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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.
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- This article is reprinted with the publisher’s permission from the JOURNAL OF TAXATION OF CORPORATE TRANSACTIONS, a bi-monthly journal published by CCH INCORPORATED. Copying or distribution without the publisher’s permission is prohibited. To subscribe to the JOURNAL OF TAXATION OF CORPORATE TRANSACTIONS or other CCH Journals please call 800-449-8114 or visit www.tax.cchgroup.com. 36
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