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Advice-of-Counsel Darren Chaker

VIEWS: 33 PAGES: 10

Advice of counsel is a common defense to a lawsuit or criminal charges. Darren Chaker posts this artcile since not too many attorneys go into such depth as this article points out.

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									                                        Taxation of Corporate Transactions/January–February 2003




T.E. Johnston: Reliance on
Advice of Counsel Defense
Leads to Implied Waiver
of the Attorney-Client Privilege
(If You Wield It As a Sword,
You May Lose the Shield)
By Jeffrey B. Frishman and James M. Lynch*


                                                   Jeffrey Frishman and James Lynch examine
                                                   how a taxpayer’s reliance on the advice of
                                                   counsel defense resulted in an implied waiver
                                                   of the attorney-client privilege.
                                                   Introduction
                                                   The attorney-client privilege is relied on regularly and with
                                                   confidence by clients and attorneys in their dealings. Its
                                                   operative principle is well known: where the privilege ap-
                                                   plies, it generally protects communications between
                                                   attorney and client from being discovered by parties out-
                                                   side the privileged relationship. Case law sometimes
                                                   reminds us, however, that while the attorney-client privi-
                                                   lege is durable, it may be lost when a court perceives that
                                                   the privilege is being abused.
                                                     The U.S. Tax Court issued such a reminder in its recent de-
                                                   cision in T.E. Johnston,1 where the IRS successfully argued
                                                   that a taxpayer impliedly waived the attorney-client privilege
                                                   during pre-trial litigation by affirmatively asserting good faith
                                                   reliance on the advice of counsel as a defense to a civil fraud
                                                   penalty asserted by the IRS under Section 6663 of the Internal


                                                               Jeffrey B. Frishman, J.D., LL.M., is a Partner
                                                               in the Chicago office of Winston & Strawn.

                                                                 James M. Lynch, J.D., LL.M., is a Partner
©
    2002 J.B. Frishman and J.M. Lynch                          in the Chicago office of Winston & Strawn.


                                                                                                                       27
     Implied Waiver of the Attorney-Client Privilege


     Revenue Code (“the Code”).2 In          erwise distribute Estrella’s assets.         At the end of the day, Fitzsimon
     Johnston, the Tax Court concluded       These assets included stock in            apparently was unhappy missing
     that allowing the taxpayer to retain    Shorecliffs Golf Course, Inc.             out on the sale of the Shorecliffs
     the privilege over legal advice on      (“Shorecliffs,” which held title to a     golf course and also with the man-
                                                                 golf course of        ner in which SCE was being
                                                                 the same name)        operated. In 1993, he brought a
                                                                 and 22 property       state court suit in California
                                                                 lots (“the Equest-    against Shannon, Spence, Sea-
          Implied waiver is a more complicated                   rian lots”). The      Aire, Johnston, Uppaway and
           matter. The implied waiver doctrine                   Shorecliffs stock     Shorecliffs. Among other allega-
           broadly refers to the situation where                 and the Eques-        tions, the lawsuit complained that:
                                                                 trian lots were       ■ Johnston and Spence fraudu-
          privilege waiver is not intended by the                distributed to Sea-        lently induced Fitzsimon to
       client, but nonetheless is deemed to have Aire, Shannon                              sell his interest in Shorecliffs
                    occurred … by a court.                       and Fitzsimon in           shortly before the golf course
                                                                 varying interests.         was sold; and
                                                                    On May 11,         ■ Fitzsimon was deprived of prof-
                                                                 1989, Shannon,             its in SCE through self-dealing
     which he intended to rely as a de-      Sea-Aire and Fitzsimon entered                 transactions and the diversion
     fense to the fraud penalty would        into an option agreement whereby               of profits by other partners.
     improperly deny the government          Shannon obtained the right to pur-           With regard to Shorecliffs, a re-
     the ability to seek vital evidence it   chase the Shorecliffs shares held by      sulting trial found that Fitzsimon
     needed to challenge the taxpayer’s      Sea-Aire and Fitzsimon. Shortly           was defrauded in connection with
     affirmative defense. This article ex-   thereafter, Shannon acquired              the sale of the golf course. With
     amines the implied waiver doctrine      Fitzsimon’s Shorecliffs shares.           regard to SCE, it was stipulated in
     as applied in Johnston.                 However, under an apparent side           settlement that the partnership be
                                             agreement between Shannon and             dissolved with an ensuing final
                                             Johnston, Sea-Aire was allowed to         accounting. In the end, Fitzsimon
     T.E. Johnston—                          retain its Shorecliffs shares. On June    was awarded compensatory and
                                        3
     Background Facts                        28, 1989, Spence and Johnston
                                             met with an attorney, Thomas
                                                                                       punitive damages as judgment in
                                                                                       connection with the Shorecliffs/
     In the mid-1970s, Thomas E.             O’Keefe, regarding the sale of            SCE lawsuit, for which judgment
     Johnston (“Johnston”) participated      Shorecliffs. O’Keefe had repre-           was upheld on appeal.4
     in real estate development ventures     sented Johnston and his related              Apparently not quite satisfied,
     through a wholly-owned corpora-         entities for many years and was his       Fitzsimon subsequently brought
     tion named Sea-Aire Properties, Inc.    longstanding tax counsel. On June         suit against O’Keefe and his law
     (“Sea-Aire”). In one venture, Sea-      30, 1989, the golf course was sold        firm for malpractice, fraud and spo-
     Aire became a partner in a limited      to a third party for somewhere be-        liation of evidence in connection
     partnership named Estrella Proper-      tween $5 million and $6 million.          with the Shorecliffs transactions. In
     ties, Ltd. (“Estrella”), established to   With regard to the Equestrian           that suit, Fitzsimon sought the notes
     develop property in California. From    lots, Shannon apparently sold its         O’Keefe made at the June 28, 1989,
     June 30, 1978, through March 30,        interest to Sea-Aire after the lots       meeting with Spence and Johnston.
     1989, Estrella had three other part-    were distributed from Estrella, and       Fitzsimon argued that any privilege
     ners: Shannon Developers, Inc.          the 22 lots were later contributed        protecting the notes had been
     (“Shannon”), wholly-owned by an         to the formation of a new limited         waived as a result of O’Keefe’s par-
     individual, Darrel S. Spence; Leo A.    partnership in 1989, SCE, in which        ticipation in the proceedings
     Fitzsimon (“Fitzsimon”); and Borg-      Sea-Aire, Johnston and Fitzsimon          regarding Shorecliffs, in which
     Warner Equity Corporation (“Borg”).     were partners. In 1992, another           O’Keefe provided deposition and
     On March 30, 1989, as a result of       entity related to Johnston,               trial testimony. Fitzsimon further ar-
     Borg’s apparent disappointment          Uppaway Investments, Inc.                 gued that the crime-fraud
     with Estrella’s operations, the four    (“Uppaway”), became a substituted         exception to the attorney-client
     partners agreed to dispose of or oth-   partner in SCE, replacing Sea-Aire.       privilege would allow for discov-

