Conservation Easement Promoters’ Claims Precluded, Insurers Argue

CERTAIN UNDERWRITERS AT LLOYD'S, FIDELIS UNDERWRITING LIMITED, AND HDI GLOBAL SPECIALTY SE,
Plaintiffs,
v.
STRATEGIC CAPITAL PARTNERS, LLC, RICKY NOVAK, AND JAMES FREEMAN,
Defendants.

PLAINTIFFS' COMPLAINT FOR DECLARATORY JUDGMENT

Plaintiffs Certain Underwriters at Lloyd's, Fidelis Underwriting Limited, and HDI Global Specialty SE (collectively, “Underwriters”), seek a declaration, pursuant to 28 U.S.C. § 2201, that the claims for coverage under the fund and investment management liability and fraud insurance policy number FIJ0022931477 (the “Policy”) by Defendants Strategic Capital Partners, LLC (“Strategic”), Ricky Novak, and James Freeman (each individually an “Insured,” and collectively the “Insureds”) are precluded by the Policy's previously notified or known matters exclusion, and in support thereof, state as follows:

I. INTRODUCTION

1. The Insureds are defendants in underlying lawsuits arising out of their promotion of syndicated conservation easements. Under the U.S. Internal Revenue Code, a taxpayer can claim a deduction for the fair market value of a conservation easement (i.e., an easement intended to perpetually protect land) donated to certain organizations. Some promoters syndicate conservation easement transactions, which attempt to give investors the opportunity to obtain charitable contribution deductions in amounts that can exceed the invested amount. In effect, individuals invest in an entity that has an interest, either directly or indirectly, in land. A conservation easement is placed on the property, entitling a charitable deduction, which is allocated to the investors (for each to take as a deduction on his or her personal taxes). Because some of these deductions were significantly more than the investors' investment, the IRS closely scrutinized these transactions.

2. The Insureds knew or should have known that investors were likely to pursue claims against them for their participation in and promotion of the syndicated conservation easements at issue in the referenced underlying lawsuits. In 2016, the Internal Revenue Service (“IRS”) designated syndicated conservation easements, such as those promoted by the Insureds, as a “listed transaction.” A “listed transaction” is a transaction that is the same as or similar to transactions that the IRS has determined to be a tax avoidance scheme. The designation increased the likelihood that the IRS would closely scrutinize the claimed deductions. In March 2019, the IRS added syndicated conservation easements to its “Dirty Dozen” of tax scams. The Insureds were aware that their syndicated conservation easements were listed transactions. And, the IRS audited some of the transactions the Insureds promoted, disallowed the various conservation easement deductions, and issued significant penalties for taking the deduction.

3. Investors did file lawsuits against the Insureds. Two of these lawsuits are at issue in this declaratory judgment action. First, in Hill v. Strategic Capital Partners, No. 2021CV345934, pending in the Superior Court of Fulton County, Georgia, (the “Hill Lawsuit”), investor Vernon Hill contends that the Insureds are liable for wrongfully promoting two investments in syndicated conservation easements. Mr. Hill contends among other allegations that the Insureds “orchestrated a scheme to inflate the potential value of the underlying real property through the use of false assumptions and inflated appraisals.” On March 31, 2017, the IRS sent a Notice of Final Partnership Administrative Adjustment (“FPAA”) to Green Creek LLC, a syndicated conservation easement promoted by the Insureds. The FPAA advised that the IRS disallowed Green Creek's claimed $19.6 million charitable contribution and that a 40% penalty would be imposed. Similarly, on June 24, 2019, the IRS disallowed an approximately $22 million deduction claimed by Vista Hills Investments, LLC, another syndicated conservation easement promoted by the Insureds. Investor Hill participated in each of these syndicated conservation easements and claimed charitable deductions approximately four times greater than his investments.

4. The Insureds also found themselves as named defendants in a class action lawsuit, Hoover v. Strategic Capital Partners, No. 21-CV-01299, pending in the United States District Court for the Northern District of Georgia, (the “Class Action”). In the Class Action, the named plaintiffs seek to represent a nationwide class of investors that participated in the syndicated conservation easements. The Class Action alleges in part that the Insureds participated in a “multi-year fraudulent scheme” from 2013 to 2019 whereby they sold interests in syndicated conservation easements that were based on grossly inflated underlying real estate appraisals (the “Easement Scheme”). The Insureds marketed investments in the scheme by touting the potential tax-savings investors would enjoy. The Class Action similarly contends that the IRS disallowed and penalized the deductions claimed as a result of the easements. Of the five specific investments discussed in the Class Action, the IRS disallowed the deduction and assessed penalties in April 2017, June 2019, July 2020, and August 2020.

