United States v. Northern Trust Co ( 2004 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
Nos. 04-1148 & 04-1150
UNITED STATES OF AMERICA,
Plaintiff-Appellant,
v.
NORTHERN TRUST COMPANY, as trustee of
the Caterpillar Incorporated Master Trust
and the Inland Steel Industries Pension Trust,
Defendant-Appellee.
____________
Appeals from the United States District Court for the
Northern District of Illinois, Eastern Division.
Nos. 98 C 7272 & 98 C 8217—James B. Moran, Judge.
____________
ARGUED JUNE 8, 2004—DECIDED JUNE 22, 2004
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Before EASTERBROOK, KANNE, and DIANE P. WOOD,
Circuit Judges.
EASTERBROOK, Circuit Judge. Closed-end mutual funds
pay federal income tax on income and capital gains, then
notify their investors, to which the tax burden passes
through. A shareholder that is tax exempt (such as a pen-
sion trust or a university endowment) can claim a refund of
the taxes that the mutual fund paid on account of its
proportionate investment. Taxable investors get income
coupled with a credit for tax the mutual fund has paid. Two
pension trusts (for employees of Inland Steel and Caterpil-
2 Nos. 04-1148 & 04-1150
lar) were shareholders of record in Quest for Value Dual
Purpose Fund, a closed-end mutual fund. Quest reported to
Northern Trust Co., as trustee of these pension trusts, the
gains and taxes attributable to these shares. Northern
Trust then filed tax returns and claimed refunds on behalf
of the pension funds. During 1991 through 1995, the tax
years at issue in this litigation, Northern Trust received
more than $6 million in refunds for the benefit of these
pension plans.
The United States wants the money back. It contends
that, with the permission of the two pension funds, North-
ern Trust “lent” the Quest shares to “borrowers” that held
all economic incidents of ownership—the right to any
dividends on the shares, the right to vote the shares, even
the entitlement to sell them and keep the profits. If a bor-
rower elected to return the shares at the end of the term, it
retained any capital gain or loss. For this set of rights, it
paid the pension funds 102% of the market price of the
Quest shares on the date the “loans” were made. As the
United States sees things, these transactions were sales
carrying a misleading label designed to allow the pension
funds to reap tax benefits on shares that they no longer
owned—while the “borrowers,” though taxable entitles,
avoided the economic incidence of taxes on the mutual
fund’s undistributed income and capital gains.
These suits (one for each pension fund) were filed late in
1998, less than two years from the date the refund of 1995
taxes had been paid, but more than two after the refunds
for the other tax years had been disbursed. Section 6532(b)
of the Internal Revenue Code, 26 U.S.C. §6532(b), gives the
United States only two years to commence proceedings to
recover erroneously paid refunds, “except that such suit
may be brought at any time within 5 years from the making
of the refund if it appears that any part of the refund was
induced by fraud or misrepresentation of a material fact.”
The complaint alleged that the five-year period applies
Nos. 04-1148 & 04-1150 3
because Northern Trust misrepresented that the two
pension trusts were Quest’s “shareholders” and thus eligible
for refunds. On Northern Trust’s motion under Fed. R. Civ.
P. 12(b)(6), the district court dismissed the complaint (with
respect to tax years 1991 through 1994) for failure to state
a claim on which relief may be granted. 93 F. Supp. 2d 903
(N.D. Ill. 2000). As the court saw things, status as a
shareholder is a mixed question of law and fact, and thus
not a “fact” as §6532(b) uses that term; and a “misrepre-
sentation” occurs only if the taxpayer acts with a deceptive
state of mind, which the complaint did not allege. Four
years later the parties settled the United States’ claim with
respect to the 1995 tax year—Northern Trust eventually
paid 100¢ on the dollar—and the district court entered a
final judgment, from which the United States appealed.
Dismissal under Rule 12(b)(6) was irregular, for the
statute of limitations is an affirmative defense. See Fed. R.
Civ. P. 8(c). A complaint states a claim on which relief may
be granted whether or not some defense is potentially
available. This is why complaints need not anticipate and
attempt to plead around defenses. See, e.g., Gomez v.
Toledo, 446 U.S. 635 (1980); United States Gypsum Co. v.
Indiana Gas Co., 350 F.3d 623 (7th Cir. 2003). So it is
irrelevant that the complaint did not plead that Northern
Trust set out to deceive the Internal Revenue Service, or
was negligent (or grossly negligent) in applying for refunds.
Resolving defenses comes after the complaint stage. Even
with respect to elements of the plaintiff’s claim, complaints
need not plead facts or legal theories. See, e.g., Swierkiewicz
v. Sorema N.A., 534 U.S. 506 (2002); Bartholet v. Reishauer
A.G. (Zürich), 953 F.2d 1073 (7th Cir. 1992).
“Misrepresentation” differs from “fraud;” otherwise
§6532(b) would be redundant. Understandably, therefore,
Northern Trust does not contend that the United States had
to plead with particularity under Fed. R. Civ. P. 9(b). Yet if
the normal approach of Rule 8(a) applies, this complaint is
4 Nos. 04-1148 & 04-1150
unimpeachable. Indeed, it goes beyond what is necessary,
for the complaint does anticipate the limitations defense
and meet it with a claim that Northern Trust made a
“misrepresentation of a material fact.” What more could be
required? If, as the district court believed, the word “misrep-
resentation” connotes a culpable state of mind, then the
complaint pleads that state of mind by using the word
“misrepresentation,” for under Rule 9(b) “[m]alice, intent,
knowledge, and other condition of mind . . . may be averred
generally.” And if, as the United States contends, negligent
errors may be called “misrepresentations,” again the
complaint is sufficient. Instead of jettisoning the complaint,
the district judge should have invited the parties to file
motions for summary judgment or held a bench trial; then
we would know what state of mind the persons who pre-
pared these tax returns had, and we could determine
whether that was enough under the statute. Precipitate
dismissal of the complaint has prolonged this litigation
needlessly.