28
                                        Taxation of Corporate Transactions/January–February 2003


ery of the notes, on the ground that     Fitzsimon, wanted to obtain evi-         cussed below, the court’s analysis
O’Keefe participated in a scheme         dence from O’Keefe, including            in Johnston is consistent with case
to defraud Fitzsimon of his interest     O’Keefe’s attorney notes from the        law admonishing that privilege
in Shorecliffs.5 However, the Cali-      June 28, 1989, meeting among             claims seeking to wield the privi-
fornia trial court rejected these        O’Keefe, Spence and Johnston deal-       lege as both a sword and a shield
arguments and held that the notes        ing with the sale of the Shorecliffs     are not favored.13
were protected from discovery by         golf course. The IRS filed a pre-trial
the attorney-client privilege, a rul-    motion in limine, arguing that
ing upheld by the California             Johnston should not be entitled to       Attorney-Client
appellate court.6                        assert the attorney-client privilege
                                         to prevent disclosure of the notes
                                                                                  Privilege Basics
                                         or testimony about the notes at trial.   The attorney-client privilege gen-
Johnston’s Tax Court                     The IRS raised three grounds as to       erally protects from compelled
Privilege Dispute                        why privilege should not apply to
                                         O’Keefe’s notes. Two of the argu-
                                                                                  disclosure communications be-
                                                                                  tween attorneys and their clients
The above events set the back-           ments were identical to Fitzsimon’s      made for the purpose of obtain-
ground for Johnston’s Tax Court          positions in his California law suit     ing or imparting legal advice or
dispute. Johnston apparently failed      against O’Keefe and his law firm,        assistance.14 The privilege is in-
to report the Shorecliffs sale on his    i.e., that O’Keefe’s deposition and      tended to foster “full and frank
1989 return, either original or as       trial testimony in the state court pro-  communication between attor-
amended, and the IRS issued a            ceedings regarding Shorecliffs           neys and their clients and thereby
statutory notice of deficiency de-       resulted in privi-
termining that his failure to report     lege waiver or
the transaction (with the attendant      that the crime-
underpayment of tax) was fraudu-         fraud exception            As one might expect from a facts-and-
lent and subject to penalty under        negated any privi-
Code Sec. 6663.7 Johnston filed a        lege protection.
                                                                     circumstances-based doctrine, courts
Tax Court petition challenging the       The Tax Court            have not established a uniform standard
notice of deficiency and the IRS,        never addressed for determining whether the attorney-client
in its answer, set forth facts sup-      those arguments,               privilege should be lost through
porting its fraud determination.8        however, because
   In replying to the IRS’s fraud al-    the IRS suc-                            implied waiver.
legation, Johnston claimed in            ceeded with a
pleadings and other papers before        different position.
the court that his 1989 return posi-     Applying the doctrine of implied         promote broader public interests
tions were prepared in good faith        waiver, the Tax Court held that          in the observance of law and the
based upon the advice of qualified       Johnston waived the attorney-cli-        administration of justice.”15 A clas-
experts. This is an understandable       ent       privilege       over      his  sic formulation of the privilege
affirmative defense. The fraud pen-      communications with O’Keefe, in-         provides that:
alty is not imposed with respect to      cluding the notes, by asserting
an underpayment of tax (or portion       good faith reliance on qualified           (1) Where legal advice of any
thereof) if a taxpayer can show that     experts (one of whom was O’Keefe,          kind is sought (2) from a pro-
                                                                  11
there was reasonable cause for           the court concluded) as an affir-          fessional legal advisor in his
such underpayment and that he            mative defense to the IRS’s fraud          capacity as such, (3) the com-
acted in good faith with regard to       penalty determination. In reach-           munications relating to that
the return position. 9 Thus, a           ing this conclusion, the Tax Court         purpose, (4) made in confi-
taxpayer’s good faith reliance on        identified several approaches used         dence (5) by the client, (6) are
the advice of his attorney, accoun-      by courts in examining the implied         at his instance permanently
tant or other professional may be a      waiver of privilege, and followed          protected (7) from disclosure
defense to fraud.10                      the approach set forth in J. Hearn         by himself or by the legal ad-
                                                        12
   In developing its fraud case          v. B.J. Rhay, a leading case on            visor, (8) except the protection
against Johnston, the IRS, like          implied privilege waiver. As dis-          be waived.16

