Notorious Illinois Whistle-Blower Targets 85 Foreign Tailors

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By Michael J. Bologna

A prolific whistle-blower plans to file as many as 85 lawsuits under the Illinois False Claims Act targeting tailors based in Hong Kong and London that fail to collect and remit state sales and use taxes.

Chicago attorney Stephen B. Diamond, known to some as the “king of qui tam,” recently told Cook County Circuit Court Judge James E. Snyder he has already filed more than four dozen FCA actions against foreign-based bespoke tailoring businesses. Diamond said dozens of additional lawsuits would be filed in the coming weeks, seeking unpaid taxes and penalties on behalf of the state ( Illinois ex rel. Stephen B. Diamond P.C. v. Raja Fashions Ltd., Ill. Cir. Ct., No. 17 L 39, 5/18/17 ).

The custom-tailoring tranche of lawsuits marks a new frontier for Diamond, the most prolific tax whistle-blower in the country.

Diamond has filed more than 900 actions under the FCA over the last 15 years. The lawsuits have featured several themes, but allege a retailer failed to properly administer the Illinois sales and use tax. Diamond has filed 111 lawsuits against online retailers, 202 against liquor distributors and 147 against wineries. More than 450 of Diamond’s suits alleged a retailer failed to impose tax on shipping and handling charges.

Veteran state and local tax practitioners expressed disappointment with this latest legal strategy after defending hundreds of retailers targeted by Diamond and his firm Stephen B. Diamond P.C. They accuse Diamond of jamming circuit court with small-stakes claims that conflict with the spirit of the FCA.

“Diamond has created a new opportunity to extort money where there is no fraud, and it’s just too bad,” David S. Ruskin, a partner in the Chicago office Horwood Marcus & Berk Chartered, told Bloomberg BNA.

Establishing Nexus?

Diamond told Snyder all of the new cases involve the same tax questions: whether foreign-based tailoring businesses establish nexus with Illinois by hosting trunk shows in Illinois for the benefit of in-state customers, and whether transactions involving these foreign-based tailors and Illinois customers are taxable under the state’s sales and use tax statutes.

“So we’re talking here about 80 or 85 cases, all of which involve tailors who come to Illinois, set up shop in a hotel room, make sales, and enter into sales contracts, and then collect no sales tax. So we think it’s the same issue,” Diamond said, according to a transcript of the status hearing before Snyder.

By way of example, the first lawsuit unsealed in Cook County named Hong Kong-based Grand Tailors Ltd. The action describes a business model in which Grand Tailors convenes a series of fitting meetings each month with customers at hotels in the Chicago area. Customers can see samples, pick out fabrics, and be measured for custom-made suits, shirts, tuxedos, and overcoats. Tailors in Hong Kong sew the garments and ship them directly to the customer.

State Won’t Intervene

In the last week, almost three dozen FCA lawsuits have been unsealed after Illinois Attorney General Lisa Madigan (D) declined to intervene in the actions. Most of the lawsuits were filed shortly after the beginning of the year.

Diamond said another 17 lawsuits have been filed, but remain under seal. He told Snyder he intends to file another 30 cases in the coming weeks.

A spokesman for the Diamond law firm declined to discuss this latest pattern of litigation.

Under the FCA, complaints from whistle-blowers, also known as relators, are initially filed under seal and reviewed by the Illinois Attorney General. The seal is lifted in cases where the attorney general declines to intervene, permitting the whistle-blower to sue the defendant on behalf of the state.

Charles Godbey, an assistant Illinois attorney general, told Judge Snyder the state wouldn’t likely intervene in any of the cases. At the same time, Godbey said the state plans to take “an active role in initial negotiations” to accommodate defendants interested in quick settlements and payments of back taxes and penalties “without the expense of discovery.”

Court Supervision

Godbey expressed concern that discovery requests by Diamond could get unwieldy and costly without close supervision by the court, creating obstacles for settlement. Godbey asked Snyder for a process in which initial discovery could be postponed for 60 to 90 days to give each defendant an opportunity to answer his or her complaint and explore options for settlement with the state.

“This would provide an opportunity for the State to resolve these matters to the extent that they can be quickly resolved without excessive attorneys’ fees which might possibly obstruct settlement in certain instances and thereafter permit Relator to proceed with discovery in those cases where settlement appears not likely,” Godbey said.

Snyder said Godbey’s request was reasonable.

“I’m open to a structure that allows that kind of cost savings,” Snyder said.

Revenue Department’s Role?

But Ruskin, who is already receiving requests to represent the defendants, expressed frustration with the process being developed in circuit court. If the foreign-based tailoring industry raises real questions of tax avoidance and real revenue implications for the state, Ruskin said the controversy should be handled by the Illinois Department of Revenue rather than Diamond and the Attorney General.

“These cases should not be acceptable under the Illinois False Claims Act because they are not fraud,” he said. “These are the same old claims that Diamond has been making for years, whether you are talking about his shipping and handling or liquor tax cases, where there is no fraud. These are all issues that should be under the sole purview of the Illinois Department of Revenue.”

Jamie Yesnowitz, state and local tax practice and National Tax Office leader for Grant Thornton LLP, said the nexus questions at the heart of the Diamond-initiated lawsuits are best left to state revenue officials.

“I understand the concept behind whistle-blower lawsuits, but I think the state taxing authorities would probably be in the best position to determine whether nexus exists as a result of a particular activity,” Yesnowitz said.

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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