There remains a possibility that this complaint contained
too much rather than too little—that the United States has
pleaded itself out of court by alleging things that, if true,
devastate its claim. The complaint alleges that the “misrep-
resentation” was Northern Trust’s statement that the
pension funds were “shareholders” in Quest. The district
court saw this as conclusive in defendant’s favor, for status
as a “shareholder” is not a “fact” but a legal characteriza-
tion of facts. This is a subject we can address now, and we
disagree with the district court’s view that only the most
concrete statements about the world are “facts” for purposes
of §6532(b). The word “fact” is a staple of the legal system,
and no one suggests that it has a special meaning in the
Internal Revenue Code. There is no linguistic problem in
saying that a characterization (“shareholder”) derived from
combining an undisclosed view of the law with undisclosed
details about the terms of the “loan” is itself a “fact” (or a
mixed question of law and fact, which is treated as a fact for
Nos. 04-1148 & 04-1150 5
many purposes). “Facts” are not limited to those things that
can be described by Newton’s three laws of motion. Those
case-specific details that serve as minor premises in the
legal syllogism and thus determine the outcome are what
we normally understand by “facts” (or “adjudicative facts”)
in the judicial process.
Consider some parallels. Is “discrimination” under Title
VII a “fact”? Ascertaining the existence of “discrimina-
tion” requires the application of legal rules to events in the
workplace (was someone of a different race promoted under
similar circumstances?, and so on). The Supreme Court
nonetheless held in Pullman-Standard v. Swint, 456 U.S.
273 (1982), that “discrimination” is a matter of fact for
purposes of Fed. R. Civ. P. 52 and appellate review. We
know from Icicle Seafoods, Inc. v. Worthington, 475 U.S. 709
(1986), that a person’s status as a “seaman” is an issue of
fact, and from National Collegiate Athletic Association v.
University of Oklahoma, 468 U.S. 85 (1984), that the
definition of a “market” in antitrust law is an issue of fact.
Why should the identification of a “shareholder” differ? All
of these are characterizations arrived at by applying legal
rules to events that may or may not be in dispute. If the
district court articulates the wrong legal rule, it makes an
error of law on the way to its finding of fact, but this does
not render the characterization itself a proposition of “law.”
One could see the same thing through the lens of defama-
tion law. Suppose someone points a finger and shouts:
“That man is a shareholder of Quest!” The statement could
be defamatory if it implied disreputable conduct—if, for
example, the person were a judge who had just rendered a
decision in favor of Quest rather than recusing himself.
Statements that imply propositions that can be true or false
are statements of “fact” rather than “opinion” in tort law.
See, e.g., Stevens v. Tillman, 855 F.2d 394 (7th Cir. 1988)
(discussing this doctrine). The proposition “the Inland Steel
Industries Pension Trust is a shareholder of Quest” implies
6 Nos. 04-1148 & 04-1150
things that can be true or false—at a minimum, that the
pension fund owned shares (as opposed to bonds or war-
rants) during the taxable year in question, and that it was
the beneficial rather than bare legal owner of the shares (in
other words, that it did not hold them as trustee, let alone
as bailee, pledgee, or custodian). The United States con-
tends, however, that the pension fund did not enjoy benefi-
cial ownership in these shares. That may be true or false;
and if the pension fund transferred beneficial ownership of
the shares, then the statement that it remained a “share-
holder” is a misrepresentation of fact. It is no different from
the assertion “the Inland Steel Industries Pension Trust
owns 100,000 shares of Quest” when as a result of sales and
other transfers to third parties it owned only 10,000. That
misstatement, which would increase the tax refund by an
order of magnitude, would be one of fact.
Nothing else in the complaint had any potential to scuttle
the claim. Thus we must remand. We have learned enough
about §6532(b) to say that, when ruling on motions for
summary judgment or holding a bench trial, the district
court should not treat the word “misrepresentation” as
limited to intentional deception. Only one appellate opinion
to date has discussed that word’s meaning. Lane v. United
States, 286 F.3d 723 (4th Cir. 2002)—which considers and
disapproves the district court’s opinion in this litiga-
tion—holds that because “misrepresentation” appears in the
same sentence as the word “fraud,” it must mean some less
culpable state of mind. The fourth circuit thought that gross
negligence would do; we need not decide whether even that
much is essential. One way to understand §6532(b) as a
whole might be that, when the return discloses enough that
all the IRS has to do is check the calculations and apply the
law, then the period of limitations is two years; but if the
IRS must independently discover facts that contradict the
return, then it has an extra three years to do the legwork.
Then if Northern Trust had represented that “the Inland
Nos. 04-1148 & 04-1150 7
Steel Industries Pension Trust owns 100,000 shares of
Quest” when it owned only 10,000, that statement would be
a “misrepresentation” even if it was just a typographical
error (the addition of an extra zero). The only way to
identify such an error would be to ask the pension fund or
Quest for original records, a step that may not occur even
in an audit (itself a rare event). Many dictionaries define
“misrepresentation” to include both intentional and inad-
vertent misstatements. Whether that is the best way to
treat this word in this statutory context is a question that
need not yet be answered, for the United States tells us that
it is prepared to demonstrate that Northern Trust commit-
ted gross negligence, or worse. Only if it comes up short will
it be necessary to pin down the word’s meaning.
REVERSED AND REMANDED
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—6-22-04