New Jersey

Warning: The following opinion is provided for purposes of discussion only. We have not Shepardized™ this opinion, and do not know the subsequent disposition of this case nor whether the effect of the opinion has been overruled or superceded by other law.

United State v. Shan,
2002.DNJ.0000162 (D.N.J. 02/28/2002)

UNITED STATES DISTRICT COURT DISTRICT OF NEW JERSEY

Civ. No. 00-5805 (DRD)

2002.DNJ.0000162

February 28, 2002

UNITED STATES OF AMERICA, ON BEHALF OF ITS AGENCY, THE BUSINESS ADMINISTRATION, AND THE U.S. SMALL BUSINESS ADMINISTRATION, AS RECEIVER FOR TAROCO CAPITAL CORPORATION PLAINTIFFS,
v.
HAONAN SHAN A/K/A HELEN SHAN, JIAN ZHANG A/K/A JOHN ZHANG, HUDSON EXCHANGE, INC. AND DAVID R.C. CHANG DEFENDANTS.

Vincent F. Papalia, Esq. John V. Danner, Jr., Esq. Saiber Schlesinger Satz & Goldstein, LLC One Gateway Center, 13th Floor Newark, NJ 07102-53111 Attorneys for Defendants, Haonan Shan a/k/a Helen Shan and Jian Zhang a/k/a John Zhang Neil R. Gallagher, Esq. Assistant United States Attorney 970 Broad Street, Room 502 Newark, NJ 07102; John G. Silberman, Esq. Trial Attorney U.S. Small Business Administration 409 Third Street, S.W., 7th Floor Washington, D.C. 20416 Attorneys for Plaintiffs, United States of America and The Small Business Administration, as Receiver for Taroco Capital Corporation

The opinion of the court was delivered by: Debevoise, Senior District Judge

NOT FOR PUBLICATION

OPINION

On December 11, 2001, Magistrate Judge Hedges ordered Defendants, Hoanan Shan ("Shan") and Jian Zhang ("Zhang") to produce to Plaintiffs "complete and accurate copies of their federal income tax returns, including all supporting documentation such as W-2 and 1099 Forms for the years 1996-1999 inclusive." United States v. Shan, 00-Civ- 5805, Order at 1 (D.N.J. Dec. 11, 2001). Shan and Zhang now move, pursuant to 28 U.S.C. § 636(b)(1)(A) and Fed.R.Civ.P. 72(a) to reverse Magistrate Judge Hedges's Order, dated December 11, 2001 on the ground that the Order unreasonably invades Shan's and Zhang's privacy interests. Defendants also argue that the Judge Hedges's order was improper because they were unfairly denied an opportunity to fully brief the issue before Judge Hedges issued the Order. For the reasons set forth below, Judge Hedges's Order, dated December 11, 2001, is affirmed.

Factual Background and Procedural History

The Small Business Administration ("SBA") is an agency of the United States of America, established by Section 4 of the Small Business Act of 1958, 15 U.S.C. § 633 (West 2001). The SBA qua SBA holds a judgment against David R.C. Chang ("Chang") in excess of $1 million, entered in the United States District Court for the District of New Jersey, for failure to return funds that he held in an escrow account as escrow agent. *fn1 (Am. Compl. 2.) The United States District Court for the District of New Jersey has also appointed the SBA as Receiver of Taroco Capital Corporation ("Taroco") and has empowered it to marshal and liquidate Taroco's assets and resolve claims by and against Taroco and the receivership estate. (Id. 3.) As Receiver of Taroco, the SBA obtained a judgment, entered in District Court for the District of New Jersey, against Chang in excess of $2.1 million for, among other things, breach of fiduciary duties as an officer and director of Taroco. (Id. 4, 18.) The gravamen of this action is that Haonan Shan ("Shan") and Jian Zhang ("Zhang") were the recipients of a fraudulent conveyance of land located at 675 Sidney Road, Pittstown, New Jersey (the "Property") from defendant Hudson Exchange, Inc. ("Hudson Exchange"), which is the alleged alter ego of defendant Chang, and therefore the conveyance should be annulled.

