IN THE

ARIZONA COURT OF APPEALS

DIVISION ONE

WILLIAM R. COULTER; MARK TKACH; and MILLS A. BROWN,

Plaintiffs/Appellants,

v.

GRANT THORNTON, LLP, Defendant/Appellee.

No. 1 CA-CV 14-0625

FILED 1-3-17

Appeal from the Superior Court in Maricopa County

No. CV2011-020270
The Honorable J. Richard Gama, Judge Retired

AFFIRMED IN PART, REVERSED IN PART, AND REMANDED

COUNSEL

Aiken, Schenk, Hawkins & Ricciardi, PC, Phoenix

By Joseph A. Schenk, J. Tyrrell Taber, Michael R. Devitt
Counsel for Plaintiffs/Appellants

Bryan Cave LLP, Phoenix and Kansas City, MO

By Lawrence G. Scarborough, James D. Smith, Craig S. ODear,
Fred L. Sgroi
Counsel for Defendant/Appellee
 COULTER v. GRANT THORNTON
Opinion of the Court

OPINION

Judge Kent E. Cattani delivered the opinion of the Court, in which

Presiding Judge Diane M. Johnsen and Judge John C. Gemmill (retired)
joined.

C A T T A N I, Judge:

1 William R. Coulter, Mark Tkach, and Mills A. Brown

(collectively, Appellants) raise an issue of first impression relating to
when accountant malpractice claims accrue for purposes of the statute of
limitations. Consistent with the discovery rule, we hold that determining
the accrual date is a fact-based inquiry that turns on when a party knew or
reasonably should have known of facts establishing a basis for the claim.
Accordingly, and for reasons that follow, we reverse the superior courts
ruling dismissing Appellants claims against the accounting and tax
advisory firm Grant Thornton, LLP for breach of fiduciary duty,
professional negligence, negligent misrepresentation, common law fraud,
aiding and abetting, and racketeering. We affirm the merits-based
dismissal of Appellants breach of contract and breach of the implied
covenant of good faith claims, and we remand for further proceedings.

FACTS AND PROCEDURAL BACKGROUND

2 In 2000, Appellants hired Grant Thornton to implement

strategies intended to reduce their income tax liability arising from their
financial interests in automobile and motorcycle dealerships in Arizona.
Upon the recommendation of Blair Stover, a principal with Grant Thornton,
Appellants each established an ESOP/S structure, which involved the
creation of a single-owner employee stock ownership plan (ESOP)
holding the stock of a related S corporation.1 Appellants each used the
ESOP/S structure in the 2002 tax year.

1 The ESOP/S strategy promoted by Grant Thornton attempted to

avoid taxation by having an operating company pay management fees to a
newly created management company. See United States v. Stover, 650 F.3d
1099, 1104 (8th Cir. 2011) (describing the ESOP/S structure). The
management company would elect subchapter S status and create an ESOP

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Opinion of the Court

3 The IRS disapproved of the ESOP/S structure and issued a

Notice of Deficiency to Coulter and Tkach in 2006 and 2007. The notices
reflected millions of dollars in tax deficiencies and accuracy related
penalties under Internal Revenue Code (I.R.C.) 6662. 26 U.S.C. 6662.2
Stover assured Appellants that they would ultimately prevail against the
IRS, and Coulter and Tkach challenged the deficiency determinations and
penalties in United States Tax Court. Following lengthy litigation, they
settled with the IRS in 2011, agreeing to pay taxes on the income that had
been shielded from taxation by the ESOP/S structure.

4 Brown did not receive a notice of deficiency with respect to

the ESOP/S structure, but he received a notice of deficiency with respect to
a Roth/S structure that he had likewise implemented on Stovers
recommendation. Brown entered into a Closing Agreement with the IRS
in July 2011, under which he agreed to pay additional excise taxes in the
amount of $254,938.20 as a result of his use of the Roth/S structure and to
have all the monies used to fund his Roth IRA between 2002 and 2008 taxed
as ordinary income.

