, "Continuous Group" or "C-Group," is defined in the materials as a plan of group term life insurance with a special conversion option. When combined with the EPIC Plan and Trust, actuarially determined deposits are fully deductible.

Upon retirement, the participants may convert to an individual universal life special conversion policy and take tax free annual distributions.

Although the premium costs on the C-Group product were significantly greater than premiums for a conventional group term life insurance policy, Barrett and Papetti explained that under EPIC, FMC would reap large tax benefits by deducting the annual contributions. FMC would pay the annual tax deductible contributions. Approximately twenty percent of each annual payment covered the premiums for group life insurance for FMC's employees. The remaining eighty percent would accumulate in a reserve "fund" to pay the conversion benefits when the principal-employees*fn2 retired. Upon retirement, the employee would use the excess contributions to buy "conversion credits" to obtain the individual's universal life policy. In the first year after conversion, the Dameos would pay a post-retirement premium of $5,000 and their converted policy would have a cash value of approximately $255,000; the following year another $5,000 premium would further increase the policy's cash value. Thereafter, the Dameos could borrow against the individual policy, withdrawing the cash value without incurring a tax consequence. "In other words, the benefits would include tax- free deductions to purchase the insurance and a tax-free loan after conversion." Finderne I, supra, 355 N.J. Super. at 183.

Barrett and Papetti gave the Dameos schedules specifying the annual retirement benefit at age sixty-five. The documents represented that upon conversion at age sixty-five, Rocque and Daniel would receive annual tax free annuity-like payments of $26,532, and $24,541, respectively for twenty-years.

FMC executed the EPIC adoption agreement on January 1, 1991. FMC also set up a trust to act as a vehicle to deliver the program of benefits promised by EPIC to its covered employees. Finderne I, supra, 355 N.J. Super. at 187. FMC participated in EPIC for six years paying $336,591.86 in contributions.

The EPIC plan was substantively challenged by the IRS. The IRS concluded EPIC was not an employee benefit plan, but a method to defer compensation. Therefore, the employer's claimed business expenses were disallowed and the employees could be taxed on the benefits received.

FMC was audited for the tax years 1994 and 1995. The IRS disallowed the deductions for the EPIC contributions that exceeded the actual cost of the employees' term life insurance benefits. In its settlement with the IRS, FMC remitted approximately $50,000 to pay the taxes deemed due and interest on those payments for the two identified tax years. The IRS agreed to waive applicable penalties and the potential recovery for unpaid taxes in the remaining years of FMC's EPIC participation. Also, FMC agreed to terminate its EPIC participation.

FMC ceased making EPIC contributions in 1996. The last payment covered premiums due up to September 1, 1997. The Dameos attempted to recover the contributions believed to have accrued in EPIC's reserve fund. They learned the reserve was not an actual depository of funds, but a book entry.

In a February 25, 1998 letter, Barrett urged the Dameos to exercise the right to convert the insurance and cautioned that the term insurance coverage would lapse without payment of the outstanding sums due. The overdue premium owed was $72,967.86. Eventually, the Dameos completed the documentation for conversion of the policies. The insurance company denied the requests, stating the policy had lapsed.

Plaintiffs' amended complaint asserted a variety of causes of action, including violation of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C.A. §§ 1961-1968, and the New Jersey Racketeering Act (NJRICO), N.J.S.A. 2C:41-1 to -41-6.2, as well as claims of fraud, consumer fraud, equitable fraud, negligent misrepresentation, breach of fiduciary duty, conspiracy, and aiding and abetting.*fn3

Plaintiffs asserted Barrett and Papetti failed to warn the beneficial tax features of EPIC were not sanctioned by the IRS, and failed to disclose they received commissions based on plaintiffs' EPIC contributions. Additionally, plaintiffs maintained Barrett and Papetti knew EPIC had no reserve fund to pay promised benefits upon the termination of participation because the hefty contributions were used to pay the promoters' commissions. Finally, plaintiffs contend defendants failed to reveal that Commonwealth Life Insurance Company (Commonwealth), the company providing the convertible term policies through EPIC, was not licensed in New Jersey.

Prior to trial, defendants submitted a $350,000 offer of judgment. Plaintiff did not accept and the offer expired. The jury verdict was returned on August 4, 2005. The trial court molded the verdict, and after the addition of pretrial interest, a judgment was entered against Barrett and Papetti each for $36,734.60. Plaintiffs' post-verdict motions for a judgment not withstanding the verdict or for a new trial were denied. Also, defendants' motions for counsel fees because plaintiffs declined to accept the offer of judgment were denied. The appeals and cross-appeals followed.

II.

Important to the understanding of plaintiffs' claims is a brief discussion of the federal tax provisions implicated by EPIC. The Deficit Reduction Act of 1984 (Act), (Pub. L. 98-369 (1984), amended the Internal Revenue Code (Code) to add sections 419 and 419A. The intended effect of these amendments was to squarely limit the deductibility of an employer's contributions to pre-fund an employee welfare benefit fund. 26 U.S.C.A. § 419 and § 419A. Concerned with the tax shelter potential when employers claimed deductions for expenses that had not yet been incurred, the amended statute espoused the general policy that "contributions paid or accrued by an employer to a welfare benefit fund . . . shall not be deductible" by the employer, except as specifically allowed by the statute. 26 U.S.C.A. § 419(a). If a plan qualified, such that the contributions were deductible, then 26 U.S.C.A. § 419(a)(2) and (b) limited the amount and nature of the payments. Generally, deductions were limited to the actual cost of the circumscribed benefits and the maximum aggregate total benefit per employee was capped at $50,000. Ibid.

The related amendments adding 26 U.S.C.A. § 419A(a), allowed employers to establish "qualified asset accounts" consisting of assets set aside to provide for the payment of employee benefits for (1) disability, (2) medical, (3) supplemental compensation or severance pay, or (4) life insurance. The Code section set forth similar rules that limited funding and the permitted deductions for these benefit plans. One provision sanctioned an employer's pre-funding of limited post-retirement benefits using a trust or "reserve" account. 26 U.S.C.A. § 419A(c)(2). To be deductible, contributions to a reserve account must accumulate solely for the payment of qualified post-retirement medical and life insurance benefits in accordance with a stated formula. Ibid. Further, the fund must be nondiscriminatory, i.e., cover all employees, and the maximum aggregate total benefit per employee must not exceed $50,000. 26 U.S.C.A. § 419A(e).

Other Code amendments in the Act imposed an excise tax to discourage abusive use of welfare benefit plans. 26 U.S.C.A. § 4976. The excise tax was assessed on the employer and equaled 100 percent of any "disqualified benefits" provided by the welfare benefit plan. Ibid.

A special kind of multiple employee welfare benefit plan was exempt from the funding restrictions of sections 419 and 419A. A plan that was part of a "10 or more employer plan," 26 U.S.C.A. ยง 419A(f)(6), was permitted to deduct contributions as business expenses so long as no single employer contributed more than ten percent of the total contributions and the allocated plan ...


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