In their Amended Complaint, Plaintiffs note that Chang is subject to several other judgments, including a child support judgment in favor of Chang's ex-wife (id. 19) and a civil money judgment for over $1.9 million in favor of the Industrial Bank of Latvia (id. 20). Chang is also a defendant in: (1) a complaint filed by Broadway National Bank, N.A. in New Jersey Superior Court, Hunterdon County, to foreclose a mortgage on certain real property located in Clinton, New Jersey; (2) a complaint filed by Asia Bank, N.A. in New Jersey Superior Court, Hunterdon County, to foreclose a mortgage on certain real property located in Clinton, New Jersey; and (3) a complaint filed by First Pioneer Farm Credit, ACA in New Jersey Superior Court, Hunterdon County, to foreclose a mortgage on certain real property located in Franklin Township, New Jersey. (Id. 21-24). To avoid these creditors, Chang allegedly used Hudson Exchange, his alter-ego, to convey the Property to Shan and Zhang, who would hold it for his benefit. (Id. 56.)

Chang purchased the Property from John and Catherine Raymond (the "Raymonds") by a Contract of Sale dated September 31, 1992. (Id. 11.) In connection with the sale, Chang gave the Raymonds a mortgage in the principal amount of $800,000, on which he eventually defaulted, and the Raymonds filed a complaint on or about April 9, 1997 in New Jersey Superior Court, Hunterdon County, to foreclose on Chang's mortgage. (Id. 25.) By Sheriff's Deed, dated December 15, 1997, the Raymonds reclaimed title to the Property free and clear of any mortgages or judgment liens. (Id. 26.)

Approximately six months later, on June 8, 1998, Ms. Raymond, who had become the sole titleholder of the Property following her husband's death, executed a Contract of Sale and a Deed, thus transferring the Property to Hudson Exchange for $960,000. (Id. 32- 33.) The government alleges that Hudson Exchange is a company wholly- owned and controlled by Chang, and thus is an alter-ego of Chang. *fn2 (Id. 32, 55-57.)

Shan and Zhang purchased the Property from Hudson Exchange, a New Jersey Corporation, pursuant to an April 10, 1998 real estate sales contract, notwithstanding the fact that Hudson Exchange did not take title of the property until June 8, 2002. (Id. 8, 11.) On July 28, 1998, the contract closed and Hudson Exchange transferred title to the Property to Shan and Zhang. (Id. 52.) The purchase price of the Property was $1.6 million, which was financed in part by a $1.1 million mortgage given by Asia Bank (the "Shan Mortgage"), as well as a down- payment of $600,000. *fn3 (Id. 36-37, 41).

In their Amended Complaint, Plaintiffs allege that the sale from Hudson Exchange to Shan and Zhang was a fraudulent conveyance by Chang. (Id. 64-85.) The Plaintiffs allege that Hudson Exchange is the alter-ego of Chang, (id. 55), and that Shan's past actions suggest that she has acted and continues to act on behalf of Chang and as Chang's nominee and agent (id. 59).

Plaintiffs filed their initial complaint on November 27, 2000, which they amended on November 30, 2001. In their Amended Complaint, the Plaintiffs seek the avoidance of the transfer of the property from Hudson Exchange to Zhang and Shan to the extent necessary to satisfy the debts owed to SBA and the Receiver; a writ of execution allowing the Plaintiffs to pierce the corporate veil of Hudson Exchange and levy execution on the Property; or in the alternative, if Zhang and Shan have transferred or further encumbered the Property, a money judgment against Shan and Zhang equal to the actual damages incurred by the Plaintiffs as a result of such transfer or encumbrance. Jurisdiction over this case rests upon 28 U.S.C. § 1331 & 1345.

In the course of discovery, Plaintiffs served interrogatories and requests for documents upon Shan and Zhang. Among the documents requested were documents and information regarding Shan and Zhang's income, including a specific request for their federal income tax returns. (Certified Statement of John V. Danner, Jr., Ex. B.) Shan and Zhang objected to Plaintiffs' request for the tax information and did not produce the documents. (Def.'s Br. at 4.) After a conference with the litigants on November 16, 2001, Magistrate Judge Hedges issued an Order requiring Shan and Zhang to provide plaintiffs with their federal income tax returns and supporting documents for the years 1996-1999 inclusive. Shan and Zhang now appeal from that portion of the Order. Standard for Review