5 In November 2011, Appellants filed a complaint in superior

court against Grant Thornton and other defendants.3 Grant Thornton
moved to dismiss several of Appellants claims as barred by applicable
statutes of limitations. The superior court granted the motion and
dismissed those claims. Grant Thornton then filed a motion for partial
summary judgment on Coulter and Tkachs breach of contract claim, which
the court also granted. Finally, Grant Thornton filed a motion to dismiss

to hold the companys stock. Id. The ESOPs sole beneficiary would be the
owner of the operating company. Id. Because an ESOPs income is not
subject to taxation until distribution, the ESOP/S scheme would, if allowed,
indefinitely avoid or defer the recognition of taxable income. Id.
2 Absent material revisions after the relevant date, we cite a statutes
current version.

3 Stover left Grant Thornton in 2001. Appellants followed him as

clients to his new firm, Kruse Mennillo, LLP. In addition to Stover and
Kruse Mennillo, the complaint also named Nevada Corporation Associates,
Inc., a company that provided management services for the tax structures.
Appellants stipulated to dismiss their claims against Kruse Mennillo and
Stover, but Nevada Corporation defaulted. At the time Appellants filed
their notice of appeal, the claim against Nevada Corporation remained
pending.

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Opinion of the Court

or, in the alternative, for summary judgment on Appellants remaining

claims for fraudulent concealment and contractual bad faith. The superior
court similarly granted this motion.

6 The court then entered final judgment under Arizona Rule of

Civil Procedure (Rule) 54(b) and awarded Grant Thornton $495,231.60 in
attorneys fees. This timely appeal followed.

DISCUSSION

I. Dismissal Based on the Statute of Limitations.

7 We review de novo a dismissal under Rule 12(b)(6) for failure

to state a claim. Coleman v. City of Mesa, 230 Ariz. 352, 355, 7 (2012).
Dismissal under Rule 12(b)(6) is only appropriate if, assuming the truth of
all well-pleaded factual allegations, as a matter of law [ ] plaintiffs would
not be entitled to relief under any interpretation of the facts susceptible of
proof. Id. at 356, 89 (alteration in original) (citation omitted). Given
our preference to resolve claims on their merits, the statute of limitations
defense is not favored. CDT, Inc. v. Addison, Roberts & Ludwig, C.P.A., P.C.,
198 Ariz. 173, 175, 5 (App. 2000) (quoting Logerquist v. Danforth, 188 Ariz.
16, 22 (App. 1996)). Nevertheless, claims that are clearly brought outside
the relevant limitations period are conclusively barred. Montao v.
Browning, 202 Ariz. 544, 546, 4 (App. 2002).

A. First Order of Dismissal.

8 Appellants argue that the superior court erroneously

dismissed on limitations grounds their claims for breach of fiduciary duty,
professional negligence, negligent misrepresentation, common law fraud,
aiding and abetting, and racketeering. Because there is a question of fact as
to when Appellants discovered or should have discovered that they were
injured by Grant Thorntons actions, we reverse the superior courts
dismissal of these claims.

9 A two-year limitations period applies to claims for breach of

fiduciary duty, professional negligence, and negligent misrepresentation.
See A.R.S. 12-542; Sato v. Van Denburgh, 123 Ariz. 225, 227 (1979)
(professional negligence); Alaface v. Natl Inv. Co., 181 Ariz. 586, 599 (App.
1994) (negligent misrepresentation); Crook v. Anderson, 115 Ariz. 402, 403
(App. 1977) (breach of fiduciary duty). A three-year limitations period
applies to claims for common law fraud. See A.R.S. 12-543(3); Coronado
Dev. Corp. v. Superior Court, 139 Ariz. 350, 352 (App. 1984). Likewise, a

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Opinion of the Court

three-year statute of limitations applies to claims brought under Arizonas

racketeering statute. See A.R.S. 13-2314.04(F).

10 Accrual of these claims is governed by the discovery rule,

which provides that a cause of action does not accrue until a plaintiff
discovers or by the exercise of reasonable diligence should have discovered
that he or she has been injured by the defendants negligent conduct.
Anson v. Am. Motors Corp., 155 Ariz. 420, 423 (App. 1987); see also Commercial
Union Ins. Co. v. Lewis & Roca, 183 Ariz. 250, 254 (App. 1995). We review for
an abuse of discretion a superior courts factual determinations regarding
the exercise of reasonable diligence, but we review de novo the question of
when a cause of action accrues if the determination is based on a legal issue
rather than on disputed facts. Montao, 202 Ariz. at 546, 4.

