HORWOOD MARCUS & BERK CHARTERED
OPPORTUNISTIC “WHISTLEBLOWER”
EXPLOITS ILLINOIS FALSE CLAIMS ACT
March 12, 2012
If you have any questions regarding
this memorandum, or any other state
or local tax matter, please contact any
of Horwood Marcus & Berk’s state and
local tax professionals:
Fred O. Marcus
(312) 606-3210
fmarcus@saltlawyers.com
Marilyn A. Wethekam
(312) 606-3240
mwethekam@saltlawyers.com
Jordan M. Goodman
(312) 606-3225
jgoodman@saltlawyers.com
David A. Hughes
(312) 606-3212
dhughes@saltlawyers.com
David S. Ruskin
(312) 606-3235
druskin@saltlawyers.com
Jennifer A. Zimmerman
(312) 606-3247
jzimmerman@saltlawyers.com
Breen M. Schiller
(312) 606-3220
bschiller@saltlawyers.com
David A. Fruchtman
(312)281-1111
dfruchtman@hmblaw.com
There is something troubling when relying on guidance by a Department
of Revenue can get you sued. Even more fundamentally perplexing is the
possibility that such a lawsuit could be brought by a private party
purporting to act in the interests of the Department of Revenue that issued
the guidance you had so diligently followed. A frightening prospect, but
that is exactly what is happening in Illinois today. As of the date of this
writing, approximately 200 lawsuits have been filed against retailers
operating on a nationwide basis, alleging that they have fraudulently failed
to collect tax on the shipping portion of sales to Illinois customers.
These actions, colloquially referred to as “qui tam” or “whistleblower”
actions, have been brought under the under the Illinois False Claims Act
(“Illinois FCA”), which itself is modeled on the Federal False Claims Act
(“Federal FCA”). The lawsuits accuse the retailers of committing fraud
by not collecting tax on shipping charges to Illinois customers, a position
that the Department of Revenue has endorsed explicitly in the case of
several of the taxpayers, and more generally in over 30 information letters.
Both the Illinois FCA and the Federal FCA were intended “to reward
private individuals who take significant personal risks to bring
wrongdoing to light, to break conspiracies of silence among employees of
malfeasors, and to encourage whistleblowing and disclosure of fraud.”
State ex rel. Beeler, Schad & Diamond, P.C. v. Target Corp., 367 Ill. App.
3d 860, 866 (Ill. App. Ct. 1st Dist. 2006), quoting United States ex rel.
Matthews v. Bank of Farmington, 166 F.3d 853, 858 (7th Cir. 1999).
Actions under the Illinois FCA can be brought by a private person known
as the “relator.” See 740 ILCS 175/4(b). The classic relator is a
“whistleblowing insider”: an individual that is a close observer or
otherwise involved in the fraudulent activity. Id. at 1161. The most
valuable relators are “typically insiders with direct and independent
knowledge of fraud.” United States ex rel. Poteet v. Bahler Med., Inc.,
619 F.3d 104 (1st Cir. Mass. 2010). The law requires that the relator give
the information it has regarding the alleged fraud to the proper state
authority, and the state then decides whether to intervene and take over the
action. If the state declines to intervene, the relator may go forward with
its action. Those found to have violated the Illinois FCA may be liable to
the state for a civil penalty in addition to three times the amount of
damages sustained by the state. 740 ILCS 175/3.
In case you are wondering why anybody would want to be a relator, a
quick glance at the Illinois FCA reveals a possible answer: the statute
provides that the relator is entitled to not less than 25% and not more than
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30% of the proceeds of the action or any settlement. In the context of a
proper whistleblower action, where the relator is being rewarded for
taking “significant personal risk to bring wrongdoing to light”, such
financial incentives may make sense. However, where the relator is less a
personally-invested whistleblower than a disinterested busybody, financial
rewards risk distorting behavior in ways that run contrary to the original
intent of the law. Such distortions, referred to judicially as “parasitic
claims”, are eliminated by insisting that relators “must possess substantive
information about the particular fraud, rather than merely background
information which enables a putative relator to understand the significance
of a publicly disclosed transaction or allegation.” United States ex rel.
