Illinois Appellate Court Affirms Dismissal of State Tax Qui Tam Lawsuit

| |


In Depth

On March 31, 2015, the Illinois Appellate Court issued an Opinion affirming the dismissal of a qui tam lawsuit filed by a law firm acting as a whistleblower (Relator law firm) on behalf of the State of Illinois against QVC, Inc., under the Illinois False Claims Act, 735 ILCS 175/1 et seq. State of Illinois ex rel. Schad, Diamond and Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999-U (3/31/15). The lawsuit alleged that QVC had violated the Act by knowingly failing to collect and remit use tax on the shipping and handling charges associated with its internet sales of merchandise shipped to Illinois. The Opinion affirmed an important precedent previously set by the court regarding the standard for dismissal of such claims when the State comes to the aid of the taxpayer and moves for dismissal. It also established new, favorable precedent for retailers by holding that use tax voluntarily paid after the filing of a qui tam action does not qualify as “proceeds” of the action (payable as damages) within the meaning of the Act.

The Relator law firm has been engaged in the filing of Illinois use tax lawsuits against internet retailers under the Act since at least 2003. Approximately four years ago, that firm began to sue retailers for an alleged failure to remit use tax on the shipping and handling charges associated with their sales. In support of its claims, the Relator law firm cited Kean v. Wal-Mart Stores, Inc., 235 Ill.2d 351 (2009), an Illinois Supreme Court case holding that when shipping and handling charges are inextricably tied to the sale of taxable goods, tax should be imposed on those charges. The decision was not widely publicized in Illinois, and the Illinois Department of Revenue did not change its long-standing audit practice of not assessing use tax on shipping and handling charges that were separately stated on customer invoices and were equal to a retailer’s actual shipping cost.

To date, the Relator law firm has filed more than 200 “shipping and handling” lawsuits in the Circuit Court of Cook County. The lawsuits all seek damages equal to three times the Illinois use tax on the shipping and handling charges, and fines ranging from $5,500 to $11,000 for each allegedly false use tax return filed by the retailer. Roughly 20 percent of the tax and fines are payable to the Relator law firm. In addition, the Relator seeks costs and attorneys’ fees for itself and the State of Illinois.

Many retailers settled their claims with the Relator law firm rather than incurring the cost and trouble of defending against the litigation, particularly after the circuit judge to whom the cases were assigned (Thomas R. Mulroy) refused to grant defendants’ motions to dismiss filed prior to discovery. Judge Mulroy found that the cases raised a fact issue that precluded dismissal before discovery. Judge Mulroy has ruled in taxpayers’ favor, however, in the shipping and handling tax cases tried before him to date. The Office of the Illinois Attorney General (AG) has declined to intervene in the vast majority of cases filed by the Relator law firm, citing a lack of resources. The Act permits the Relator to proceed on its own to attempt to collect a recovery from defendants. Both the AG and the Relator law firm have profited handsomely from the settlements.

On rare occasions, the AG has agreed to intervene and support the dismissal of these cases. In QVC’s case, the AG agreed to intervene and move to dismiss the case based on the submission of affidavits establishing a favorable audit history in which the Illinois Department of Revenue was made aware of, and expressed no objection to, the fact that QVC was not collecting tax on its shipping and handling charges. In support of its motion to dismiss, the AG relied in part upon the Illinois Appellate Court’s prior ruling in State ex rel. Beeler, Schad & Diamond v. Burlington Coat Factory Warehouse Corp., 369 Ill. App. 3d (1st Dist. 2006), in which the court held that where the AG moved to voluntarily dismiss a qui tam action and the relator could not show “glaring evidence” that the State had acted in bad faith, the case should be dismissed.

Not surprisingly, the Relator law firm fought the State’s effort to dismiss the QVC litigation. It opposed (unsuccessfully) the State’s motion to intervene and argued that the “glaring bad faith” standard for dismissal should not apply because the State must have entered into a settlement agreement with QVC. In support of its settlement theory, the Relator law firm noted that QVC had begun collecting and remitting tax on its Illinois shipping and handling charges shortly after the litigation papers were served on it. After allowing limited discovery to the Relator (the deposition of the QVC employee who had submitted an affidavit denying the existence of any settlement) the circuit court granted the motion to dismiss. The circuit court also rejected the Relator law firm’s motion for an award of its attorneys’ fees and costs, as well as a percentage of the tax proceeds paid by QVC to the State on its shipping and handling charges for sales made after it was served with the Relator’s complaint. The Relator law firm appealed the circuit court’s ruling.

In affirming the circuit court’s ruling, the Opinion strongly affirmed the standard for dismissal established by Burlington Coat Factory. In addition, the Opinion created favorable new precedent by establishing that the Relator’s claim for damages under the Act cannot include tax paid by a defendant based on a voluntary change in its conduct after the filing of the litigation.

The Relator law firm argued that even if the circuit court properly dismissed its complaint, the Act required the State to pay the Relator fees for its help in producing income for the State. Looking to the federal False Claims Act (on which the Illinois Act is modeled), the appellate court held that the Relator was not entitled to a recovery because it was not a “prevailing party” within the meaning of the Act and, moreover, QVC’s tax payments on its shipping and handling charges were not “proceeds” of the litigation. The Opinion emphasized that the circuit court did not order QVC to pay any civil penalty or damages, or provide any relief for the misconduct alleged in the complaint. The appellate court emphasized that the term “prevailing party” does not include a party that has achieved the desired result because the lawsuit brought about a voluntary change in a defendant’s conduct.

The McDermott Difference McDermott’s State & Local Tax Practice Group represented QVC in this litigation.