5. The Insureds sought coverage for the Hill Lawsuit and the Class Action. While Underwriters agreed to reimburse the Insureds for their defense costs, Underwriters reserved their rights under various terms, conditions, and exclusions in the Policy.

6. Among other grounds, Underwriters reserved their rights under the Policy's exclusion for previously notified or known matters (the “Known Matters Exclusion”). This exclusion precludes coverage for Loss in connection with any Claim resulting from “any Wrongful Act which any [of the Insureds] had knowledge of prior to the Continuity Date where such [Insured] believed at the time that such known Wrongful Act could reasonably be expected to give rise to a Claim.”¹ The Continuity Date is November 1, 2019.

7. Prior to November 1, 2019, the Insureds knew that the syndicated conservation easements they promoted were listed transactions and that the IRS had disallowed the deductions claimed in numerous investments. Moreover, they knew the IRS had assessed penalties for these deductions. Consequently, the Insureds knew that their actions could reasonably be expected to give rise to lawsuits against them, such as the Hill Lawsuit and Class Action. Therefore, the Known Matter Exclusions applies, and Underwriters seek a declaration that this exclusion precludes coverage for the Hill Lawsuit and Class Action.

II. PARTIES

8. Plaintiffs Certain Underwriters at Lloyd's are comprised of various syndicates that issued the Policy, each with its principal place of business in London, England. None is a citizen of Georgia.

9. Plaintiff Fidelis Underwriting Limited is a corporation incorporated under the laws of England and Wales, with its principal place of business in London.

10. Plaintiff HDI Global Specialty SE is a European company, with its principal place of business in Hanover, Germany.

11. Defendant Strategic Capital Partners, LLC is a limited liability company organized under the laws of Delaware with its principal place of business in Atlanta, Georgia. Upon information and belief, Strategic may be served with process by serving its registered agent for service, Strategic Investment Holdings Group, LLC, at 1072 W. Peachtree Street NW #78646, Atlanta, Georgia 30357.

12. Upon information and belief, Defendant Novak is a principal of Strategic and resides in Atlanta, Georgia.

13. Upon information and belief, Defendant Freeman is a principal of Strategic and resides in Dunwoody, Georgia.

III. JURISDICTION AND VENUE

14. This Court has subject matter jurisdiction over this action for declaratory relief pursuant to 28 U.S.C. §§ 1332, 2201, and 2202 and Rule 57 of the Federal Rules of Civil Procedure. The amount in controversy exceeds $75,000.00.

15. An actual controversy within the meaning of § 2201 exists between the parties regarding Underwriters' rights, duties, and obligations under the Policy for coverage for the Hill Lawsuit and Hoover Lawsuit.

16. Venue is proper in this Court under 28 U.S.C. § 1391 because the Insureds reside in this judicial district and a substantial part of the events giving rise to the claim occurred in this district.

IV. FACTUAL ALLEGATIONS

A. The Policy

17. Underwriters issued the Policy for the period of November 1, 2020 to November 1, 2021.²

18. The Policy has a continuity date of November 1, 2019.

19. Insuring Clause Sections 1 and 2 are relevant to this lawsuit. Section 1 provides coverage to Management Insureds for “Loss resulting from any Claim made against them arising from the performance of or failure to perform Management Services.”³ Section 2 provides coverage to Insured Persons for “Loss resulting from any Claim made against them arising from their Insured Capacity” or “Loss for which the Management Insured has provided or agreed to provide indemnification to any Insured Person.”⁴

20. The Policy defines each of the terms in bold.

21. Management Insureds includes Strategic.⁵

22. Insured Person is defined to include, in relevant part, “any natural or legal person” who was acting in their Insured Capacity, which is defined to include directors, officers, members, managing members, or functional equivalent of any Management Insured.⁶

