Estate of Spear v. Commissioner of Internal Revenue Service ( 1994 )

Opinions of the United
1994 Decisions States Court of Appeals
for the Third Circuit
11-21-1994
Estate of Spear v. Comm. IRS
Precedential or Non-Precedential:
Docket 93-7727
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
___________
NO. 93-7727
___________
ESTATE OF LEON SPEAR, Deceased;
JEANETTE SPEAR, HARVEY SPEAR and
ROBERT SPEAR, Administrators and
JEANETTE SPEAR,
Appellants
v.
COMMISSIONER OF INTERNAL REVENUE SERVICE
_____________________________________________
Appeal from the United States Tax Court
Tax Court No. 87-03276
_____________________________________________
Argued: June 24, 1994
Before: BECKER, HUTCHINSON, Circuit Judges, and
PADOVA, District Judge.*
(Filed November 21, 1994)
MARK S. HALPERN, ESQUIRE (ARGUED)
BARRY A. FURMAN, ESQUIRE
Furman & Halpern, P.C.
401 City Avenue, Suite 612
Bala Cynwyd, PA 19004
ALAN C. KESSLER, ESQUIRE
Buchanan, Ingersoll,
Professional Corporation
Two Logan Square, 12th Floor
18th & Arch Street
Philadelphia, PA 19103
*Honorable John R. Padova, United States District Judge for
the Eastern District of Pennsylvania, sitting by designation.
Attorneys for Appellants
PAULA K. SPECK, ESQUIRE (ARGUED)
GARY R. ALLEN, ESQUIRE
RICHARD FARBER, ESQUIRE
U.S. Department of Justice
Tax Division
P.O. Box 502
Washington, DC 20044
Attorneys for Appellees
__________________________
OPINION OF THE COURT
____________________________
BECKER, Circuit Judge.
Jeanette Spear and the Estate of her late husband, Leon
Spear, ("taxpayers") appeal the decision of the United States Tax
Court assessing substantial income tax deficiencies and fraud
penalties against them following a five-day trial. The tax
court's decision depends in significant measure on "deemed" facts
resulting from a sanction imposed because of Jeanette Spear's
failure to appear and testify at trial. These deemed facts were
critical to the outcome because they not only furnished the
predicate for use by the Internal Revenue Service ("IRS") of the
net worth method to determine income tax liability, but also
appear to have shifted the burden of proof on both net worth and
fraud from the IRS to the taxpayer.
The tax court imposed this quite severe sanction
notwithstanding that it had before it a five-hour long videotaped
deposition of Jeanette Spear taken for possible use at trial
which covered all the ground of reasonably expected trial
testimony. Moreover, the ultimate basis for imposition of the
sanction, Jeanette Spear's putative bad faith in failing to
appear at trial, is based on such a frail foundation that the tax
court's bad faith finding does not survive even deferential
review. Given these considerations, and the fact that the other
factors that we consider in applying the principles used to
assess the validity of sanctions favor the taxpayers, we conclude
that the sanction imposed here was improper and an abuse of
discretion. We will therefore vacate the tax court's decision
and remand for further proceedings.
I. FACTS AND PROCEDURAL HISTORY
A. Background
During the years in question, taxpayers were the sole
shareholders in several corporations which operated a large
number of parking lots in Center City Philadelphia on the fringe
of the downtown area. The IRS contends that taxpayers skimmed
money from these cash businesses and failed to report it as
income. The IRS based its assessment of deficiencies on the net
worth method, under which it determined income by subtracting
taxpayers' net worth at the end of the tax year from their net
worth at the beginning of the tax year with appropriate
adjustment for nontaxable receipts and nondeductible
expenditures. The IRS often uses this method when the taxpayers'
income and expense records are inadequate or incomplete.
In 1986, the IRS issued a Notice of Deficiency to
taxpayers assessing income tax deficiencies of $51,271.70,
$157,706.46 and $93,536.23 for the years 1975, 1976 and 1977
respectively. The Notice also asserted fraud penalties of
$25,635.85, $78,853.23 and $46,768.12 for the same years. JA 27-
33. Taxpayers sought a redetermination of these assessments in
tax court. On October 31, 1989, Leon Spear suffered a stroke and
died soon thereafter. The tax court substituted the Estate of
Leon Spear as a defendant.
The taxpayers contended at trial that: 1) the IRS had
inappropriately used the net worth method because they had kept
adequate records of their income; 2) the source of the funds that
led to the large increase in their net worth was $380,000 in cash
that Leon Spear's father had given to him years earlier which had
been kept in safe deposit boxes, so that taxpayers' net worth at
the beginning of the 1975 was far higher than the IRS believed;
and 3) the parking lots could not have produced sufficient income
to account for the increase in net worth the IRS claimed. The
tax court rejected these contentions and concluded that there
were tax deficiencies of $43,354.65, $155,504.29 and $92,053.20
for 1975, 1976 and 1977. It also imposed fraud penalties of
$21,677.32, $77,752.14 and $46,026.60 for the same years.
Although taxpayers repeat on appeal their contentions
about the use of the net worth method, and challenge the factual
findings pertaining to net worth as clearly erroneous, they also
strenuously argue that the court committed reversible error by
sanctioning them for Jeanette Spear's failure to testify. The
sanction was a linchpin of the tax court's decision, and we limit
our discussion of the record to the facts bearing on the
sanctions issue.
B. The Facts Leading to the Imposition of Sanctions
In April 1990, the tax court entered an order setting
the case for trial on November 9, 1990. JA 5. The IRS
subpoenaed Jeanette to appear at trial because she was the only
living witness to the alleged 1957 gift of $380,000 from Leon's
father, and because she had been responsible for maintaining the
books of the parking corporations. JA 923-24.
On October 25, 1990, taxpayers moved for a continuance
on the basis that Jeanette was experiencing emotional trauma
based on the anniversary of her husband's death (a death she
attributed to the prosecution by the IRS, JA 11-12) and the
approach of the trial. On November 2, 1990, Dr. Sol B.
Barenbaum, a psychologist chosen by the Commissioner, examined
Jeanette and reported that she could testify without mental or
physical harm. JA 10-13, 124-25. However, on November 5, 1990,
Jeanette was admitted to the psychiatric unit of Nazareth
Hospital in Philadelphia after her attending physician, Dr.