                                                                                                                          29
     Implied Waiver of the Attorney-Client Privilege


       The attorney-client privilege rec-    its officers and directors.”23 The     opinion in Johnston shows,
     ognizes that a lawyer’s first step in   power to assert (or waive) privi-      where the privilege holder as-
     resolving a legal problem “is as-       lege passes to new management          serts a claim which requires an
     certaining the factual background       and former management is un-           examination of privileged com-
                                                               able to assert       munications in order for the
                                                               (or waive) the       opposing party to be able to
                                                               p r i v i l e g e    prove or disprove the claim.31
      Although the automatic waiver approach against                         the       As one might expect from a
                                                               wishes of new        facts-and-circumstances-based
           has been adopted by other courts,                   management. 24       doctrine, courts have not estab-
        it is understandably criticized as being                 Waiver of the      lished a uniform standard for
         too rigid in its approach to resolving                attorney-client      determining whether the attorney-
                                                               privilege may        client privilege should be lost
                    implied waiver issues.                     be express or        through implied waiver. Indeed,
                                                               implied. The         case law identifies several ap-
                                                               privilege is ex-     proaches to the implied waiver
     and sifting through the facts with      pressly waived when the client         question, including:
     an eye to the legally relevant.”17      knowingly provides privileged          ■ an automatic waiver rule;
     When the client sits down with the      information to a party outside         ■ a balancing test;
     lawyer for the purpose of seeking       the privileged relationship.25 The     ■ the three-pronged test set forth
     legal representation and the lawyer     privilege “evaporates upon any vol-         in Hearn v. Rhay; and
     takes notes, those notes may be pro-    untary disclosure of confidential      ■ the restrictive test set forth in
     tected from disclosure by the           information.”26 Voluntary disclosure        Rhone-Poulenc Rorer, Inc. v.
                                     18
     attorney-client privilege. Of           may result in waiver of not just the        Home Indemnity Co.32
     course, it is well established that     communications disclosed, but of          Each of these approaches to ap-
     “the privilege only protects disclo-    all privileged communications on       plying the implied waiver doctrine
     sure of communications [and] does       the same subject matter.27             is discussed in turn below.
     not protect disclosure of the under-       Implied waiver is a more com-
     lying facts by those who                plicated matter. The implied           The Automatic Waiver Rule
     communicated with the attorney.”19      waiver doctrine broadly refers to      Under the so-called automatic
       The attorney-client privilege ap-     the situation where privilege          waiver rule, a litigant’s mere as-
     plies whether the client is an          waiver is not intended by the cli-     sertion of a claim, counterclaim
     individual or a corporation.20 Within   ent, but nonetheless is deemed         or affirmative defense raising an
     a corporate structure, the attorney-    to have occurred (is “implied”) by     issue in litigation results in the
     client privilege applies to protect     a court. The doctrine is an appli-     waiver of privilege over commu-
     privileged communications shared        cation of a “fairness” principle to    nications related to the issue.33
     among a parent corporation, sub-        privilege claims.28 That is, where     The party seeking relief, in effect,
     sidiaries and affiliates; all such      the facts and circumstances of a       “waives whatever privilege he
     entities are considered to be the “cli- case suggest that the party claim-     has” when he brings his position
     ent” for privilege purposes.21          ing the attorney-client privilege      to court.34 The underlying ratio-
                                             may be claiming it in a manner         nale for the automatic waiver
                                             inconsistent with the traditional      approach seems to be the view
     Privilege Waiver                        purposes underlying the attor-         that it provides a level playing
     When the privilege attaches to an       ney-client privilege, waiver may       field for litigants. In Independent
     attorney-client communication, it       be deemed. 29 For example,             Productions Corp. v. Loew’s, Inc.,
     belongs solely to the client and        waiver may be implied where a          a leading case on automatic
     may only be waived by the cli-          privilege holder selectively dis-      waiver, the court explained that
     ent. 22 In the case of a solvent        closes privileged information in       “[i]t would be uneven justice” to
     corporation, the authority to waive     an effort to obtain gain an ad-        allow litigants to come into court
     the attorney-client privilege “rests    vantage in litigation. 30 Waiver       seeking redress, yet withhold in-
     with the corporation’s manage-          also may be implied, as the dis-       formation which may lead to or
     ment and is normally exercised by       cussion below of the Tax Court’s       materially aid in a valid defense

30
                                       Taxation of Corporate Transactions/January–February 2003


on the basis of privilege.35 In that    defend against are entwined with          erable.45 Similarly, if privileged
case, the plaintiffs brought a pri-     important evidence that will be           information is only one of multiple
vate anti-trust lawsuit and             unavailable if privilege is main-         sources of indirect evidence avail-
subsequently refused to answer          tained.41 The balancing test has          able to an opposing party, then the
questions posed by the defen-           been explained as requiring the           privileged information may not be
dants in pre-trial depositions on       party seeking the privileged infor-       “vital” to the opposing party’s abil-
the grounds of First Amendment          mation to show both (1) that the          ity to present its case.46 There is
testimonial privilege. Analogizing      communications sought are rel-            no specific test for determining
to attorney-client privilege prin-      evant to his case; and (2) that it        whether information is considered
ciples, the court expressed its         would be “unreasonably diffi-             vital, but case law strongly sug-
view that, regardless of the plain-     cult” to obtain the information           gests that information is vital if the
tiffs’ intention, they must be          contained in the communications           opposing party has no alternative
deemed to have waived their as-         elsewhere or that duplicative evi-        to obtain it but from the privileged
sumed privilege, since they             dence will be helpful to the              communication. 47 The over-
“initiated the action and forced        case. 42 The balancing test has           arching consideration of the Hearn
defendants into court.” 36 Al-          been criticized as having a “lack         v. Rhay approach to implied waiver
though the automatic waiver             of concreteness” or for being ap-         is whether it would be “manifestly
approach has been adopted by            plied without an adequately               unfair” to the opposing party to
other courts,37 it is understand-       articulated standard.43                   sustain the privilege under the facts
ably criticized as being too rigid                                                and circumstances.48
in its approach to resolving im-        Hearn v. Rhay
plied waiver issues. Privilege          Under the approach of Hearn v.            Rhone-Poulenc Restrictive Test
issues “involve subtle and sensi-       Rhay, implied waiver of the attor-        The restrictive approach to im-
tive questions that should not be       ney-client privilege occurs when,         plied waiver set forth in
summarily ignored without a             after examining the facts and cir-        Rhone-Poulenc Rorer, Inc. v.
more penetrating analysis.”38 The       cumstances, a court is satisfied          Home Indemnity Co.49 is a rejec-
automatic waiver rule, which pre-       that each of the following three          tion of the other three approaches.
cludes any consideration of the         conditions exists:                           As described above, the other
parties’ relative interests involved    ■ A party asserted privilege as a         approaches to applying implied
in the privilege dispute, may                 result of some affirmative act it   waiver focus on whether a posi-
“lead to needlessly harsh re-                 took, such as filing a law suit.    tion involving privileged
sults.” 39 The Tax Court has            ■ As a result of the affirmative          information has been raised in liti-
effectively acknowledged the                  act (such as filing the law suit)   gation, the relevancy of the
harshness of the automatic waiver             the party claiming privilege        privileged information to the case,
approach; it is the court’s settled           put the privilege communica-        and the opposing party’s need for
position that the mere filing of a            tions in issue by making them       such information to prepare its
petition raising a claim, without             relevant to the case.               case. In Rhone-Poulenc, the court
more, does not result in the            ■ Maintaining the privilege               set forth a more restrictive stan-
waiver of privilege.40                        would deny the opposing party       dard, concluding that a privileged
                                              access to information vital to      communication’s relevance to a
Balancing Test                                its defense in the case.44          claim should not be a factor in
This approach to implied waiver           Thus, the Hearn v. Rhay ap-             determining whether the privilege
weighs a litigant’s privilege claim     proach focuses on action taken by         should be waived, even if the
against an opposing party’s need        a litigant that placed the privileged     communication is vital, highly
for discovery of the privileged         communications in issue in the            probative, directly relevant or
communication in order to               case and whether the opposing             even goes to the core of an issue.50
present its case. This approach         party can defend its position with-       The court’s rationale was that fo-
begins with a presumption in fa-        out the privileged information. The       cusing on relevance or an
vor of preserving privilege, but        mere fact that a privileged com-          opposing party’s need for informa-
acknowledges that “privilege            munication is relevant to issues          tion      misapprehends          and
ends” where the opposing party          raised in a case does not make a          undermines the traditional pur-
can show that the claims he must        privileged communication discov-          pose of privilege, i.e., “to assure a