11 Here, the superior court concluded that Appellants claims

accrued when the IRS issued notices of deficiency in 2006 and 2007, and that
the claims (other than for breach of contract and breach of the implied
covenant of good faith) were thus time-barred. The court relied on CDT v.
Addison, in which this court addressed accrual of a cause of action for
accountant malpractice alleged to have caused an assessment of delinquent
taxes, interest, and penalties against the taxpayer. 198 Ariz. at 175, 5.
There, the taxpayer had sued its accounting firm more than two years (the
relevant limitations period) after the taxing authoritys audit that exposed
the taxpayers underpayment (and of which the taxpayer was informed),
but within two years of the taxing authoritys formal adoption of the
auditors recommendation and assessment in a Notice of Determination.
Id. at 34. This court held that, as between the date a taxing authority
notifies a taxpayer of potential liability and the date the taxing authority
issues its final determination, the latter controlled for statute of limitations
purposes; there was no definitive assessment of tax liability against [the
taxpayer] until the taxing authority issued its formal assessment. Id. at
17475, 179, 3, 2021.

12 The instant case presents a different question, however. CDT

did not address the scenario in which, as here, the taxpayer continues to
consult with the accountant after the IRSs issuance of a notice of deficiency,
and continues to rely on the accountants advice in challenging the IRSs
determination in the tax court.

13 Although Arizona appellate courts have not addressed this

issue, courts in other jurisdictions have done so and have taken varied
approaches. Some courts have concluded that the dispositive date in such
a case is the date the taxpayers liability is ultimately resolvedthat is, after

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Opinion of the Court

the final decision in the tax appealrather than when the IRS issued its
final notice of deficiency. See Peat, Marwick, Mitchell & Co. v. Lane, 565 So.
2d 1323, 1325 (Fla. 1990); Clark v. Deloitte & Touche LLP, 34 P.3d 209, 216,
23 (Utah 2001). Other courts have adopted a similar bright-line rule using
the date of the IRSs notice of deficiency, regardless whether the taxpayer
appeals the IRSs determination and regardless how long that appeal may
take. See, e.g., Curtis v. Kellogg & Andelson, 86 Cal. Rptr. 2d 536, 542 (App.
1999); Beane v. Dana S. Beane & Co., P.C., 7 A.3d 1284, 1289 (N.H. 2010).
Finally, other courts have determined that neither of those dates is
necessarily dispositive and have instead adopted a fact-based approach
focused on when the plaintiff knew or should have known of the negligence
and resulting injury under the facts of the particular case. See Kennedy v.
Goffstein, 815 N.E.2d 646, 650 (Mass. App. Ct. 2004). We are persuaded that
neither bright-line rule adequately addresses discovery of a cause of action
for accounting malpractice and thus adopt the fact-based approach.

14 Although bright-line rules are often useful, there are

compelling reasons to forego a rule under which a malpractice claim
necessarily accrues immediately upon issuance of the taxing authoritys
final determination (before any appeal). As the Florida Supreme Court
pointed out in Peat Marwick, commencing the limitations period at the time
of the IRSs notice of deficiency would mean that a plaintiff would be
required to file an accounting malpractice action asserting that the tax
advice was improper, even if the taxpayer reasonably continued to rely on
the accountants advice to challenge the IRSs determination in a tax appeal.
565 So. 2d at 1326. To require a party to assert these two legally
inconsistent positions in order to maintain a cause of action for professional
malpractice is illogical and unjustified. Id. And under these
circumstances, as the Utah Supreme Court noted in Clark, there [was] no
loss or injury unless a third party, the [Tax Court], decide[d] to assess a tax
deficiency. 34 P.3d at 216, 23 (citation omitted and alterations in
original). Accordingly, where the taxpayer and the accountant reasonably
continue to believe that the accounting advice was correct (and the taxing
authority in error), the cause of action for accounting malpractice should
not necessarily accrue when the IRS issues a notice of deficiency. See Peat
Marwick, 565 So. 2d at 1326.

15 There are similarly compelling reasons for rejecting a bright-

line rule adopting the conclusion of a tax appeal as the relevant accrual date.
If, for example, an accountant or lawyer has acknowledged that the
challenged advice was improper, or if the taxpayer obtained a second
opinion advising that the advice was improper, a fact-finder could conclude
that the taxpayer was on notice of a viable accounting malpractice claim

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Opinion of the Court

before a final tax court determination. See Kennedy, 815 N.E.2d at 650
(noting that knowledge of negligence and consequent harm might become
evident after the audit was completed).