Martin J. Durkin, was told that she had attempted suicide by gas
and possibly pills. JA 16, 125.
Taxpayers then moved for a continuance, attaching a
letter from Dr. Durkin, who is a Board-certified psychiatrist,
stating that Jeanette was suffering from "psychotic depression
and a recent serious suicide attempt" and that she needed to be
hospitalized for at least two or three weeks. JA 14. The tax
court granted the continuance on November 6. JA 7. The next day
Jeanette's son, Robert Spear, requested that she be released from
the hospital. The hospital allowed her out for the day on
November 9, 10, and 11, and discharged her on November 12. JA
143-44.
Dr. Durkin evaluated Jeanette again in December 1990,
and January, March and April, 1991. (JA 15-18). On March 18,
Dr. Durkin wrote to defense counsel that after three psychiatric
evaluations of Jeanette he had concluded that
[s]he continues to suffer from a depressive
illness with features of anxiety. I do not
feel it wise to expose the patient to a
judicial process in respect to her concerns
with the Federal Government. This type of
exposure could exacerbate her present illness
and possibly lead to another suicide attempt.
The stress could be a precipitating event to
a possible heart attack or stroke.
J.A. 15. On April 29, after conducting still another psychiatric
evaluation, Dr. Durkin again wrote to defense counsel. He stated
that based on his continuing personal evaluation of Jeanette
combined with the evaluation of a neurologist and a recreational
therapist who observed Jeanette and conducted several tests
during her hospitalization, his
opinion remains that the patient should not
be exposed to depositions or to
interrogatories because of her present
gradual emotional status. To again
summarize, I believe that any type of
exposure to these types of events would
exacerbate her depression and again cause a
psychiatric hospitalization. Worse, the
patient may again make an attempt at suicide
which could be successful.
JA 18.
There is no evidence that, after this April evaluation,
Jeanette had any further treatment until the next time the case
was set for trial. See T.C. Mem. Op. at 23. In July, 1991, the
Commissioner sought leave to take a videotaped deposition of
Jeanette, arguing that such a deposition was needed due to
Jeanette's possible unavailability for trial as a result of "her
mental, emotional or physical infirmity." JA 105. Taxpayers
opposed the application, submitting the April letter from Dr.
Durkin quoted above, in which Dr. Durkin noted Jeanette's
obsession with the trial and that she suffered from transitional
stress due to her difficulties with the IRS. JA 18.
On August 8, 1991, the IRS moved for a court-ordered
physical and mental examination to determine Jeanette's ability
to testify. Taxpayers opposed the application, submitting
another letter from Dr. Durkin stating that a forced examination
or appearance in a court would "be a serious danger to Mrs.
Spear," JA 21, and pointing out that Jeanette had previously
undergone a court ordered examination. Taxpayers also submitted
an affidavit from Dr. Marvin Rubin, a psychologist who had
treated Jeanette from November 15, 1989 through October 24, 1990,
stating that:
[w]hether correctly or incorrectly Jeanette
attributes the death of her husband to the
fear and anxiety that he had relating to the
Internal Revenue Service hearing. Jeanette
is very anxious and upset about the
possibility of herself dying at the hearing.
It is my professional opinion that Jeanette
is incapable presently to withstand the
trauma of a court hearing due to her
emotional and psychological state. Add in
the fact that the anniversary of her
husband's death is imminent, the effect would
psychologically devastating.
J.A. 11-12.
The court denied the motion for a videotaped deposition
but granted the motion for a physical and mental examination.
Taxpayers refused to have Jeanette appear for the examination and
the Commissioner moved for sanctions. See T.C. Mem. Op. at 24.
Taxpayers then decided that it was preferable for Jeanette to
appear for the videotaped deposition than the physical
examination. JA 165. On November 13, 1991, the court ordered
Jeanette to appear for the videotaped deposition and scheduled
briefing on the sanctions motion.
On December 12, 1991, the IRS deposed Jeanette (on
videotape) for more than five hours. In taxpayers' submission,
they gave the IRS great leeway in questioning, objecting only
eight times and not asking any follow up questions in order not
to elevate Jeanette's level of stress. The taxpayers contend
that Jeanette was distressed and confused at times during the
deposition; the IRS asserts that she showed that she could
testify coherently and knowledgeably. Compare JA 650, 764-65,
807, 814 with JA 638-40, 659-63, 736-38, 750-52. At the
conclusion of the deposition, IRS counsel asked that the
transcript be marked for use at trial. JA 921. After the
deposition, the court granted the IRS' motion to withdraw its
request for sanctions and denied the IRS' motion for a competency
hearing as moot. JA 185.
The IRS subpoenaed Jeanette to appear as a witness at
trial. On February 17, 1992, taxpayers notified IRS counsel that
Jeanette would not appear at trial because doing so would
endanger her health and because the IRS had taken her videotaped
deposition two months earlier. The Commissioner moved to compel
Jeanette to testify or for sanctions. On February 20, the tax
court held a hearing at which the Commissioner's counsel offered
to limit Jeanette's testimony to one or two hours and to "hold it
in an atmosphere similar to that of a deposition." JA 8, 835-36,
921, 926, 929. Taxpayers did not accept this arrangement, and
the court ordered Jeanette to appear and testify on February 24.
See T.C. Mem. Op. at 25.
Taxpayers requested that the court schedule an
evidentiary hearing on February 25 for Dr. Durkin to testify
about Jeanette's condition and thus to help the court understand
why she could not testify. JA 837, 920. The court denied the
request on the grounds that it would disrupt the trial schedule,
see T.C. Mem. Op. at 24, although counsel offered to have Dr.
Durkin testify before Jeanette's scheduled testimony so as not to
disrupt the trial. JA 930. The court agreed to accept another
affidavit from Dr. Durkin instead, stating "[i]f it's just a
matter of effectiveness of presentation, oral versus writing,
then I'm not going to have a hearing for that purpose." JA 932.