                                                                                                                           31
     Implied Waiver of the Attorney-Client Privilege


     client that he or she can consult       manner. The advice of counsel is       the legal advice they received was
     with counsel in confidence.” 51         placed in issue where the client as-   protected from disclosure by the
     Under Rhone-Poulenc’s restrictive       serts a claim or defense, and          attorney-client privilege. In those
     test, implied waiver may result if,     attempts to prove that claim or de-    circumstances, the court in Hearn
     and only if, a party injects a privi-   fense by disclosing or describing an   v. Rhay concluded that each of the
     leged communication into the            attorney-client communication.”53      three elements of implied waiver
     case which is an essential element                                             existed, and, therefore, the prison
     bearing on the claim in issue.52                                               officials waived their right to as-
       In Rhone-Poulenc, the plaintiff       The Tax Court’s                        sert the attorney-client privilege.
     (Rhone) filed an action for declara-
     tory judgment seeking to establish
                                             Application of                         First, the court found that the
                                                                                    prison officials’ assertion of privi-
     insurance coverage for claims be-       Implied Waiver                         lege was related to their claimed
     ing made against it related to the      in Johnston                            defense of good faith reliance on
     transmission of HIV through one                                                counsel, and therefore occurred
     of its products. A seminal issue in   In ruling that the implied waiver        as a result of their own affirma-
     the case was whether Rhone knew       doctrine negated privilege protec-       tive act in the case. The court
     that a particular blood product       tion over O’Keefe’s attorney noted       further concluded that since the
     was causing the transmission of       in Johnston, the Tax Court applied       substance of the legal advice the
     HIV before it acquired the insur-     the three-pronged approach of            prison guards received was ger-
     ance regarding the product.           Hearn v. Rhay. The court explained       mane to their affirmative defense,
                                                             that Hearn v.          claiming the affirmative defense
                                                             Rhay had been          had the effect of placing the privi-
                                                             discussed with         leged information at issue.
                                                             approval by the        Finally, the court concluded that
            Pursuing an affirmative defense in
                                                             United States          the privileged information was
         litigation of good faith, reliance on the           District Court for     vital to the plaintiff’s case, since
        advice of counsel may well result in the             the District of        it impacted the plaintiff’s ability
           implied waiver of the attorney-client             Columbia54 and         to meet his burden of proof of
                                                             had been ex-           establishing that the prison offi-
           privilege over the legal advice given.            pressly adopted        cials acted with malice or
                                                             by the United          otherwise unreasonably disre-
                                                             States Court of        garded his constitutional rights.58
     Although Rhone had gathered           Appeals for the Ninth Circuit, the          In applying the implied waiver
     facts about the issue prior to ac-    venue for any appeal of Johnston’s       approach of Hearn v. Rhay in
     quiring insurance and sought legal    Tax Court case.55 The court also         Johnston, the Tax Court concluded
     advice regarding the facts, the       noted that it had previously favor-      that Johnston clearly claimed and
     court concluded that Rhone was        ably cited Hearn v. Rhay.56              argued in filings before the court
     not relying on the legal advice it       In Hearn v. Rhay, a prisoner          that he relied on the “advice of
     received to support its declaratory   (Hearn) sued prison officials for        qualified experts” in connection
     judgment action, and had not in-      allegedly violating his civil rights     with the positions taken on his
     jected the advice of its counsel as   for twice placing him in solitary        1989 tax return. Although Mr.
     an essential element of its case.     confinement in the mental ward           Johnston tried to persuade the
     Accordingly, the court held that the  of a state penitentiary without first    court that his references to “quali-
     attorney-client privilege was not im- holding a hearing or other form of       fied experts” referred to an
     pliedly waived. In rejecting implied  due process review. In response          accountant who assisted him with
     waiver in Rhone-Poulenc, the Third    to the suit, the prison officials        filing his tax returns and not
     Circuit thus explained that “[a]dvice pleaded an affirmative defense of        O’Keefe, the court found
     is not in issue merely because it is  qualified immunity, contending           Johnston’s argument unavailing.
     relevant, and does not necessarily    that they acted in good faith by         The Tax Court concluded that
     become at issue merely because the    obtaining legal counsel before           O’Keefe was one of the experts
     attorney’s advice might affect the    acting upon the prisoner.57 The          Johnson relied upon in support of
     client’s state of mind in a relevant  prison officials also claimed that       his 1989 return. The court pointed