23. Management Services are defined as “the services and activities performed by the Management Insured, or by any person or third party for whom the Management Insured is responsible, including but not limited to a) management and/or advisory services to a Fund Entity; and b) management and/or advisory services . . . pursuant to a written agreement for such services; and c) advice regarding investment in, formation, capitalisation or disposition of or rendering management advisory services to an Outside Entity pursuant to an oral or written agreement for such activities; and d) 1031 qualified intermediary services, . . . tax credit brokerage, real estate and conservation consulting.”⁷

24. Loss includes “damages, compensation, compensatory restitution, settlements, pre and post judgment interest, regulatory or civil fines where insurable by law and Costs, Charges and Expenses incurred by each Management Insured under Sections 1 or 2(b) or Insured Person under Sections 2(a).”⁸

25. Costs, Charges and Expenses includes “reasonable costs, charges, fees, disbursements and expenses incurred by an Insured in the investigation, defence, settlement, or appeal of any Claim.”⁹

26. Wrongful Act, in turn, is broadly defined as “any actual or alleged . . . error, misstatement, misleading statement . . . act, omission, neglect, negligence, breach of duty, breach of trust, . . . or any breach of statute in respect of which civil liability arises.”¹⁰

27. Claim includes “any written or oral demand for damages or other relief alleging a Wrongful Act.”¹¹

28. The Known Matters Exclusion states “Underwriters shall not be liable for Loss under this Policy in connection with any Claim . . . resulting from:

i. any Wrongful Act or any fact, circumstance or situation which has been the subject of any notice given prior to the Policy Period under any other similar insurance policy and acknowledged as a valid notification under such policy; or

ii. any prior and/or pending litigation against the Insureds as of the Continuity Date, or any fact, circumstance, situation, transaction or event underlying or alleged in such litigation regardless of the legal theory upon which such Claim is predicated; or

iii. any Wrongful Act which any Management Insured or Insured Person had knowledge of prior to the Continuity Date where such Management Insured or Insured Person believed at the time that such known Wrongful Act could reasonably be expected to give rise to a Claim.”¹²

B. Strategic's Syndicated Conservation Easement Advising

29. The Insureds promoted and sold syndicated conservation easement transactions that purported to give investors the opportunity to claim charitable contribution deductions in amounts that vastly exceeded the investment.

30. In a syndicated conservation easement, investors in a partnership or other pass-through entity (such as a limited liability company) are able to claim a charitable contribution deduction for the donation of a conservation easement. The investors purchase an interest, directly or indirectly, in a pass-through entity that holds real property. The entity that holds the property contributes a conservation easement encumbering the property to a tax-exempt entity. As a result of the conservation easement, the entity receives a charitable contribution deduction, which it can then allocate among its investors. Each investor can then report on his or her federal income tax return a charitable contribution deduction for his or her allocated portion of the conservation easement.

31. Promoters of syndicated conservation easements, such as the Insureds, promoted these transactions by claiming the investors could claim charitable contribution deductions in amounts that exceeded the amount invested. Allegedly, the promoters obtain an inflated appraisal of the real property, which forms the basis of the deductions in excess of the investment.

32. The IRS cracked down on syndicated conservation easements by auditing and disallowing the resulting tax deductions. In December 2016, the IRS issued Notice 2017-10, which designated syndicated conservation easements — such as those created by the Insureds — as a “listed transaction.”¹³ On March 19, 2019, the IRS “warned taxpayers to steer clear of abusive tax avoidance schemes” and specifically identified syndicated conservation easements as one such scheme, adding them to its “Dirty Dozen” of tax scams to avoid.¹⁴

C. The Hill Lawsuit

33. Vernon Hill filed the Hill Lawsuit on February 17, 2021, against the Insureds and several other entities. Hill seeks damages associated with losses sustained by the disallowance of the tax deductions and his investments in syndicated conservation easements promoted by the Insureds. Hill amended his complaint on May 19, 2021, and then filed a second amended complaint on June 28, 2021.