On February 23, the day before she was to testify,
Jeanette was again admitted to Nazareth Hospital. According to
the hospital records, the accuracy of which Dr. Durkin certified
as the attending physician, Jeanette had a "major depressive
affective disorder, recurrent episode, severe with psychotic
behavior" and "unspecified acute reaction to stress." JA 225.
Dr. Durkin's admission note states that Jeanette cried frequently
during the evaluation, had a hopeless demeanor, and had
difficulty concentrating. JA 232-33. Although her sons reported
that she may have been abusing valium, laboratory tests did not
show the presence of valium or any similar substances in her
system. JA 217, 232, 234-40, opinion at 26. Jeanette did not
appear in court on February 24 and the tax court granted the
Commissioner's motion for sanctions. JA 186, 1095.
On February 25, the day after she was supposed to
testify, while the trial was still going on, Jeanette checked out
of the hospital. The taxpayers did not inform the court that
Jeanette had done so (T.C. Mem. Op. at 26).
C. The Sanctions Themselves
As a result of Jeanette's failure to testify, the tax
court sanctioned the taxpayers by deeming the Commissioner to
have "made a prima facie showing" of the allegations in paragraph
7 of the Commissioner's answer, those dealing with net worth and
fraud, JA 186, 1095-96 opinion at 33, and to have "met the burden
of going forward as to those allegations. This shifts the burden
of going forward with evidence to petitioners to rebut
respondent's allegations of fraud." T.C. Mem. Op. at 33.
Among the facts the court deemed to be true were that:
(1) taxpayers had furnished only incomplete tax records to the
IRS; (2) the IRS had determined correct taxable income for the
years 1975-77 on the basis of the net worth method; (3) taxpayers
did not have available any cash on hand as of December 31, 1974
which was not deposited in one of their bank accounts; (4)
taxpayers used unreported income to acquire eight real estate
properties in their names or the name of a wholly owned nominee
corporation used to conceal their real estate holdings, and also
used unreported income for other expenditures; and (5) taxpayers
understated their taxable income for the years 1975-77 with
fraudulent intent.
In a net worth case, the Commissioner must: (1)
establish with reasonable certainty an opening net worth; and (2)
either (a) show a likely income source, or (b) negate possible
nontaxable income sources. Holland v. United States, 348 U.S.
132-38 (1954), T.C. Mem. Op. at 36. By deeming the IRS to have
established correct taxable income on the basis of the net worth
method, the tax court appears to have shifted the burden of proof
on this central aspect of the case. T.C. Mem. Op. at 33 (holding
for the IRS generally, the court stated that "[p]etitioners did
not provide sufficient evidence to overcome these deemed facts").
That the imposition of sanctions may well have been
critically important to the result is especially clear when
considering the fraud counts. The tax court did state that:
Respondent has the burden of proving fraud by
clear and convincing evidence. Sec. 7454(a);
Rule 142(b). First, respondent must prove
the existence of an underpayment. Parks v.
Commissioner, 94 T.C. 654, 660 (1990).
Respondent may not rely upon the taxpayer's
failure to carry the burden of proof as to
the underlying deficiency. Parks v.
Commissioner, supra at 660-661; Petzholdt v.
Commissioner, 92 T.C. 661, 700 (1989); Estate
of Beck v. Commissioner, 56 T.C. 297, 363
(1971). Second, respondent must show that
the taxpayer intended to evade taxes by
conduct intended to conceal, mislead, or
otherwise prevent tax collection. Petzholdt
at 699. Stoltzfus v. United States, 398 F.2d
1002, 1005 (3d Cir. 1968); Parks v.
Commissioner, supra at 661; Rowlee v.
Commissioner, 80 T.C. 1111, 1123 (1983).
T.C. Mem. Op. at 55. Yet the tax court seemed to enable the
Commissioner to surmount this steep burden of proof by relying on
the facts deemed to be true. The court wrote:
On February 24, 1992, the Court imposed
sanctions on petitioners because Jeanette
Spear violated an order of the Court by
unreasonably refusing to testify at trial.
The Court ordered that respondent is deemed
to have made a prima facie showing that the
facts in paragraph seven of the amended
answer (paragraph 7) are established.
Petitioners did not convince us that any of
the statements of facts in paragraph 7 are
wrong. As discussed below, we conclude the
facts stated in paragraph 7 and the entire
record in this case clearly and convincingly
show that Leon and Jeanette Spear are liable
for fraud for each year in issue.
T.C. Mem. Op. at 55-56.
Despite these indications that the tax court switched
the burden of proof as well as the burden of production, there
are many other places in the opinion that make it appear that the
tax court found sufficient evidence of net worth and of fraud
without relying on the deemed facts. Nonetheless, because we are
unsure whether the court relied on these facts and shifted the
burden of proof, and because the consequences to the taxpayers
are so significant, we must assume that the court did rely on
these facts. We will thus treat the sanction as one that
essentially shifted the burden of proof (and production) on net
worth and on fraud.
We note that shifting the burden of proof on the fraud
counts would be an even more severe sanction here than it would
be ordinarily because the tax court relied on taxpayers' fraud to
reject their statute of limitations defense. See T.C. Mem. Op.
at 62. Fraud will defeat a statute of limitations defense, Sec.
6501(c)(1), and if taxpayers had prevailed on the fraud count,
they may well have had a valid statute of limitations defense.1
See T.C. Mem. Op. at 62-63. In sum, the sanction in this case
was quite significant and may well have controlled the outcome.
II. DISCUSSION
A. The Applicable Sanctions Standard
T.C. Rule 104(c) as quoted in Gerling Intern. Ins. Co.
v. C.I.R., 839 F.2d 131, 136 n.7 (3d Cir. 1988), provides in
pertinent part that:
"If a party. . . fails to obey an order made
by the court . . . the Court may make such
orders as to the failure as are just and
among others the following:
(1) An order that the matters regarding
which the order was made or any other
designated facts shall be taken to be
1
The Tax Court did not reach this issue because it found
fraud.
established for the purposes of the case in
accordance with the claim of the party
obtaining the order.
The rule is quite similar to Fed. R. Civ. P. 37(b)(2), and we
construe them in pari materia. We review the sanction of deeming
facts to be true under an abuse of discretion standard. See Ins.