32
                                        Taxation of Corporate Transactions/January–February 2003


to statements Johnston made in fil-      attorney notes after Johnston placed    purchases, Chevron sued Pennzoil
ings before the court referring to       the privileged communications in        to enjoin it from acquiring addi-
O’Keefe as his tax counsel render-       issue by claiming good faith reliance   tional stock on the basis that
ing advice over many years, and          on experts as a defense to the al-      Pennzoil’s SEC disclaimer was
in particular in 1989 when the           leged fraud penalties. The court        misleading or not made in good
Shorecliffs matters later at issue in    explained that in order for the IRS     faith. In response, Pennzoil argued
the Fitzsimon trial were ongoing.59      to refute Johnston’s affirmative de-    that its SEC filing was submitted
The court also focused on the text       fense, it must show that such           in good faith based on tax advice
of a legal fees billing entry pre-       reliance was unreasonable or did        it received from its legal counsel
pared by Mr. O’Keefe for June 28,        not actually occur. The court con-      that control of Chevron manage-
1989, the precise date of the notes      cluded that the IRS could satisfy its   ment was not necessary for
subject to the privilege claim. That     burden of proof “only through           Pennzoil to achieve Code Sec.
billing entry described a meeting        knowledge of what tax advice Mr.        1033 tax deferral.67 In challenging
among Johnston, Spence and               Johnston received,” which included      Pennzoil’s affirmative defense,
O’Keefe regarding Shorecliffs and        communications from O’Keefe.64          Chevron intended to argue that
referencing various items, includ-       The court further admonished that       Pennzoil could not secure its tax
ing tax research and strategy            maintaining privilege over O’Keefe’s    deferral without representation on
planning regarding basis, install-       communications would unfairly al-       Chevron’s board. In discovery,
ment and exchange issues.60 These        low Johnston to selectively disclose    Chevron sought written materials
facts persuaded the Tax Court that       information from particular experts,    from Pennzoil supporting
Johnston had asserted privilege in       since the court previously had con-     Pennzoil’s belief that its Code Sec.
furtherance of an affirmative de-        cluded that Johnston’s affirmative      1033 position was reasonable and
fense he raised (relying on advice       defense contemplated good faith         sound. Pennzoil refused to pro-
he received from O’Keefe), satis-        reliance on other experts besides       vide any such documents, arguing
fying the first element of implied       O’Keefe. The court observed that        that its tax position was protected
waiver under Hearn v. Rhay.61            the IRS would be prejudiced if          from disclosure by the attorney-
  The Tax Court further found that       Johnston were allowed to disclose       client privilege. 68 Chevron
by asserting privilege over              only some of the expert advice he       defeated Pennzoil’s privilege
O’Keefe’s June 28, 1989, notes as        received regarding his 1989 tax         claim. The Ninth Circuit held that
an affirmative act, Johnston placed      return (which the court presumed        Pennzoil waived the privilege by
the privileged communications            would not be advice detrimental         using the advice of counsel both
with O’Keefe at issue by making          to Johnston’s position).65              as a “sword” to defeat Chevron’s
the communications relevant to              In denying Johnston the oppor-       tax arguments and as a “shield”
the case.62 In reaching this con-        tunity to maintain his privilege        to protect the advice from disclo-
clusion, the Tax Court noted that        claim, the Tax Court acted consis-      sure. The court explained that by
Johnston admitted that he received       tent with an established body of        claiming that its tax position was
tax advice from O’Keefe in 1989,         case law holding that an affirma-       reasonable because it was based
and further noted that the Califor-      tive defense premised on                on the advice of counsel, Pennzoil
nia appellate court found                reasonable or good faith reliance       put the advice at issue in the case,
substantial evidence that O’Keefe        on the advice of counsel results        and that privilege over the advice
was hired to render tax advice and       in the implied waiver of privilege.     must be deemed waived because
research tax liability issues for           A good case illustration cited in    Chevron needed access to that
Johnston. The Tax Court thus con-        Johnston is Chevron Corp. v.            very advice in order to demon-
cluded that since Johnston was           Pennzoil.66 Pennzoil had been ac-       strate that Pennzoil’s SEC filing
relying on legal advice he received      quiring significant amounts of          was misleading.69
from O’Keefe as a defense to             Chevron stock as part of a strat-          In another example, the Second
fraud, that legal advice was at is-      egy to take advantage of the tax        Circuit similarly analyzed the im-
sue in the case.63                       deferral provisions of Code Sec.        plied waiver doctrine in the
  Finally, the Tax Court concluded       1033. Although Pennzoil dis-            context of the defense of good
that it would be manifestly unfair to    claimed in an SEC filing any intent     faith reliance on the advice of
the IRS to allow Johnston to main-       to exert control over Chevron           counsel in P.A. Bilzerian.70 In that
tain privilege over O’Keefe’s            management through its stock            case, the defendant in a securities

