Joseph D. Wargo. (Photo: Alison Church)
An Atlanta-based private equity investment firm is suing longtime legal counsel Alston & Bird over claims that Alston lawyers provided bad legal advice based on a multi million-dollar math error—then allegedly attempted to cover it up.
MSouth Equity Partners filed the legal-malpractice suit against Alston to claw back more than $7.6 million in federal and state taxes and interest the investment firm said it was forced to pay to the IRS following a 2011 investment deal involving another Alston client in which MSouth held a majority interest and on which Alston lawyers provided legal advice, the malpractice complaint contends.
The complaint claims that Alston & Bird lawyers "admitted in correspondence to the IRS" that they likely made a mistake when they advised LMS Intellibound Group, Inc.—in which MSouth held a majority share—that LMS' 2011 merger with another investment firm to form a new venture, Capstone Logistics LLC, would not be skeptically viewed by the IRS as a way of avoiding taxes.
Filed with the complaint are affidavits from the former chair of the tax section of the Atlanta Bar Association and the State Bar of Georgia and a professor of legal ethics at Mercer University's Walter F. George School of Law contending that Alston & Bird's erroneous tax advice and its subsequent failure to acknowledge the error to MSouth Equity and LMS, both of which it represented, violated state professional standards of legal ethics and constituted legal malpractice.
In addition, law professor Patrick Longan said that Alston compounded its initial tax error, not only by failing to notify its clients of its erroneous advice after the IRS launched an audit of LMS in 2014, but also by advising MSouth when Capstone was sold in 2014 that it should indemnify Capstone's prospective buyer on any outstanding tax liability. This advice served to shield the law firm from liability associated with what eventually resulted in a total tax liability exceeding $15 million—$7.6 million of which eventually was billed to MSouth based on its majority holdings in LMS.
The complaint, filed in Fulton County Superior Court in Atlanta for MSouth by Joseph Wargo of Atlanta's Wargo & French, also seeks punitive damages based on allegations that the law firm exhibited "willful misconduct, malice, and fraud," as well as a "conscious indifference to the potential consequences" to its clients. The suit also asks for legal fees and pre-judgment interest.
MSouth's partners include three former ranking executives of Bellsouth Corp.: Barry L. Boniface, Bellsouth's former chief strategy and development officer who also served as a managing director at Barclays Capital and Lehman Brothers; Charles Stubbs, former president of BellSouth Intelliventure and former CEO of Yellowpages.com; and Mark Feidler, Bellsouth's former president and COO and former COO of Cingular Wireless.
Among MSouth's many investments are Heartland Media, Bank of the Ozarks, Community & Southern Bank and CRH Healthcare (a chain of urgent care centers in Alabama and Georgia).
Wargo had no comment on the complaint. Nick Clarke, Alston's spokesman in New York, said the firm would have no comment, but added, "We value all of our clients and regret it when any issue arises in a client relationship."
According to the complaint, LMS' 2011 merger with a second company to create Capstone, and a subsequent $60 million cash distribution to LMS shareholders, led to the tax liability. Alston attorneys advised both LMS and MSouth that the legal structure of the deal would prevent it from being considered a "disguised sale" intended to hide taxable earnings from the merger.
But Alston lawyers apparently were wrong. According to the affidavit of Raymond Carpenter, the state bar's former tax section chairman, Alston's mathematical calculations on which the firm based its tax advice were off, eventually signaling the IRS that the way in which the deal was structured was intended to avoid taxes on the $60 million distribution to LMS and MSouth.
The complaint alleges that, when Alston learned from the IRS that its clients would likely be assessed millions in additional and unforseen taxes, the firm kept the information to itself rather than acknowledge that it was liable for the extra taxes.
"In my opinion, Alston & Bird violated the Georgia Rules of Professional Conduct in its representation of MSouth," Longan said. "An independent lawyer might have advised Msouth to try to address [the Capstone buyer's] concerns by seeking payment or indemnity from Alston & Bird. There was a significant risk that Alston & Bird's financial interest in avoiding such liability would foreclose those options."