Corp. of Ireland v. Compagnie Des Bauxites, 456 U.S. 694, 707,
102 S. Ct. 2099, 2107 (1982); Ali v. Sims, 788 F.2d 954, 957 (3d
Cir. 1986).
In the context of discovery abuse, the Supreme Court
has provided guidance on use of the sanction of deeming facts to
be established. In Ins. Corp. of Ireland, 456 U.S. at 707, 102
S. Ct. at 2107, the Court explained that
Rule 37(b)(2) contains two standards -- one
general and one specific -- that limit a
district court's discretion. First, any
sanction must be `just'; second, the sanction
must be specifically related to the
particular `claim' which was at issue in the
order to provide discovery.
In that case the Court held that the district court had not
abused its discretion in deeming facts establishing personal
jurisdiction to be true absent proof to the contrary, because
defendants had repeatedly agreed to comply with discovery orders
and then failed to do so despite warnings that sanctions would
result. Ins. Corp. of Ireland at 707-09, 102 S. Ct. at 2107.
The Court held that the second requirement, that the sanction be
related to the claim at issue, was met because the sanctions took
as established facts that plaintiff was seeking to prove through
discovery.
This court has not elaborated on or applied the
Insurance Corp. of Ireland standard. In Ali, supra, we held that
where a district court sanctioned defendants by deeming
allegations in plaintiff's complaint to be admitted and granted
summary judgment for plaintiff, the ruling was equivalent to a
default judgment and thus required application of the standards
we had set for issuing a sanction of dismissal. See 788 F.2d at
957. More specifically, we held in Ali that, under the factors
we had articulated in Poulis v. State Farm Fire and Casualty Co.,
747 F.2d 863 (3d Cir. 1984), the sanctions constituted an abuse
of discretion. In Poulis we had explained that our review of a
district court's dismissal with prejudice "is guided by the
manner in which the trial court balanced [six] factors . . . and
whether the record supports its findings." Poulis, 747 F.2d at
868. The six factors are:
(1) the extent of the party's personal
responsibility; (2) the prejudice to the
adversary caused by the failure to meet
scheduling orders and respond to discovery;
(3) a history of dilatoriness; (4) whether
the conduct of the party or the attorney was
willful or in bad faith; (5) the
effectiveness of sanctions other than
dismissal which entails an analysis of
alternative sanctions; and (6) the
meritoriousness of the claim or defense.
Id.In Ali we applied these factors to reverse a sanction
deeming certain facts to be true. We held that, even if there
was inexcusable delay by the defendants in that case, there was
no bad faith, no history of dilatoriness, little prejudice from
the delay that was caused, and less severe sanctions were
probably available. Under those circumstances, sanctions that
were equivalent to dismissal constituted an abuse of discretion.
Id. at 957-58. We explained that, "[i]n Poulis, we established
the strong presumption against sanctions that decide the issues
of a case." Id. at 958.2
Here, unlike in Ali, the tax court's sanction did not
end the case. At most the tax court deemed certain key facts
admitted and reversed the burden of proof. While this is a
severe sanction, it is not the same as deeming allegations in a
complaint to be admitted or granting a default judgment. In
Chilcutt v. United States, 4 F.3d 1313 (5th Cir. 1993), the Fifth
Circuit considered the standards for imposing a similar sanction
(of deeming prima facie elements of the plaintiffs' liability
claim to be established). The court held that, although a
court's decision to deem certain facts established may sometimes
be equivalent to a default judgment, it was not equivalent where
the sanctioned party (the government) was allowed to present its
2
We have reviewed sanctions deeming facts to be
established on only two other occasions, and in neither did we
establish standards for determining whether the trial court
abused its discretion. In Reynolds v. United States, 192 F.2d
987, 998 (3d Cir. 1951), we held that where the government
continued to refuse to produce documents based on a claim of
privilege that had been overruled, the court was authorized by
Rule 37 to deem the facts sought to be proved by the documents to
be admitted -- but we did not consider whether the court had
abused its discretion in applying such a sanction. And in
Gerling we held that a similar sanction was illegitimate because
there had not been any discovery abuse -- thus, there was no
question whether the court had abused its discretion in imposing
sanctions for discovery abuse. See Gerling, 839 F.2d at 139.
case in chief and could have prevailed if it had established its
contentions by a preponderance of the evidence. Id. at 1320 &
n.18. Thus, instead of imposing the sanction under the standards
appropriate for a dismissal, the court applied the two standards
of Insurance Corp. of Ireland (the requirement of "justness" and
the requirement that the sanction be related to the particular
claim at issue in the order to provide discovery) -- "along with
a third -- that the sanction meet the Rule 37 goals of punishing
the party which has obstructed discovery and deterring others who
would otherwise be inclined to pursue similar behavior." Id. at
1321.
Because the sanction was not equivalent to default, for
which a prerequisite under Fifth Circuit law is flagrant and
willful disregard, the court suggested, in what it admitted to be
dicta, that flagrant and willful disregard was not necessary.
Id. at 1322 n.23. On the facts of the case, the Chilcutt court
upheld the sanction. It stated that, where the district court
had warned the government that it would issue sanctions and the
government had repeatedly promised to be forthcoming, the
plaintiffs had a colorable claim, and the evidence the government
had hidden was relevant to the plaintiff's case, the sanction was
just, related to the claim sought to be proved, and was necessary
to compensate for non-compliance and to deter future violations.
As for other considerations, the government's conduct was willful
and was not solely the fault of its attorney. Id. at 1321-25.
We agree with the Chilcutt court that cases on the
sanction of dismissal are not automatically applicable to the
sanction of deeming certain facts to be established.
Nonetheless, the Poulis factors are relevant to evaluating such a
sanction. This is clear from the fact that, in evaluating
whether a district court has properly exercised its discretion in
imposing the sanction of exclusion of testimony, a sanction less
harsh than dismissal and probably similar to shifting the burden
of proof, we consider factors similar to those in Poulis. See
Meyers v. Pennypack Woods Home Ownership Ass'n, 559 F.2d 894 (3d
Cir. 1977). We consider:
(1) the prejudice or surprise in fact of the
party against whom the excluded witnesses
would have testified, (2) the ability of that
party to cure the prejudice, (3) the extent
to which waiver of the rule against calling
unlisted witnesses would disrupt the orderly
and efficient trial of the case or of other
cases in the court, and (4) bad faith or
willfulness in failing to comply with the
district court's order.