                                                                                                                        33
     Implied Waiver of the Attorney-Client Privilege


     fraud prosecution intended to ar-                                   testimony from the defendant that                     waiver of the attorney-client privi-
     gue at trial that he lacked criminal                                he believed his actions were le-                      lege over the legal advice given. Tax
     intent because he discussed his                                     gal “would have put his                               advisors and clients both empha-
     alleged fraudulent securities trans-                                knowledge of the law and the                          size the importance of privilege in
     actions with his attorney prior to                                  basis for his understanding of                        their dealings. It is important, how-
     engaging in them, and believed                                      what the law required in issue.                       ever, to keep in mind that the
     that the transactions were legal. In                                His conversations with counsel                        privilege is not intended to be used
     a motion in limine at trial, the de-                                regarding the legality of his                         as both a sword and a shield. For
     fendant asked the court to rule that                                schemes would have been di-                           strategic reasons, a client may be
     he could testify as to his belief in                                rectly relevant in determining the                    faced with the situation of assert-
     the lawfulness of his transactions                                  extent of his knowledge and, as                       ing a claim or defense that injects
     without waiving his privileged at-                                  a result, his intent.”71                              privileged advice into litigation.
     torney-client communications.                                                                                             Tax advisors and clients need to un-
     The trial court denied the                                                                                                derstand that if the claim or defense
     defendant’s motion, holding that
                                                                         Conclusion                                            is raised that “can only be effec-
     the privilege application would                                     Johnston highlights an important                      tively disproven through the
     depend upon the substance of the                                    practice point: Pursuing an affirma-                  discovery of attorney-client com-
     defendant’s testimony. The defen-                                   tive defense in litigation of good                    munications,”72 the cost of pursuing
     dant refused to testify. On appeal,                                 faith, reliance on the advice of coun-                that claim or defense is likely to be
     the Second Circuit explained that                                   sel may well result in the implied                    the privileged communications.
                                                                                             ENDNOTES

     *
         The authors thank their associate, Alfonso                           (Cal. Super. Ct.). The appellate court opin-          Co., CA-9, 974 F2d 1156, 1162 (1992); P.A.
         Canela, for his thoughtful research assistance                       ion is unpublished and the Supreme Court              Bilzerian, CA-2, 926 F2d 1285, 1292 (1991).
                                                                                                                               14
         in the preparation of this article.                                  of California denied Fitzsimon’s petition for         Upjohn Co., SCt, 81-1 USTC ¶9138, 449 US
     1
         T.E. Johnston, 119 TC —, No. 3, (Aug. 8,                             review. L.A. Fitzsimon v. Good, Wildman,              383, 389, 101 SCt 677.
                                                                                                                               15
         2002). Specific page cites to Johnston in this                       Hegness & Walley, No. S082444, 1999 Cal.              Upjohn, 449 US, at 389. These policy con-
         article are to the Tax Court’s slip opinion,                         LEXIS 7950 (S.Ct. Cal. filed Nov. 10, 1999).          siderations are so significant that the attor-
                                                                         7
         which is available on the court’s Web site at                        The civil fraud penalty is imposed on any             ney-client privilege generally continues af-
         w w w. u s t a x c o u r t . g ov / I n O p H i s t o r i c /        part of any underpayment of tax attributable          ter death. Swidler & Berlin, SCt, 524 US
         Johnston.TC.WPD.pdf.                                                 to fraud. Code Sec. 6663(a). The IRS bears            399, 407, 118 SCt 2081 (1998). (“Know-
     2
         All references to “Code” or “section” refer                          the burden of establishing a taxpayer’s               ing that communications will remain con-
         to the Internal Revenue Code of 1986 as                              fraudulent intent by clear and convincing             fidential even after death encourages the
         amended, unless otherwise specified.                                 evidence. Code Sec. 7454(a); Rule 142(b),             client to communicate fully and frankly
     3
         Since the Tax Court’s opinion in Johnston                            Tax Court Rules of Practice and Procedure.            with counsel.”)
                                                                                                                               16
         addressed pre-trial motions, the facts stated                        In Johnston, at 17, the IRS also determined           J.J. Evans , CA-7, 113 F3d 1457, 1461
         in the court’s opinion were not factual find-                        that Johnston fraudulently understated tax-           (1997) (quoting J OHN H. W IGMORE , E VI -
         ings for purposes of adjudicating the sub-                           able income related to understatements of             DENCE IN T RIALS AT C OMMON L AW , §2292 (§§
         stantive tax issues before the court. Rather,                        tax in 1991 and 1992, although it is unclear          2175-2396, Vol. VIII) (Rev. Ed. 1961).
         the stated facts were intended to provide                            from the opinion what the determination               While there is no federal common law
         context for the court’s analysis of the mo-                          relates to for those years.                           accountant-client privilege, recently en-
                                                                         8
         tions before it, taken from pleadings, mov-                          Rule 36(b), Tax Court Rules of Practice and           acted Code Sec. 7525 established a statu-
         ing papers, responses and attachments filed                          Procedure, specifies that “the answer shall           tory privilege protecting certain commu-
         with the court. The court noted that none of                         contain a clear and concise statement of              nications made on or after July 22, 1998,
         the stated facts appeared to be in dispute.                          every ground, together with the facts in sup-         between taxpayers and tax advisors au-
         Johnston, supra note 1, at 3.                                        port thereof on which the Commissioner                thorized to practice before the IRS un-
     4
         See L.A. Fitzsimon v. S.C. Equestrian Lots, Ltd.,                    relies and has the burden of proof.”                  der Circular 230. Since the statutory tax
                                                                         9
         No. G018290 (Cal. Ct. App. filed May 25,                             Code Sec. 6664(c).                                    advisor privilege exists only “to the ex-
                                                                         10
         1999), aff’g, No. 704870 (Cal. Super. Ct.). The                      See R.W. Boyle, SCt, 85-1 USTC ¶13,602,               tent” of the attorney-client privilege
         appellate court opinion is unpublished.                              469 US 241, 250–51, 105 SCt 687; E.S.                 (Code Sec. 7525(a)(1)), the common law
     5
         Under the crime-fraud exception to the at-                           Spruill Est. , 88 TC 1197, 1245, Dec.                 doctrine of implied waiver addressed
         torney-client privilege, the privilege does not                      43,904 (1987); J. Marinzulich, 31 TC 487,             herein presumably applies equally to the
         apply to any communications “made for the                            490, Dec. 23,261 (1958).                              statutory privilege.
                                                                         11                                                    17
         purpose of getting advice for the commis-                            Johnston, supra note 1, at 17–23.                     Upjohn, supra note 14, 449 US, at 390–91.
                                                                         12                                                    18
         sion of a fraud or crime.” F.S. Zolin, SCt, 89-                      J. Hearn v. B.J. Rhay, DC Wash., 68 FRD 574           Swidler & Berlin, supra note 15 (attorney’s
         1 USTC ¶9380, 491 US 554, 109 SCt 2619.                              (1975).                                               handwritten notes taken during a two-hour
     6                                                                   13
         See L.A. Fitzsimon v. Good, Wildman,                                 Columbia Pictures Ind., Inc. v. Krypton Broad-        meeting with client were privileged).
                                                                                                                               19
         Hegness & Walley, No. G020125 (Cal. Ct.                              casting of Birmingham, Inc., CA-9, 259 F3d            Upjohn, supra note 14, 449 US, at 395–96
         App. filed Aug. 24, 1999), aff’g, No. 733226                         1186, 1196 (2001); Chevron Corp. v. Pennzoil          (“The client cannot be compelled to answer