A district court reviewing a magistrate judge's order on a non-dispositive motion may modify or vacate the order only if the ruling was "clearly erroneous or contrary to law." 28 U.S.C. § 636(b)(1); Fed.R.Civ.P. 72(a); Loc. R. 72.1(c)(1); see Cipollone v. Liggett Group, Inc., 785 F.2d 1108, 1113 & n. 5 (3d Cir.1986). "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.' " Dome Petroleum Ltd. v. Employers Mut. Liab. Ins. Co., 131 F.R.D. 63, 65 (D.N.J. 1990) (quoting United States v. U.S. Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1948)). A ruling is contrary to law if the magistrate judge has misinterpreted or misapplied applicable law. Gunter v. Ridgewood Energy Corp., 32 F.Supp.2d 162, 164 (D.N.J. 1998).

Analysis

Generally, "parties may obtain discovery regarding any matter, not privileged, that is relevant to the claim or defense of any party." Fed.R.Civ.P. 26(b)(1). This broad scope of discovery, however, can be limited by the court if it determines that the discovery sought is, inter alia, obtainable from some other source that is more convenient, less burdensome, or less expensive. Id. R.26(b)(2)(i).

Although it has never explicitly declared the existence of a qualified privilege for tax returns, the Third Circuit has recognized a public policy favoring non-disclosure of income tax returns as confidential communications between a taxpayer and the government. See DeMasi v. Weiss, 669 F.2d 114, 119 (3d Cir. 1982). The DeMasi court noted that against this privacy interest, a district court must balance a number of factors, including a plaintiff's need for the information, its materiality and its relevance. See id. at 120. Some courts have articulated this balancing test by requiring that the party requesting production of tax returns demonstrate that the tax returns are "relevant to the subject matter of the action or to the issues raised thereunder, and further, that there is a compelling need therefor because the information contained therein is not otherwise readily obtainable." Blakely v. Continental Airlines, Inc., Civ. No. 93-2194, at *8 (D.N.J. Feb. 27, 1997) (citing Cooper v. Hallgarten & Co., 34 F.R.D. 482, 483-484 (S.D.N.Y. 1964); see also Gattegno v. PricewaterhouseCoopers, LLP, Civ. No. 00- CV-1399, at *6, *11 (D. Conn. Nov. 16, 2001) (citing other cases following the Cooper rule and adopting the rule).

The essence of Plaintiffs' complaint is that Chang, through his alleged alter-ego, Hudson Exchange, bought the Property from the Raymonds and then sold it to Shan and Zhang for the purpose of shielding some of his assets from the claims of his myriad creditors. Discovery by the SBA in aid of execution of its judgment against Chang has already yielded evidence that Chang paid: (1) $50,000 in certified funds from his personal checking account to Shan on July 9, 1998 - the day of the closing of the transaction at issue in this case; (2) $100,000 from his personal checking account to Shan on April 27, 1999 for "rent 7/98- 2/99"; (3) $58,096.06 from his personal checking account on April 27, 1999 to Asia Bank for "loan #1-1249 Jian Zhang" - Asia Bank's internal reference number to the Shan Mortgage; and (4) thousands of dollars of payments through his alleged alter-ego, Hudson Exchange, business checking account from 1998 through 2000 for services on the Property including heating oil, electric, telephone, satellite television, landscaping and security alarms. (Decl. Of John G. Silberman, 13-14, Ex. E, F, H.) This evidence supports Plaintiffs' theory that Shan acts as Chang's nominee and is being used to perpetrate a fraud.

Nevertheless, in their Answers to Interrogatories, Shan and Zhang assert that the Property has never been rented and that the upkeep and mortgage payments have been made by themselves. *fn4 (Pl.'s Br. at 2.) At her deposition, however, Shan states that the property had been rented to a tannery since July 1998 and that the rental proceeds arising from the rental were used to service the Shan Mortgage. In addition, Shan stated that she was "not very familiar with [the Property] because since [they] acquire[d] that farm, [they] just rented it to . . . somebody else to be there." (Shan Dep. at 15.)