Id. Meyers and Poulis supply the sources of the standard we
adopt here.
Comparing the Meyers factors with Poulis, Factor 4 goes
to a party's culpability as do factors 1, 3, and 4 of the Poulis
factors. See supra at 16. Factors 1 and 2 go to prejudice as
does factor 2 of Poulis. Factor 2 also goes to the ability to
correct the problem with action less harsh than the sanction
being considered as does factor 5 in Poulis. Moreover, just as
the ultimate Poulis calculus is a balancing, we think that
balancing similar factors is appropriate in assessing a sanction
of deeming established certain facts. We apply a sliding scale -
- the harsher the sanction being imposed, the more the balance
will have to be against the party being sanctioned to justify the
sanction. See National Hockey League v. Metropolitan Hockey
Club, Inc., 427 U.S. 639, 643, 96 S. Ct. 2778, 2781 (1976)
(dismissed); Society Internationale Pour Parcipations
Industrielles et Commerciales v. Rogers, 357 U.S. 197, 212, 78 S.
Ct. 1087, 1096 (1958) (dismissal); Donnelly v. Johns-Manville
Sales Corp.,677 F.2d 339, 342-43 )3d Cir. 1982) (dismissal);
Meyers v. Pennypack Woods Home Ownership Ass'n, 559 F.2d 894 (3d
Cir. 1977) (exclusion of critical evidence).
This approach is consistent with the Fifth Circuit's
opinion in Chilcutt. Although the Chilcutt court held that the
dismissal cases were not on point and that the test from
Insurance Corp. of Ireland applied, the court referenced all of
the factors we consider in dismissal cases. It considered the
culpability of the sanctioned party including whether the
violation was solely the fault of the attorney or was also the
fault of the client, and the effectiveness of alternative
sanctions. And while the court stated that willfulness was not
required to impose a sanction of deeming facts proved (thus,
incorporating our sliding scale theory of the appropriateness of
sanctions), it also implied that willfulness was relevant. It
stated that "of course, the flagrancy of a party's behavior must
be directly proportionate to the severity of the sanction
imposed." Chilcutt at 1322 n.23.3
3
. Although the Chilcutt court also considered the role of
the sanction in deterring future abuses, we need not consider
that factor here since a deterrence analysis clearly does not fit
This approach is also consistent with Insurance Corp.
of Ireland itself. The standard articulated there, that a
sanction must be 1) just and 2) specifically related to the
particular `claim' which was at issue, was essentially a general
standard for all Rule 37 sanctions. Thus, like our opinion here,
our opinions in Poulis and Meyers had to be consistent with
Insurance Corp. of Ireland because they involved Rule 37
sanctions. They were consistent with it because they were an
elaboration of the meaning of "just" and "related to the
particular claim" in particular contexts.
In sum, in reviewing a trial court order deeming
evidence admitted as a sanction for litigation misconduct, we
will engage in a weighing and balancing exercise in which we
consider: 1) culpability (including willfulness and bad faith,
and whether the client was responsible or solely the attorney);
2) prejudice; and 3) whether lesser sanctions would have been
effective. In making the actual balancing we utilize a sliding
scale, so that bad faith, for example will have to be quite high
to tip the balance if other factors strongly favor the taxpayers.
We view this exercise to be a transliteration of the Insurance
Corp. of Ireland standard in that the prejudice consideration
subsumes the specific relatedness requirement, all of the factors
of which essentially elaborate on "justness."
the unusual facts of this case. See our discussion of taxpayer's
alleged bad faith infra at p. 24-30.
B. Application of the Standard
1) The Need to Show Bad Faith or Willfulness.
In the jurisprudence of dismissal, willfulness or bad
faith is almost always required in order for dismissal to be
within the proper scope of the court's discretion. In the
particular cases before it, the Supreme Court, at a minimum, has
required some sort of fault for dismissal to be allowable.
Compare Societe Internationale Pour Parcipations Industrielles et
Commerciales v. Rogers, 357 U.S. 197, 212, 78 S. Ct. 1087, 1096
(1958) (where party could not comply with discovery order due to
Swiss law, dismissal was inappropriate. It was "due to inability
and not to willfulness, bad faith, or any fault of petitioner.")
with National Hockey League v. Metropolitan Hockey Club, Inc.,
427 U.S. 639, 643, 96 S. Ct. 2778, 2781 (1976) ("[D]ismissal was
appropriate in this case by reason of respondents' `flagrant bad
faith' and their counsel's `flagrant disregard' of their
responsibilities.").
Some courts have held that willfulness or bad faith is
always required before dismissal is an acceptable sanction. See
Ford v. Fogarty Van Lines, Inc., 780 F.2d 1582, 1583 (11th Cir.
1986) ("Absent a clear record of delay or contumacious conduct by
the plaintiff, the trial court's discretion is limited to the
application of lesser sanctions [than dismissal]."); Wilson v.
Volkswagen of America, Inc., 561 F.2d 494 (4th Cir. 1977);
Telectron, Inc. v. Overhead Door Corp., 116 F.R.D. 107, 131 (S.D.
Fla. 1987). But see United States v. Sumitomo Marine & Fire Ins.,
Co., 617 F.2d 1365, 1369 (9th Cir. 1980) (although government did
not exhibit bad faith, dismissal was necessary to deter flagrant
disobedience that resulted from understaffing).
Although we have held that dismissals are an extreme
sanction reserved for cases comparable to National Hockey League
where there was flagrant bad faith, see Poulis, 747 F.2d 863,
867-68, we have sometimes upheld a court's sanction of dismissal
even when there was no willfulness or bad faith. See Poulis, 747
F.2d at 868-70; cf. Hicks v. Feeney, 850 F.2d 152, 156 (3d Cir.
1988) (not all Poulis factors have to be present for dismissal).