34. Hill alleges that the Insureds created various sham companies in a conspiracy to create and sell fraudulent syndicated conservation easements and that he invested in two such companies.¹⁵ In each of these transactions it is alleged the Insureds “orchestrated a scheme to inflate the potential value of the underlying real property through the use of false assumptions and inflated appraisals.”¹⁶ The Hill Lawsuit further contends that, in each instance, “once an inflated value was obtained, the Defendants elected to subject the real property to a conservation easement, generating substantial tax deductions for charitable contributions based upon the inflated appraisals.”¹⁷

35. The Hill Lawsuit addresses two specific investments promoted by the Insureds.

36. First, the Hill Lawsuit alleges that on December 18, 2013, the Insureds directed Hill to invest $120,000 in Green Creek, LLC (“Green Creek”).¹⁸ Green Creek subsequently obtained a conservation easement, allowing Hill to claim a $508,777 charitable deduction for 2013.¹⁹

37. The IRS sent an FPAA to Green Creek dated March 31, 2017.

38. The FPAA advised that the IRS disallowed Green Creek's claimed $19.6 million charitable contribution and that a 40% penalty would be imposed.

39. The Insureds knew that the IRS disallowed the deduction associated with Green Creek and assessed penalties.

40. The IRS “disallowed the charitable contribution deduction taken by Green Creek, LLC and consider[ed] the Green Creek, LLC conservation easement to be abusive.”²⁰

41. Second, on October 22, 2015, Hill contends he invested $100,000 in Vista Hills Investments, LLC (“Vista Hill”).²¹ The Hill Lawsuit contends Vista Hill then obtained property and subjected it to a conservation easement, which allowed Hill to claim a $440,961 charitable contribution deduction.²² The Hill Lawsuit further contends that the IRS “disallowed the charitable contribution deduction taken by Vista Hill Investments, LLC and considers the Vista Hill Investments, LLC conservation easement to be abusive.”²³

42. In a letter dated June 24, 2019, the IRS provided notice that the deduction claimed by Vista Hill was disallowed and assessed penalties against it.

43. The Insureds knew of the IRS's disallowance of the deductions associated with Vista Hill and the penalties assessed.

D. The Class Action Lawsuit

44. C. Jackson Hoover, Matthew and Heather Greiner, Edward Spratt, Ronald Hebert, Sandi Douget, and Samuel Agnew filed the Class Action Lawsuit on behalf of themselves and a putative class of similarly situated investors against the Insureds and numerous other defendants on March 31, 2021. The plaintiffs filed their First Amended Class Action Complaint on June 25, 2021.

45. The Class Action alleges that the Insureds participated in a “multi-year fraudulent scheme” whereby they sold interests in syndicated conservation easements that were based on grossly inflated underlying real estate appraisals.²⁴

46. The Class Action alleges that the Insureds marketed investments in the scheme by touting the potential tax-savings investors would enjoy. The Insureds allegedly used the Easement Scheme to “effect numerous conservation easement transactions that differed in name and location but not in substance.”²⁵ Plaintiffs claim that the Defendants told investors that “the transactions were legal and an entirely legitimate way to serve the environment and reduce their tax bill.”²⁶

47. The Class Action contends that these transactions were not “properly and legitimately valued or implemented” because the Insureds utilized a “prepackaged collection of bogus, grossly inflated appraisals, donations of easements that lacked a valid conservation purpose, deficient form documents, and faulty easement deeds, all delivered via a mountain of misrepresentations and omissions.”²⁷ The Insureds allegedly served as the developer and sponsor of the easement transactions at issue in the Class Action and worked on every aspect of the transactions.²⁸

48. The Class Action describes five transactions: the DeSoto tract in Shelby County, Alabama (the “DeSoto Transaction”), the Turtle River tract in Glynn County, Georgia (the “Turtle River Transaction”), the Bear Creek tract in Coweta County, Georgia (the “Bear Creek Transaction”), the Rock Spring tract in Morgan County, Alabama (the “Rock Spring Transaction”), and the Vista Hill tract in Chatham County, North Carolina (the “Vista Hill Transaction”). Allegedly, these and other conservation easement transactions “differed in name and location but not in substance.”²⁹

49. The Class Action alleges that the Turtle River Transaction involved a 380-acre tract of land located in Glynn County, Georgia that the Insureds allegedly began promoting in 2013.³⁰ To facilitate this transaction, the Insureds allegedly acquired 3,500 acres for $12.1 million, subdivided it into syndicates that were purchased by investors for a total of $37 million, and claimed that the conservation easement entitled the investors to $141 million in deductions.³¹