16 A fact-based approach more appropriately addresses the

relevant circumstances in any given case, and is consistent with how we
have addressed analogous claims involving attorney malpractice. See Lewis
& Roca, 183 Ariz. 250, 25758 (holding that the limitations period for filing
a claim against an attorney who had advised an insurer to deny a coverage
claim did not commence when a lawsuit was filed against the insurer, but
instead began when a court ruling in the coverage lawsuit made clear that
the position advanced by the lawyer was incorrect).

17 Applying that approach here, we conclude that the superior

court erred by finding that the limitations period necessarily commenced
upon the IRSs issuance of a notice of deficiency. Instead, there remains a
fact question regarding whether Appellants reasonably continued to rely
on Stovers reassurances, and when they discovered (or should have
discovered) that the accounting advice was improper and the IRSs position
would be upheld on appeal. We thus reverse the superior courts dismissal
of Appellants claims for breach of fiduciary duty, professional negligence,
and negligent misrepresentation on statute of limitations grounds, and we
remand to allow a jury to determine the appropriate accrual date for
Appellants claims.

B. Second Order of Dismissal.

18 After the superior court dismissed the initial tort claims,

Appellants amended their complaint in November 2011 to add a claim for
fraudulent concealment, asserting that [d]uring the period from 2001
through the present, Defendants, and each of them, fraudulently concealed
from Plaintiffs the fact that they were engaged in a scheme to profit from
selling invalid and worthless tax structures to unsuspecting clients in
exchange for the payment of exorbitant fees. The superior court dismissed
Appellants claim for fraudulent concealment as barred by the three-year
statute of limitations. See A.R.S. 12-543(3).

19 The statute of limitations for a fraudulent concealment claim

begins to run when the defrauded party discovers or with reasonable
diligence could have discovered the fraud. Mister Donut of Am., Inc. v.
Harris, 150 Ariz. 321, 323 (1986); see also Wells Fargo Bank v. Ariz. Laborers,
Teamsters and Cement Masons Local No. 395 Pension Tr. Fund, 201 Ariz. 474,
496, 87 (2002) (as corrected) (discussing elements of fraudulent

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Opinion of the Court

concealment claim). This type of claim includes [f]raud practiced to

conceal a cause of action. Acton v. Morrison, 62 Ariz. 139, 144 (1945).

20 As with the previously-discussed claims, the parties dispute

when Appellants claim for fraudulent concealment accrued, with Grant
Thornton focusing in particular on Appellants knowledge of a complaint
filed by the United States Department of Justice against Stover in the
District Court for the Western District of Missouri, United States v. Stover,
731 F. Supp. 2d 887 (W.D. Mo. 2010), affd, 650 F.3d 1099 (8th Cir. 2011). In
that case, the District Court in 2010 enjoined Stover from promoting certain
tax schemes, including the ESOP/S. See Stover, 731 F. Supp. 2d at 914.

21 Appellants were aware of this lawsuit and reviewed a copy of

the complaint in June 2008. Grant Thornton thus argues that Appellants
claim for fraudulent concealment accrued at the very latest when they read
the complaint in United States v. Stover. Appellants argue that their claim
did not accrue until the District Court issued its decision against Stover in
August of 2010. As with our ruling regarding the other statutes of
limitation, we conclude that the determination of when the fraudulent
concealment claim accrued is a fact question that must be resolved by a jury.

22 The filing of a complaint against Stover did not resolve

whether he had in fact committed fraud. Given Stovers continuing
representations that Appellants would prevail in their tax case and that the
charges against him were not well founded, we conclude that the statute of
limitations on Appellants fraud claim did not necessarily commence when
Appellants received a copy of the governments complaint against Stover.
Instead, there is a fact question regarding when Appellants discovered or
should have discovered that the governments claims against Stover were
meritorious.4 Accordingly, we reverse the superior courts ruling

4 As with the professional malpractice claims, there may be

circumstances under which a party may be deemed to be on notice of a
fraud claim prior to the conclusion of litigation underlying the basis for the
claim. But here, Stover did not admit liability, and there is no indication of
facts that necessarily established that Appellants should have known the
federal government would prevail in its complaint against Stover. Compare
Lewis & Roca, 183 Ariz. at 254 (defendant law firm advised plaintiff
insurance company to deny coverage on an insurance claim submitted by a
third party; although the insurance company sustained appreciable
damage when it incurred costs for attorneys fees in a coverage suit filed by
the third party, the insurance company had no reason to know that such

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Opinion of the Court

dismissing the claim for fraudulent concealment on statute of limitations

grounds.