Nonetheless, we generally have not upheld dismissal absent
willfulness and bad faith. See Donnelly v. Johns-Manville Sales
Corp., 677 F.2d 339, 342-43 (3d Cir. 1982) (dismissal was an
abuse of discretion where there was delay in obtaining local
counsel but it was due to failure to move with dispatch rather
than to bad faith, where the delay caused little prejudice to the
defendant, and where the district court did not consider an
alternative sanction). Even with respect to the less extreme
sanction of exclusion of evidence, we have held that with respect
to critical evidence, "the exclusion of critical evidence is an
`extreme' sanction, not normally to be imposed absent a showing
of willful deception or `flagrant disregard' of a court order by
the proponent of the evidence." Meyers at 905 (quoting Dudley v.
South Jersey Metal, Inc., 555 F.2d 96, 99 (3d Cir. 1977)).
Although, like the Chilcutt court, we do not have to
decide the issue, we assume that, when the sanction of deeming
facts to be true is not the equivalent of dismissal, willfulness
and bad faith are not prerequisites for imposing that sanction.
When a party does not provide information to another party to
which that party is entitled, a court is certainly permitted to
"even out" the proceedings by shifting the burden of proof in a
fair way even in the absence of bad faith. Moreover, in
Insurance Corp. of Ireland, the Supreme Court upheld a sanction
of deeming facts to be established, even though the court had
made no explicit finding of bad faith, finding repeated
violations of discovery orders to constitute sufficient fault to
justify the sanction.
Nonetheless, the presence of willfulness and bad faith
certainly enhances the case for sanctions. Shifting the burden
of proof, as the tax court seems to have done here when it deemed
certain facts to be established, is a fairly extreme sanction.
It significantly changes the likely outcome at trial. In the
absence of willfulness or bad faith, other factors would have to
weigh strongly in the favor of such a severe sanction to justify
it.
2) Did Jeanette's Conduct Constitute Bad Faith?
The tax court's decision to sanction taxpayers was
essentially bottomed on its finding that Jeanette was
deliberately attempting to avoid her testimonial duties. The
finding of bad faith was grounded upon the following: 1)
Jeanette's illness and hospitalizations correlated with the time
of her scheduled testimony; 2) the lack of evidence of illness at
other times; 3) the taxpayers' agreement to a deposition after
the court ordered a mental and physical examination of Jeanette,
while initially maintaining that Jeanette could not be deposed;
4) Jeanette's competent answer to questions at her deposition,
demonstrating a significant knowledge of the case; 5) taxpayers
failure to timely inform the court that Jeanette could not
testify (twice) or see a psychiatrist (once); and 6) taxpayers
failure to inform the court that Jeanette had been released from
the hospital until after the trial was over. T.C. Mem. Op. at
27-29.
A different explanation exists, however, for the
correlation between the severity of Jeanette's illness and the
imminence of court appearances (and the resultant tardiness of
taxpayers informing the court that Jeanette could not testify)
from the one that posits that the alleged illness was a tactic to
avoid testifying. A legitimate, medically grounded connection
may have existed between Jeanette's illness and the imminence of
court appearances. In order to disbelieve this explanation (and
believe that the correlation demonstrated that Jeanette was
making up the illness to avoid court appearances), the tax court
had to entirely discredit the evaluation of several physicians.
Dr. Durkin, a board-certified psychiatrist and
apparently neutral witness who had never treated Jeanette prior
to her admittance to the emergency room at Nazareth hospital,
consistently diagnosed Jeanette as having a major depressive
disorder, and did so upon Jeanette's admission to the hospital
shortly before trial. He also maintained that this disorder was
related to her difficulties with the IRS, and he stated on
several occasions between November, 1991 and August, 1992, that
testifying would pose a serious threat to Jeanette's health.
JA15-JA18. Dr. Durkin reached this conclusion based on several
examinations of Jeanette, including examinations during a time
when trial was not imminent. Moreover, he based his opinion not
only on his own evaluation but on that of a neurologist and a
recreational therapist who had examined Jeanette during her first
hospitalization.
Dr. Durkin's evaluation was corroborated by the
affidavit of Dr. Rubin, who also concluded that Jeanette's
illness was related to the legal proceedings. JA11. He stated
that she attributed her husband's death to those proceedings and
feared dying herself as a result of them. He added that
testifying would be psychologically devastating to her. Like the
tax court, these physicians were certainly aware of the
possibility that Jeanette was feigning illness in order to avoid
testifying, and yet they opined to the contrary. The only doctor
who concluded that Jeanette was capable of testifying did so
before her first hospitalization.4
The tax court's other justifications for its findings
also do not demonstrate bad faith. The fact that taxpayers
eventually agreed to allow Jeanette to be deposed does not show
that their concern with her appearance at court proceedings was
not genuine. Taxpayers were faced with a choice of having
Jeanette submit to a mental and physical examination, having her
4
Dr. Sol B. Barenbaum, a psychologist chosen by the
Commissioner, examined Jeanette on November 2, 1990.
deposed, or facing a significant possibility of sanctions. Their
reluctant agreement to a deposition does not demonstrate a lack
of concern that such a deposition would affect Jeanette's health.
We have viewed the videotape deposition which we
describe infra at 32. Although Jeanette broke down and cried and
had to be soothed on several occasions, and seemed confused as to
questions at others, she basically gave a lucid deposition
without emotional breakdown, a factor that, as the tax court
noted, would seem to undermine the doctors' conclusions that
testifying would be emotionally devastating to her.5 But we are
not physicians. The deposition revealed Jeanette to be quite
emotionally upset, and we cannot say with assurance that the fact
that she was able to testify on one occasion automatically means
that she could always do so.
Dr. Durkin continued to believe after this deposition
(at the time of her second hospitalization) that Jeanette was
suffering from a major depressive order. And he reported that
upon hospitalization "she indicated that she became quite anxious
and quite upset when she discovered that the Internal Revenue
Service wished her to be deposed for another hour period of time.
She add[ed], `[t]hey have all that they can possibly get from me,
what else are they looking for.'" JA 232. Thus, Jeanette's fear
of the IRS may have escalated after the videotaped deposition.
5
On the other hand, if Jeanette gave a full and lucid
deposition, that undermines the IRS's position that it was
prejudiced by her failure to appear at trial. See infra at 32-
34.