50. In a letter dated April 17, 2017, the IRS notified the Insureds that it disallowed Turtle River's conservation easement deduction in its entirety.³² In addition to the disallowance of the deduction claimed for the Turtle River Transaction, the IRS “imposed a gross valuation misstatement 40% penalty and a substantial valuation misstatement 20% penalty in the alternative.”³³

51. The Insureds were aware of the disallowance of the Turtle River Transaction and the assessed penalties. The associated entity filed a petition with the United States Tax Court on June 30, 2017, contesting the IRS' determination to disallow the Turtle River Transaction deduction.³⁴

52. With respect to the DeSoto Transaction, the Class Action alleges that this transaction involved a 161-acre tract of land located in Shelby County, Alabama. The Insured allegedly began promoting the DeSoto Transaction in 2016.³⁵ To facilitate the transaction, the Insureds allegedly acquired land for $709,207, sold it to the DeSoto Syndicate for over $5 million, and declared an easement valued at $25 million.³⁶

53. Allegedly, in connection with this investment, the Insureds notified the potential investors that the IRS had designated syndicated conservation easements as listed transactions.³⁷

54. Allegedly, the IRS notified the transaction's Tax Management Partner (“TMP”) DeSoto Investors that it was conducting an audit, and in August 2020, the IRS sent the Insureds an FPAA notifying them that it disallowed the DeSoto Transaction's conservation easement deduction in its entirety.³⁸ The deduction was disallowed, in part, because of the overvaluation of the real estate, resulting in the IRS imposing a gross valuation misstatement penalty of 40% or alternatively a substantial valuation misstatement penalty of 20%.³⁹

55. Allegedly, the associated entity's tax matters partner filed a petition with the United States Tax Court contesting the IRS' disallowance of the DeSoto Transaction's deduction.⁴⁰

56. The Class Action alleges that the Bear Creek Transaction involved a 185-acre tract of land located in Coweta County, Georgia that the Insureds allegedly began promoting in 2015.⁴¹ The Insureds allegedly acquired the land for $1.3 million, which they sold to Bear Creek members for $5 million, and claimed that the conservation easement entitled the investors to $24 million in deductions.⁴²

57. The IRS audited the Bear Creek Transaction, and in a letter dated July 20, 2020, the IRS notified the Insureds that it disallowed Bear Creek's conservation easement deduction in its entirety and that it imposed a 40% penalty.⁴³

58. The Insureds were aware of the disallowed deduction from the Bear Creek Transaction and the assessed penalties. A petition was filed with the United States Tax Court on October 14, 2020, contesting the IRS' determination to disallow the Bear Creek Transaction deduction.⁴⁴

59. With respect to the Rock Spring Transaction, the Class Action alleges that this transaction involved a 121-acre tract located in Morgan County, Alabama. The Insured allegedly began promoting the Rock Spring Transaction in 2016.⁴⁵ The Insureds generated a charitable contribution tax deduction through the donation of a fee simple interest in the Rock Spring Property as opposed to the donation of a conservation easement. The Class Action alleges this was “functionally the same” as donating a conservation easement.⁴⁶ To facilitate the transaction, the Insureds allegedly acquired land for $839,553, and declared the fair market value of the fee simple donation as $23,560,000 within one week of purchasing the land.⁴⁷

60. Allegedly, in connection with this investment, the Insureds notified the potential investors that the IRS had designated syndicated conservation easements as listed transactions.⁴⁸

61. The IRS audited the Rock Spring Transaction, and it disallowed the Rock Spring Transaction deduction and imposed a 40% penalty in a letter dated August 7, 2020.⁴⁹

62. The Insureds were aware of the disallowed Rock Spring Transaction and the assessed penalties. The associated entities filed a petition with the United States Tax Court on November 9, 2020, contesting the IRS' determination to disallow the Rock Spring Transaction deduction.⁵⁰

63. The Class Action alleges that the Vista Hill Transaction involved a 112-acre plot of land out of a larger 607-acre plot of land located in Chatham County, North Carolina.⁵¹ To facilitate the transaction, the Insureds allegedly purchased 513 acres for $1,438,000 and another 94 acres for $800,000, then subdivided the tract into five different tracts.⁵²

64. The IRS audited the Vista Hill Transaction, and in a letter dated June 24, 2019, the IRS notified the Insureds that it disallowed Vista Hill's conservation easement deduction in its entirety and that it suffered from a gross valuation misstatement or, alternatively, a substantial valuation misstatement.⁵³