Stinson, Lyons, Gerlin & Bustamante, P.A. v. Prudential Ins. Co., 944
F.2d 1149, 1160 (3d Cir. N.J. 1991).
The current spate of cases, all 200, were filed by the same Chicago-based
law firm (“the Relator”). The Relator is not itself, nor is it working with,
an entity or person that would traditionally be thought of as a
whistleblower. The Relator has no “insider knowledge”, and it would be
ludicrous to suggest that it is taking great personal risk to bring
wrongdoing to light. Instead, the Relator is an opportunist taking
advantage of a law that was never intended to apply to relators like it or to
cases like these.
In fact, the cases alleging fraud against retailers for not collecting Illinois
tax on shipping charges are not the first attempt by the Relator to exploit
the Illinois FCA. Beginning in 2002, the Relator brought suit against
numerous out-of-state retailers alleging that they had fraudulently failed to
collect use tax on purchases made over the Internet by customers in
Illinois. The Relator’s law firm purchased goods over the Internet from
retailers that were not themselves physically present in Illinois, but that
were affiliated with “bricks and mortar” entities operating retail stores in
the state. The Relator was not charged use tax on its purchase. Upon
receipt of the goods purchased, the Relator returned the goods to the
“bricks and mortar” store operated by the retailer’s Illinois affiliate. It
was the Relator’s position that the ability to return the good in Illinois
created nexus between Illinois and the out-of-state retailers sufficient to
impose a use tax collection responsibility on those retailers.
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In addition to questioning whether the Relator is a proper whistleblower
under Illinois FCA, the current cases involving shipping charges strike
many as substantively suspect. Any taxpayer attempting to understand
Illinois law on the proper taxation of shipping charges will likely finish
the exercise with more questions than answers. Lending to the confusion,
some of the retailers currently being sued for fraud had their tax treatment
of shipping charges approved under audit by the Department of Revenue.
Others had relied upon a leading provider of transaction tax management
software to calculate and record transaction taxes on sales to Illinois, and
the software was designed by its provider to treat “shipping charges” as
exempt from Illinois use tax. Most of the retailers facing actions under
the Illinois FCA have locations in Illinois and are registered as Illinois
retailers. And while specific details vary, all of the retails facing suit have
been operating within a legal landscape that is muddled and confusing.
The fact that these actions involve a disputed legal question about which
more than one reasonable interpretation exists can be clearly seen by
reference to the Department’s own publicly available guidance, along with
widely-used and respected tax research tools, such as RIA Checkpoint’s
State Tax Chart and CCH’s Smart Chart. Nevertheless, the lawsuits filed
by the Relator are a reality even though many find it frankly offensive, if
not completely illogical, that a taxpayer making a good-faith effort to
understand and apply a confusing aspect of the tax law could find
themselves in court, being sued for fraud.
HMB COMMENT
The qui tam actions described above have paved the path for the filing of
additional, opportunistic lawsuits, brought by relators who exploit legal
uncertainties to their own financial advantage. One legal area ripe for
such exploitation is unclaimed property, where the law is evolving at a
rapid pace, and causing mass confusion about what property is subject to
the law and who must report to the state. In fact, a suit under the Illinois
FCA filed in Cook County Court and unsealed in January of 2012, alleges
that two insurance companies perpetrated a "massive fraud" when they
kept more than $524 million in unclaimed life insurance money that
should have been turned over to Illinois. While the surrounding details
remain unknown, the suit against the insurance companies evidences a
worrying trend in whistleblower actions for businesses that are attempting
to follow uncertain and often confusing laws, including legal grey areas
spawned by court decisions that raise more issues than they address.
Although businesses may find some comfort in knowing that suits
premised on violations of the Illinois Income Tax Act are disallowed
under the Illinois FCA, the recent foray into unclaimed property is
troubling.
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