34
                                                      Taxation of Corporate Transactions/January–February 2003


                                                                          ENDNOTES

                                                                                                            43
     the question ‘What did you say or write to             v. Meredith, CA-8, 572 F2d 596, 611, note            FDIC v. Wise, supra note 38, 139 FRD, at 171.
                                                                                                            44
     the attorney?’ but may not refuse to disclose          5 (1978).                                            J. Hearn, supra note 12.
                                                       25                                                   45
     any relevant fact within his knowledge                 In re Sealed Case, CA-DC, 82-1 USTC ¶9335,           Amlani, CA-9, 169 F3d 1189, 1195 (1999);
     merely because he incorporated a statement             676 F2d 793, 818; AT&T, CA-DC, 206 U.S.              Zenith Radio Corp., CA-FC, 764 F2d 1577,
     of such fact into his communication to his             App. D.C. 317, 642 F2d 1285, 1299 (1980).            1580–81 (1985).
                                                       26                                                   46
     attorney”) (quoting City of Philadelphia Pa.           Carter v. Gibbs, CA-FC, 909 F2d 1452, 1458           Amlani, id., 169 F3d, at 1195.
                                                                                                            47
     v. Westinghouse Elec. Corp., DC Pa., 205               (1990), cert. denied, SCt, 498 US 811 (1990);        Frontier Refining, Inc. v. Commercial
     FSupp 830, 831 (1962)); Saba Partnership,              see also B.C. Bernardo, 104 TC 677, 684,             Union Assurance Co. , CA-10, 136 F3d
     78 TCM 684, Dec. 53,604(M), TC Memo.                   Dec. 50,705 (1995); Hartz Mountain Ind.,             695, 701–702 (1998); Amlani, id., 169
     1999-359, vac’d and rem’d on other                     93 TC 521, 526, Dec. 46,126 (1989).                  F3d, at 1195; Home Indemnity Co. v. Lane
                                                       27
     grounds, CA-DC, 2002-1 USTC ¶50,145, 273               Chevron Corp. v. Pennzoil Co., supra note            Powell Moss and Miller, CA-9, 43 F3d
     F3d 1135.                                              13, at 1162–1163; R.V. Jones, Jr., CA-4, 696         1322, 1326–27 (1995); Exxon Corp., DC
20
     Commodity Futures Trading Commission v.                F2d 1069, 1072 (1982); Weil v. Investment            D.C., 94 FRD 246, 249 (1981); Johnston,
     Weintraub et al., SCt, 471 US 343, 348, 105            Indicators, Research Management, CA-9,               supra note 1, at 22–3. But see Koppers Co.,
     SCt 1986 (1985); S. Fisher, SCt, 76-1 USTC             647 F2d 18, 25 (1981); Hartz Mountain Ind.,          Inc. v. Aetna Casualty and Sur. Co., DC
     ¶9353, 425 US 391, 403, 96 SCt 1569.                   id., 93 TC, at 521.                                  Pa., 847 FSupp 360, 363 (1994), arguing
21                                                     28
     Mobil Corp., DC Tex., 93-1 USTC ¶50,335,               WIGMORE, supra note 16, §2327, at 636.               that J. Hearn’s third factor is vague and
                                                       29
     149 FRD 533, 538; United Technologies                  In re Sealed Case, supra note 25, 676 F2d,           overbroad since “reasonable minds” may
     Corp., DC Conn., 979 FSupp 108, 112–14                 at 818.                                              differ over what is vital information.
                                                       30                                                   48
     (1997); Fox v. Massey-Ferguson, Inc., DC               Id.                                                  Home Indemnity Co. v. Lane Powell Moss
                                                       31
     Mich., 172 FRD 653, 670 (1995); cf. AT&T,              See, e.g., Ideal Elec. Sec. Co. v. Int’l Fid.        and Miller, id. (privilege maintained; implied
     DC D.C., 86 FRD 603 (1979) (minority-                  Ins. Co. , CA-DC, 129 F3d 143 (1997),                waiver not warranted).
                                                                                                            49
     owned subsidiaries excluded from privi-                where implied waiver resulted when the               Rhone-Poulenc Rorer, Inc. v. Home Indem-
     leged group of affiliated corporations for             plaintiff sued the defendant for reimburse-          nity Co., supra note 32.
                                                                                                            50
     privilege purposes).                                   ment of attorneys fees under an indemni-             Id., at 863–64.
22                                                                                                          51
     In re C.V. Bulow, CA-2, 828 F2d 94, 100                fication agreement and submitted attor-              Id.
                                                                                                            52
     (1987); Cox v. Administrator United States             ney-redacted billing statements as proof             Id. See Frontier Refining, Inc. v. Gorman-
     Steel & Carnegie, CA-11, 17 F3d 1386,                  of fees incurred, asserting attorney-client          Rupp Co., CA-10, 136 F3d 695, 699–700
     1417 (1994). However, while the attor-                 privilege. The court held that the redacted          (1998). The approach of Rhone-Poulenc has
     ney may not waive privilege without the                portions of the fee statements had to be             been followed in other jurisdictions. See,
     client’s authority, that authority may be              disclosed in order for the defendant to be           e.g., Cincinnati Insurance Co. v. Zurich In-
     implied by the client’s actions. In C.V.               able to fairly challenge the reasonableness          surance Co., DC N.C., 198 FRD 81 (2000).
                                                                                                            53
     Bulow, the court concluded that Bulow                  of the fees incurred.                                Rhone-Poulenc, supra note 32, 32 F3d, at 863.
                                                       32                                                   54
     implicitly consented to his attorney’s dis-            Rhone-Poulenc Rorer, Inc. v. Home Indem-             See Code Sec. 7453 and Rule 143(a), Tax
     closure of confidential communications                 nity Co., CA-3, 32 F3d 851 (1994).                   Court Rules of Practice and Procedure,
                                                       33