Moreover, although the IRS offered to make the conditions during
Jeanette's trial testimony similar to those during her
deposition, the judge's presence at trial would have added an
intimidating factor not present during the earlier deposition.
Finally, defendants' failure to inform the tax court
of Jeanette's release from the hospital, while improper, does not
show that taxpayers were deliberately creating an excuse to avoid
having Jeanette testify. Jeanette was discharged against medical
advice, JA 225, and if taxpayers had really been attempting to
deceive the court, they would have had Jeanette stay in the
hospital until the conclusion of the trial.
Thus, in the face of contrary opinions by two experts
who had significant opportunity to examine Jeanette, the tax
court's explanation for its finding that Jeanette's "refusal to
testify was a manipulation, and not a bona fide response to
medical problems," JA 29, was extremely thin. Moreover, it seems
extremely unlikely that Jeanette was attempting to manipulate the
trial process given that she had very little to gain by doing so
-- there is little reason to believe that her testimony would
have substantially aided the Commissioner; rather, it might have
significantly hurt the Commissioner. For example, based on our
viewing of the deposition, we find Jeanette's testimony as to the
$380,000 cash hoard quite straightforward, and it seems to be
credible. Finally, we note that even if Jeanette initially went
to the hospital partly as an attempt to avoid testifying and
helping the Commissioner, after receiving medical advice, she had
every reason to worry about testifying.
Similarly, Jeanette's co-defendants, the representative
of the Estate of Leon Spear and ultimately of Jeanette's
children, had every reason to worry about the effect that
testifying would have on her. Thus, it is highly unlikely that
taxpayers' refusal to allow Jeanette to testify was based solely
on an attempt to manipulate the trial process and did not reflect
significant concern for her health. Compounding the problem is
the fact that the tax court declined to hold a hearing on the
issue because such a hearing would allegedly have disrupted the
trial schedule. Yet taxpayers offered to produce Dr. Durkin at
the time when this would not disrupt the trial. Especially in
the absence of a hearing at which the tax court could ask Dr.
Durkin why he was sure that Jeanette was not making up her
illness or at least its severity, the tax court's finding of bad
faith is seriously problematic.
We acknowledge that taxpayer was not prevented from
complying with the court's order due to an external constraint.
Even if Jeanette truly feared becoming more sick if she
testified, she still was physically capable of testifying and
consciously chose not to do so. In this sense, her non-
compliance was willful. Moreover, it was a choice that she made
rather than a choice her attorney made. Nonetheless, we think
that Jeanette's level of culpability was not high, given that we
have found that her fears of testifying were legitimate.6
6
The tax court may also have based its decision to
sanction the defendants on the fact that Jeanette did not go
through with the second court ordered physical and mental
examination, in the fall of 1991. (T.C. Mem. Op. at 34-35). But
We review the tax court's finding of bad faith and
wilfulness deferentially, i.e., for clear error. See
Commissioner v. Duberstein, 363 U.S. 278, 290-91 (1960); B.B,
Rider Corp. v. Commissioner, 725 F.2d 945, 948 (3d Cir. 1984);
DeCavalcante v. Commissioner, 620 F.2d 23, 26 (3d Cir. 1980). A
finding is clearly erroneous when although there is evidence to
support it, the reviewing court on the entire evidence is left
with the definite and firm conviction that a mistake has been
committed. United States v. U.S. Gypsum Co., 333 U.S. 364, 395
(1948). While we understand the tax court's annoyance with Mrs.
Spear, for the reasons we have elaborated on at such length, we
are left with such a firm conviction here. But even if the
problematic bad faith finding survives because of deferential
review (and if it did, it would be only by a small margin), the
result would be the same because, under the sliding scale, the
bad faith will have to be quite high to tip the balance in favor
of the IRS in view of the fact that the other factors in the
Insurance Corp. of Ireland-based test we apply strongly favor the
taxpayer, see infra at 32-35, and it is not.
3) The Need to Show Prejudice
the IRS only asked for this examination when Jeanette refused to
submit to a videotaped deposition. After Jeanette did submit,
the IRS withdrew its motion for sanctions. Thus, the Spears had
little reason to believe that she was still required to submit to
such an examination, and hence meaning her refusal to do so
cannot reasonably be deemed willful and in bad faith.
In Insurance Corp. of Ireland, the Court held that "the
sanction must be specifically related to the particular `claim'
which was at issue in the order to provide discovery." 456 U.S.
at 707, 102 S. Ct. at 2107. It may be that this requirement does
not inherently bar sanctions where there is no prejudice.
Arguably a sanction may be considered to be "specifically related
to the particular `claim'" at issue in the discovery order even
when there is little indication that the discovery would have
produced useful information. A party should certainly not be
able to gain a strategic advantage at trial by refusing to
provide information it is required to provide and avoiding
sanctions because the other side cannot demonstrate the
importance of this information.
Nonetheless, the basic thrust of the Supreme Court
jurisprudence is that sanctions that effect the outcome of the
trial should only be imposed in order to compensate for
violations that may plausibly be thought likely to affect the
outcome of the trial. See Wilson v. Volkswagen of America,
Inc., 561 F.2d 494 (4th Cir. 1977) ("Even in those cases where it
may be found that failure to produce results in the discovering
party's case being jeopardized or prejudiced, it is the normal
rule that the sanction must be no more severe than is necessary
to prevent prejudice to the movant." (quotations omitted)).7 And
7
Cf. Betz v. Commissioner, 90 T.C. 816, 823 (1988) (where
government delay in filing a brief caused no prejudice, the court
would not deem certain facts true as a sanction); Meyers v.
Pennypack Woods Home Ownership Ass'n, 559 F.2d 894 (3d Cir. 1977)
(reversing the exclusion of the witnesses' testimony where the
failure to include the witnesses in the pretrial memoranda was
so we conclude that the imposition of any sanction that affects
the likely outcome of a trial requires that the party sanctioned
have gained some advantage from his or her disobedience of a
court order. In other words, the party that gains from the
sanction must have been at least arguably prejudiced by the
misconduct of the other side.
4) Was There Prejudice?
