State Of New York v. Egon Zehnder International, Inc.

Background

This qui tam action arose under the New York False Claims Act, which allows a private person known as a relator to sue on behalf of the State and potentially receive a share of any recovery. The relator alleged that Egon Zehnder International, Inc. and its affiliate, Egon Zehnder International AG, used two accounting systems for cross-border assignments. According to the allegations, the defendants reported only some “international assistance” billings in the records used to prepare federal, New York State, and New York City tax returns, while using a broader “fax charge” system to allocate internal performance credit. The relator claimed that this caused the defendants to underreport taxable income and taxes owed.

The New York Attorney General investigated the allegations for several years. The investigation included reviewing documents, interviewing witnesses, consulting the State tax authorities, and considering an audit in which the Internal Revenue Service did not require adjustments concerning the defendants’ use of fax charges. The State initially declined to take over or intervene in the action, but later intervened for purposes of proposing a settlement.

Settlement agreement

Under the agreement, the defendants would pay $100,000. The State would receive an initial payment of $70,000, while $30,000 would be held for payment to the relator or the relator’s counsel, with any remainder paid to the State. In exchange, the State agreed to file a notice discontinuing the action with prejudice and to release claims under the False Claims Act alleged in the amended complaint. The agreement preserved specified civil, criminal, and administrative liabilities, including liabilities arising under state tax law and liabilities for conduct outside the amended complaint.

The relator objected. The relator argued that the allegations were supported by substantial evidence, that the State had understated the potential damages, that the case did not actually involve transfer-pricing issues, and that the settlement was too small. The relator also sought discovery to support the objection.

Court’s analysis

New York law allowed the State to settle despite the relator’s objection if the court found the settlement fair, adequate, and reasonable to all parties. The court applied a standard requiring it to determine whether the government had a reasonable basis for concluding that the settlement was in the government’s best interests and whether the settlement unfairly reduced the relator’s potential recovery.

The court found the State’s decision reasonable. It identified substantial risks involving whether the defendants had an enforceable obligation to pay additional New York taxes when the Internal Revenue Service had not determined that the relevant income was taxable in the United States; whether a state false-claims action could address issues involving federal transfer pricing; and whether the relator could prove falsity, materiality, and knowing misconduct. The court also noted that the case could have important consequences for the relationship between federal and state tax enforcement and for other cases involving multinational companies.

The court further concluded that the potential recovery might be much smaller than the relator claimed because the analysis had to account for both fax charges sent by the United States affiliate without corresponding billings and fax charges received by that affiliate without corresponding billings. Based on the State’s calculations, the potential recovery was approximately $1 million before any trebling, rather than tens of millions of dollars. The certain $100,000 payment therefore was not unreasonable in light of the litigation costs and the risk of an adverse ruling.

The court also rejected the argument that the settlement unfairly reduced the relator’s recovery. It stated that the settlement ensured a recovery and that the relator had no guaranteed right to prosecute the action or obtain a particular amount. The court declined to turn the settlement hearing into a trial on the merits and found that the relator had not presented evidence showing that the Attorney General’s investigation or judgment was unreliable.

Disposition

The court granted the State’s motion and determined that the Settlement Agreement was fair, adequate, and reasonable. It denied as moot the defendants’ motion to dismiss the amended complaint and the relator’s motion to file a sur-reply. The court retained jurisdiction to decide the relator’s share of the settlement and any fee-shifting issues, and directed the State and the relator to report whether they had reached an agreement about that share or to propose a briefing schedule.