65. The Insureds were aware of the disallowance of the deduction associated with the Vista Hill Transaction and the assessed penalties. The associated entity's tax matters partner filed a petition with the United States Tax Court contesting the IRS' determination to disallow the Vista Hill Transaction.⁵⁴ On May 27, 2021, the Tax Court granted partial summary judgment in favor of the IRS.⁵⁵

66. The syndicated conservation easements transactions were substantively the same.

67. As a result of the disallowance and penalty, plaintiffs allegedly were assessed back taxes, penalties, and interest.⁵⁶

68. The Insureds knew that the syndicated conservation easements they promoted were disallowed by the IRS and assessed penalties.

69. The Insureds knew or should have known that the disallowed deductions and penalties were reasonably likely to give rise to a Claim.

E. The Insureds Notified Underwriters of the Hill Lawsuit and the Class Action, and Underwriters Agreed to Provide Coverage for Defense Costs Subject to a Reservation of Rights.

70. The Insureds provided notice of the Hill Lawsuit and the Class Action to Underwriters.

71. On March 15, 2021, Underwriters agreed to pay the reasonable and necessary costs, charges and expenses incurred by the Insureds defending the Hill Lawsuit, subject to their reservation of rights. Underwriters again reiterated their reservation of rights in a letter dated September 15, 2021.

72. On June 25, 2021, Underwriters agreed to pay the reasonable and necessary costs, charges and expenses incurred by the Insureds defending the Class Action, subject to their reservation of rights. Underwriters again reiterated their reservation of rights in a letter dated September 15, 2021.

73. Among other grounds, Underwriters reserved their rights under the Known Matters Exclusion.

V. REQUEST FOR DECLARATORY RELIEF

74. Underwriters reallege the foregoing paragraphs above by reference, as if fully set forth herein.

75. There exists an actual and justiciable controversy among the parties concerning Underwriters' rights, duties, and obligations under the Policy with respect to coverage for the Hill Lawsuit and Class Action.

76. Underwriters respectfully request that this Court issue the following declarations to terminate the uncertainty or controversy giving rise to this proceeding.

COUNT ONE: DECLARATORY JUDGMENT
THE KNOWN MATTERS EXCLUSION PRECLUDES COVERAGE

77. Underwriters reallege the foregoing paragraphs by reference, as if fully set forth herein.

78. Underwriters seek a declaration that the Known Matters Exclusion precludes coverage for the Hill Lawsuit and the Class Action.

COUNT TWO: DECLARATORY JUDGMENT
NO DUTY TO DEFEND OR INDEMNIFY

79. Underwriters reallege the foregoing paragraphs by reference, as if fully set forth herein.

80. Underwriters seek a declaration that because the Known Matter Exclusion precludes coverage, the Insureds are not entitled to indemnity or any further defense from Underwriters related to the lawsuits under the Policy.

COUNT THREE: DECLARATORY JUDGMENT
REIMBURSEMENT OF DEFENSE COSTS

81. Underwriters reallege the foregoing paragraphs by reference, as if fully set forth herein.

82. Underwriters seek a declaration that they are entitled to reimbursement from the Insureds of any amounts Underwriters have paid or will pay for defense of the Hill Lawsuit or the Class Action.

VI. PRAYER

Underwriters pray this honorable Court declare and adjudicate the rights and liabilities of the parties, together with the following relief:

Jury Demand

Underwriters demand the right to a trial by jury on all issues so triable.

Respectfully submitted this 21st day of December, 2021.

WEINBERG WHEELER HUDGINS GUNN & DIAL

John C. Bonnie
Georgia Bar No. 067540
3344 Peachtree Road NE, Suite 2400
Atlanta, GA 30326
Telephone: 404-876-2700
jbonnie@wwhgd.com

TO BE ADMITTED PRO HAC VICE:
Matthew E. Pepping
Manuel Mungia, Jr.
Charles Nwabueze
CHASNOFF MUNGIA VALKENAAR PEPPING & STRIBLING LLP
1020 N.E. Loop 410, Suite 150
San Antonio, TX 78209
Telephone: 210-469-8499
mpepping@chasnoffstribling.com
mmungia@chasnoffstribling.com
cnwabueze@chasnoffstribling.com

Attorneys for Plaintiffs