II. Summary Judgment on Breach of Contract Claim.

23 Coulter and Tkach also challenge the superior courts grant of

summary judgment in favor of Grant Thornton on the merits of their breach
of contract claim. Summary judgment is appropriate if there is no dispute
of material fact and the moving party is entitled to judgment as a matter of
law. Ariz. R. Civ. P. 54(a). We review de novo the superior courts grant of
summary judgment, including its assessment of the existence of factual
disputes and its application of the law. See Cal. Cas. Ins. Co. v. Am. Family
Mut. Ins. Co., 208 Ariz. 416, 418, 5 (App. 2004); Great Am. Mortgage, Inc. v.
Statewide Ins. Co., 189 Ariz. 123, 12425 (App. 1997).

24 Coulter and Tkach alleged that Grant Thornton breached the

indemnity clause of their engagement agreements by failing to reimburse
them for penalties the IRS assessed for their use of the ESOP/S structure.
The parties engagement letter stated:

[I]n the event that either the Internal Revenue Service or the
State of Arizona assess any civil negligence or fraud penalty
which is related to any position, transaction, or structure
which is the subject of our technical advice, Grant Thornton,
LLP shall reimburse and indemnify you and your related
entities for the full amount of such penalty(s).

(Emphasis added).

25 After the IRS issued its notice of deficiency, the agency offered
to settle with Coulter and Tkach if they would agree to pay an amount that
would be computed as if the income they had placed in the ESOPs (and that
therefore had not been taxed) had been included in income in 2002, plus
penalties. But the IRS subsequently dropped its demand for penalties, and
Coulter and Tkach ultimately paid only back taxes and interest and did not
pay I.R.C. penalties.

26 On appeal, Coulter and Tkach argue that the reference to

penalty in the engagement letters was not intended to carry a restrictive
definition and that the term encompasses back taxes and interest. They thus

defense costs were the direct result of the defendant law firms negligence
until the court denied the insurance companys motion for summary
judgment in the coverage lawsuit).

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Opinion of the Court

assert that Grant Thornton is contractually liable to them for promised tax
savings that were not achieved. But this reading is inconsistent with the
plain language of the indemnity clause in the engagement letter.

27 The engagement letters referenced penalties assessed for

civil negligence or fraud, which parallels IRS penalties under I.R.C. 6662
for underpayment of tax because of a taxpayers [n]egligence or disregard
of rules or regulations, substantial understatement of income tax, or
substantial valuation misstatement.5 Thus, the plain language of the
engagement agreements only required Grant Thornton to indemnify
Coulter and Tkach for penalties, and there were no penalties assessed in
this case.

28 Appellants argue that, based on a sworn declaration

submitted by their expert witness, the amounts that Coulter and Tkach
were required to pay to the IRS greatly exceeded the amount of taxes that
they would have owed if they had not used [Grant Thornton]s ESOP/S
structure. But Appellants do not assert that the amount they paid included
an I.R.S. penalty. The indemnity clausethe only contract term Appellants
allege Grant Thornton breacheddid not guarantee the amount of tax
liability. It merely provided that the taxpayer would pay no more than the
tax owing, because Grant Thornton would reimburse any penalties
assessed. Accordingly, Grant Thornton did not breach its indemnity
obligation under the engagement agreements, and the superior court did
not err by granting judgment in favor of Grant Thornton on the breach of
contract claim.

III. Summary Judgment on Breach of the Implied Covenant of Good

Faith.