While the deposition was palpably an emotional
experience for Jeanette, and she broke down and cried several
times, her deposition was lucid and informative. As we viewed
the deposition, she possessed and was able to and did relate, in
response to questions, a great deal of information about the
affairs of the parking lot business. There were also many things
not a result of bad faith but of late discovery of the witnesses,
the plaintiff informed the defendant of the discovery of the
witnesses three weeks before trial thus minimizing prejudice, and
the possibility existed of postponing the trial for a few days,
conducting further discovery and taxing the costs to the
plaintiff); De Marines v. KLM Royal Dutch Airlines, 580 F.2d
1193, 1202 (3d Cir. 1978) (reversing the exclusion of a witness'
testimony where there was only a slight deviation from pre-trial
notice requirements, and admitting the witness was likely to
cause only slight prejudice to the defendants, who were already
aware of the basic substance of the witness' testimony); United
States v. Kincaid, 712 F.2d 1, 3 (1st Cir. 1983) ("Courts
consistently have refused to impose sanctions when the government
has destroyed evidence but the destruction did not prejudice the
defendants."); Faberge, Inc. v. Saxony Products, Inc., 605 F.2d
426, 429 (9th Cir. 1979) (declining to award sanctions under
Rule 56(g) which allows sanctions for affidavits submitted in bad
faith, because no court had relied on the affidavit submitted);
but cf. National Hockey League v. Metropolitan Hockey Club, Inc.,
427 U.S. 639, 643, 96 S. Ct. 2778, 2781 (1976) (dismissal must be
available "not merely to penalize those whose conduct may be
deemed to warrant such a sanction, but to deter those who might
be tempted to such conduct in the absence of such a deterrent. .
. .").
that she did not know or remember, but it seems unlikely that,
given that the events happened so many years ago, she would
recall additional details at trial. While Jeanette was quite
deliberate, and sometimes stated that she did not understand what
appeared to be simple questions (which were then repeated and
answered), she was direct and composed. She was apparently not
feeling well physically (as well as emotionally), but, given the
length of the deposition and the amount of detail covered, it is
difficult to see how anything more would be forthcoming at a
trial.
In our view, there was no prejudice to the IRS from
Jeanette's failure to testify. While the IRS stresses the need
to obtain the truth, the fact is that the court received Mrs.
Spear's 257-page (videotaped) deposition that we have described.
What more did it need? To repeat, having viewed the videotape,
we cannot conceive what more the IRS could have adduced at trial.
Moreover, Jeanette's testimony was favorable to the taxpayers
rather than the government; thus, the only thing the government
had a reasonable chance of gaining from her testimony was a hope
to trip her up à la Perry Mason and diminish the credibility of
taxpayers' evidence. That rarely happens in the real world, and
the Commissioner already had been presented with a chance to
question Jeanette in a five hour deposition that occurred two
months before trial during which defendants had very few
objections to the questions posed by the Commissioner's counsel.
The tax court thus had an excellent opportunity to judge
Jeanette's credibility even without her appearance at trial.
Moreover, when the IRS requested the videotaped
deposition, it did so in part because it was aware that Jeanette
might not be available for trial and it marked the transcript for
use at trial. Thus, during the deposition, the IRS had every
incentive to ask all the questions it wanted to ask at trial.
The IRS did not explain what additional questions it had for
Jeanette that she had not already answered during the deposition.
The IRS argues that there was prejudice because
Jeanette was a "key witness in this case." While Jeanette was a
key witness, this does not explain why the IRS needed her live
testimony. Although live testimony is generally preferable to
videotaped testimony, the absence of such testimony, even from a
key witness, is only minimally prejudicial when that witness is
adverse and when there is a videotaped deposition that can be
introduced in lieu of live testimony. That videotaped deposition
testimony is a staple of modern case management in federal courts
is too well established to require citation. And yet, as
taxpayers contend, "[e]ssentially, the IRS claims that it was
crucial to have Jeanette testify for a second time so that she
would not be believed." (Appellant's Reply at 19). But that, we
have noted, is no basis for a conclusion of prejudice.
5) The Balancing Exercise. In view of the
foregoing discussion, the balancing exercise is not difficult.
We have concluded that the IRS incurred no prejudice, in view of
the availability of the videotaped deposition. On the subject of
whether lesser sanctions would have been effective, this does not
seem to be a factor here. Although a finding of bad faith may
not be strictly necessary to support sanctions, see Ins. Corp. of
Ireland, 456 U.S. at 707, 102 S. Ct. at 2107; Hammond Parking Co.
v. Arkansas, 212 U.S. 322, 350-51, 29 S. Ct. 370, 380 (1908);
Meyers v. Pennypack Woods Home Ownership Ass'n, 559 F.2d 894, 905
(3d Cir. 1977), the imposition of sanctions in the absence of bad
faith generally requires a strong showing of prejudice. But
whatever rationale the tax court judge might have had, there
certainly were lesser sanctions than were employed here that
could have "sent the message." Finally, we have concluded that
the tax court's finding that Jeanette's failure to appear for
trial was in bad faith is clearly erroneous, but that, even if
not, it was sufficiently marginal that it would have been
outweighed by the other factors which strongly militated in favor
of the taxpayers' position. Hence, on the sliding scale the
result is the same. Accordingly, the sanction constituted an
abuse of discretion and must be set aside.
III. CONCLUSION
We have concluded that the sanction imposed by the tax
court, of deeming admitted the facts that furnished the predicate
for use of the net worth method, and shifting the burden of proof
on both net worth and fraud from the IRS to the taxpayer,
constituted an abuse of discretion and must be set aside. We
will therefore vacate the decision of the tax court and remand
the case for further proceedings consistent with this opinion.
The court may, of course, elect to retry the case. In that
event, it might be well advised to rely upon Jeanette's
videotaped deposition in lieu of her testimony, although perhaps
her emotional state is now better. On the other hand, the court
may simply prefer to decide the case on the basis of the existing
record, but absent the "deeming" and its consequences which we
have declared invalid.8
8
. At all events, the tax court will have to address a
number of interesting and difficult questions pertaining to the
net worth method and its application to this case, which we have
not had to reach in view of our disposition.