     by acquiescing in and encouraging the                  Independent Productions Corp. v. Loew’s,             which direct that Tax Court proceedings
     publication of the book R EVERSAL OF FOR -             Inc, DC N.Y., 22 FRD 266 (1958).                     are to be conducted pursuant to eviden-
                                                       34
     TUNE , written by his attorney. 828 F2d, at            Zenith Radio Corp., CA-FC, 764 F2d 1577,             tiary rules applicable in nonjury trials in
     100–102. But see S. Schnall v. M.E.                    1579 (1985).                                         the U.S. District Court for the District of
                                                       35
     Schnall , DC N.Y., 550 FSupp 650, 653                  Independent Productions Corp., supra note            Columbia, i.e., the Federal Rules of Evi-
     (1982), where the court held that privi-               33, 22 FRD, at 276.                                  dence (FRE). Rule 501of the FRE addresses
                                                       36
     lege was not waived when the client’s at-              Id., at 276–77.                                      attorney-client privilege issues. See also
                                                       37
     torney testified at an SEC hearing with-               See J.A. Lyons v. W.R. Johnson, CA-9, 415            Clarke v. Am. Commerce Nat’l Bank, CA-
     out his client’s authorization.                        F2d 540, 542 (1969), cert. denied, SCt, 397          9, 974 F2d 127, 129 (1992); Mass. Inst. of
23
     Weintraub, supra note 20, 471 US, at 338–              US 1027 (1970); Ghana Supply Comm’n v.               Technology, CA-1, 97-2 USTC ¶50,955,
     49. It is possible, however, for a corporate           New England Power Co., DC Mass., 83 FRD              129 F3d 681.
                                                                                                            55
     officer testifying before a grand jury to be           586, 593–94 (1979).                                  See Amlani, supra note 45, at 1195.
                                                       38                                                   56
     deemed to waive privilege on behalf of the             FDIC v. Wise, DC Colo., 139 FRD 168, 171             A.B. Karme , 73 TC 1163, 1184, Dec.
     company even though the company ex-                    (1991).                                              36,843 (1980), aff’d, CA-9, 82-1 USTC
                                                       39
     pressly asserted privilege to government               Id.                                                  ¶9316, 673 F2d 1062. Without discus-
                                                       40
     counsel. See In re Grand Jury Proceedings,             Bernardo, supra note 26, 104 TC 677, 691             sion, the court also stated that, in its view
     CA-2, 219 F3d 175 (2000). For a corpora-               (1995) (implied waiver did not occur where           of the facts in Johnston, the implied waiver
     tion in bankruptcy proceedings where a                 the taxpayers had not affirmatively raised a         doctrine also would apply to force disclo-
     trustee has been appointed, Weintraub held             claim “that can only be effectively disproven        sure of O’Keefe’s attorney notes under the
     that the power to exercise or waive the at-            through the discovery of attorney-client             automatic waiver rule, the balancing test
     torney-client privilege passes to the trustee,         communications”).                                    or the more restrictive approach of Rhone-
                                                       41
     whose function closely relates to the role             Greater Newburyport Clamshell Alliance v.            Poulenc. Johnston, supra note 1, at 15. Pre-
     management exercises outside bankruptcy.               Public Service Co. of N.H., CA-1, 838 F2d            sumably this is so because the Tax Court’s
     471 US, at 354.                                        13, 20 (1994); see Black Panther Party v.            conclusions that Johnston injected the
24
     Former officers retain no control over privi-          Smith, CA-DC, 661 F2d 1243, 1266–68                  privileged communications from O’Keefe
     lege even as to statements made to counsel             (1981), vac’d without opinion, SCt, 458 US           into the case and that the substance of the
     on matters within the scope of their corpo-            1118 (1982).                                         communications are an essential element
                                                       42
     rate functions. Weintraub, supra note 20,              Greater Newburyport Clamshell, id., 838              bearing on Johnston’s affirmative defense
     471 US, at 349; Diversified Industries, Inc.           F2d, at 22.                                          would seem to satisfy the restrictive ap-




                                                                                                                                                                  35
                                                                    ENDNOTES

                                                  63
          proach to implied waiver set forth in        Id., at 20–21.                                   manded treating defendant’s argument that
                                                  64
          Rhone-Poulenc.                               Id., at 22.                                      he filed amended returns based on the ad-
     57                                           65
          J. Hearn, supra note 12, at 577–78.          Id., at 23.                                      vice of counsel as a waiver of the attorney-
     58                                           66
          Id., at 581.                                 Chevron Corp. v. Pennzoil, supra note 13.        client privilege with regard to that advice).
     59                                           67                                               70
          Johnston, supra note 1, at 18–19.            Id., at 1157.                                    Bilzerian, supra note 13.
     60                                           68                                               71
          Id., at 19.                                  Id., at 1162.                                    Id.
     61                                           69                                               72
          Id., at 19–20.                               Id. See also A.J. Mierzwicki, DC Md., 500        Johnston, supra note 1, at 16.
     62
          Id., at 20.                                  FSupp 1331, 1335 (1980) (Fairness de-




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