29 The superior court also granted summary judgment in favor

of Grant Thornton on Appellants claim for breach of the implied covenant
of good faith. We similarly review the superior courts dismissal of this
claim de novo. See Wells Fargo, 201 Ariz. at 482, 13. We affirm the superior
courts ruling because the only alleged acts that might support this claim
occurred before the parties entered into the contract, and thus Appellants

5 IRS penalties are separate from and in addition to the tax deficiency.
See I.R.C. 6662; see also Natl Fedn of Indep. Bus. v. Sebelius, 132 S. Ct. 2566,
2584 (2012) (The Code contains many provisions treating taxes and
assessable penalties as distinct terms.).

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allegations do not support a claim that Grant Thornton acted in bad faith in
carrying out the contract.

30 Under Arizona law, there is an implied covenant of good faith

and fair dealing in every contract. See id. at 490, 59. A party violates this
covenant if he or she acts in a manner that denies the other party the
reasonably expected benefits of the contract. See FL Receivables Tr. 2002-
A v. Arizona Mills, L.L.C., 230 Ariz. 160, 169, 41 (App. 2012). A party also
breaches the implied covenant of good faith if he or she uses discretion for
a reason outside the contemplated range -- a reason beyond the risks
assumed by the party claiming a breach. Wells Fargo, 201 Ariz. at 492, 66
(citation omitted).

31 Appellants argue that Grant Thornton did two things that

constitute bad faith: (1) adopted a poor boy approach to the
implementation of the ESOP/S structure and (2) provided Appellants
names and taxpayer identification numbers to the IRS. Preliminarily, we
reject Appellants claim that Grant Thornton engaged in bad faith by
providing Appellants identifying information to the IRS in response to a
summons because, as Appellants acknowledge, compliance with a lawful
court order cannot form the basis of a tort claim.

32 Appellants remaining assertions regarding the alleged poor

boy approach are similarly unavailing. Appellants argue primarily that
Grant Thornton knew at the time it contracted with them that the ESOP/S
structure was not valid and would not deliver the promised tax benefits.
Appellants cite in particular to an email dated April 5, 2000, in which
Warren Heatley, a partner in Grant Thorntons Kansas City office,
complained about Stover and other Grant Thornton employees promoting
multiple entities structures as a tax savings vehicle:

These are not stupid people from a technical standpoint &

they have been in the business for a long time. They were
counting on not getting audited & if they did, poorly trained
IRS agents. . . . I believe that Circular 230 prohibits giving
advice that will succeed just because it is unlikely to be caught
in an audit. I have lost a lot of respect for Al, Bob & Blair
[Stover] & I wonder now that we have gotten rid [of] this
issue, what is next. I am sorry to say this, but I do not trust
these individuals. They did not consider the risk they were
subjecting their clients or the firm to or if they did they did
not care. We did not even make any serious money on this
strategy.

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33 In response to this email, Mark Johannsen, a partner in Grant

Thorntons national tax office, sent an April 5, 2000 email to several partners
and managers in Grant Thorntons Kansas City office, including Stover, in
which Johannsen stated:

I had hoped to have this issue behind us by now, however,

for a variety of reasons we have not come to a final conclusion.
We will, by the end of this month, have a final answer on how
we go forward with this strategy. In the meantime I would
ask that we not be out prospecting, marketing and selling
more of these until we have our research concluded.

34 Although this correspondence may support Appellants

negligence and breach of fiduciary duty claims, the correspondence does
not relate to Grant Thorntons conduct in attempting to carry out the
contract to which the parties agreed. Accordingly, Appellants have not
established that Grant Thornton acted in a manner to deny Appellants the
benefits they reasonably expected based on the contract. See FL Receivables,
230 Ariz. at 169, 41. Thus, the superior court did not err by granting
summary judgment on Appellants breach of the covenant of good faith and
fair dealing claim.

IV. Attorneys Fees.

35 Because we have reversed the superior courts rulings

regarding several of Appellants claims, we vacate the courts award of
attorneys fees to Grant Thornton, without prejudice to either party
asserting or reasserting a claim for fees following the conclusion of
remanded proceedings in superior court.

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CONCLUSION

36 For the foregoing reasons, we affirm in part and reverse in

part the decision of the superior court. The parties request an award of
attorneys fees on appeal pursuant to A.R.S. 12-341.01(A). In the exercise
of our discretion, we deny those requests, which may be resubmitted after
resolution of the issues that remain to be addressed in the superior court.

AMY M. WOOD Clerk of the Court

FILED: JT

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