Consequently, although the Shan and Zhang have not put their incomes directly at issue, disclosure of their tax returns for recent years is relevant to resolving whether Chang, with Shan and Zhang's aid, is hiding assets from his creditors. If Shan and Zhang had rented the property to a tannery, then they should have reported the rental income, and perhaps taken deductions, on their 1998 and 1999 tax returns. *fn5 Such an outcome would support Shan and Zhang's case and would weaken the Plaintiffs' case because it would suggest that they are bona fide purchasers acting independently of Chang. If no rental income was reported, then its absence affects Shan's credibility as a witness because she states in her deposition that the property was rented. The absence of any indication that they received rental income may also suggest that Shan and Zhang could only have met their mortgage obligations by relying upon Chang's assistance and supports Plaintiff's other evidence that Chang, through Hudson Exchange, has been servicing the Shan Mortgage. Further, the nature and extent of Shan's and Zhang's assets as shown on their income tax returns for recent years would disclose if they were in a position to assume the burdens of acquiring and maintaining the Property.

Shan and Zhang suggest that similar information could be found by reviewing their banking and financial records, which they have already produced in connection with this litigation. Although their banking records would show the size of each bank deposit and the time of each deposit, it would not identify the source of each deposit. Production of their tax returns, however, would immediately identify Shan and Zhang's sources of income, and whether such income was sufficient to service the mortgage payments to the Property.

Furthermore, although Shan and Zhang claim that compelling the production of their tax returns is unnecessary because there already exists ample evidence in support of the Plaintiffs' theories, some of which Plaintiffs have even used to prepare for this motion, Shan and Zhang still have not conceded the truth of any of Plaintiffs' theories set forth in their Amended Complaint. Further, Shan's testimony is in conflict with other evidence that she and Zhang have produced, and the tax returns should help resolve the conflicts. Consequently, the additional information provided by Shan and Zhang's tax returns could be additional, necessary evidence to aid the Plaintiffs in fulfilling their burden of proof.

Because Plaintiffs have demonstrated that the information contained in Shan and Zhang's 1996-1999 tax returns is relevant to the instant action and that such information is otherwise unobtainable, Shan and Zhang's privacy interests are overcome by the Plaintiff's need to complete the fact-finding necessary for adjudication in this case. Shan and Zhang's concerns about potential violations to their privacy interests are addressed by limitations Magistrate Judge Hedges imposed in his Order, which orders that "neither the [tax returns and supporting documentation] nor any of their contents may be disclosed, disseminated or otherwise discussed with any person or entity other than trial counsel in this case. Nor may the [tax returns and supporting documentation] be utilized in any way in this case or in any other proceeding without further order of this Court." Because the Plaintiffs in the instant action are the United States, acting on behalf of the SBA, and the SBA, Shan and Zhang are also protected by 26 U.S.C. § 6103, which provides a measure of confidentiality with respect to the disclosure and use of tax returns and tax return information by officers or employees of the United States.

CONCLUSION

Defendants' motion to reverse Magistrate Judge Hedges's Order, dated December 11, 2001, is denied and the Order will be affirmed.

An order implementing this decision will be entered.

DICKINSON R. DEBEVOISE, U.S.S.D.J.

Opinion Footnotes

*fn1 Chang held funds in escrow for Southern Orient Capital Corporation ("SOCC"), which he refused to return when demand was made by SOCC's Receiver. SOCC's claim for its escrow fund was subsequently assigned to the SBA by the Receiver for SOCC and the SBA reduced its claim to a judgment. The judgment was entered in U.S. District Court for the District of New Jersey.

*fn2 Shan and Zhang, however, contest that Chang was a party to the transaction, because Matthew Chang executed the contract of sale on Hudson Exchange's behalf, not David Chang. (Def.'s Br. at 3.)

*fn3 As a condition of the Shan Mortgage, Asia Bank required Shan and Zhang to maintain a $100,000 escrow account as extra collateral. (Am. Compl. 45.) Consequently, although the total mortgage amount was $1.1 million, Shan and Zhang paid Hudson Exchange $1 million, and used the balance to fund the escrow account to be used as collateral. (Id. 48). Plaintiffs dispute that Shan and Zhang made the $600,000 down payment, but acknowledge that proceeds of the Shan Mortgage were paid to Hudson Exchange. (Id. 38, 54.)

*fn4 Plaintiffs' Interrogatory asked for a list of all people who resided at the Property. After objecting to the term "reside" as undefined, vague and confusing, Shan and Zhang listed themselves and other friends and families. They did not appear to list anyone related to a Chinese tannery company.

*fn5 Failure to declare rental income would be considered perjury pursuant to 26 U.S.C. § 6065 (West 2001).

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