Textron decision on work product privilege

On August 13 the first circuit released an en banc decision on whether material not prepared for litigation but which "relates to a subject that might or might not occasion litigation" fall within the work product privilege (here). The materials in question were prepared in order to obtain a "clean audit" for Textron and included lawyer assessments of the risks associated with various filing positions taken by Textron in tax matters.  The majority held the materials were not privileged.  It was insufficient that they were prepared by lawyers and/or represented legal insight and it was insufficient that the only reason that the auditors required the information was that litigation could result (and could, if decided favourably to the IRS, render Textron's financial statements inaccurate).  The basic position of the Court: "To sum up, the work product privilege is aimed at protecting work done for litigation, not in preparing financial statements. Textron's work papers were prepared to support financial filings and gain auditor approval; the compulsion of the securities laws and auditing requirements assure that they will be carefully prepared, in their present form, even though not protected; and IRS access serves the legitimate, and important, function of detecting and disallowing abusive tax shelters."

The dissenting judges argued that the proper legal test is that materials were prepared because of the prospect of litigation, not that they were prepared for litigation, and that the test was satisfied here.

I don't know enough about US law on privilege to have an informed opinion about the legal accuracy of this judgment.  As a policy matter I question the desirability of requiring a company to provide its legal advice to an auditor to satisfy legal reporting requirements and then using that advice to go after the company for its tax positions.  The questionable transactions engaged in by Textron were evident from other materials and their legitimacy as tax avoidance transactions could be challenged without the aid of Textron's advice from counsel being provided to the IRS.

Comments

[john steele]

IIRC, that outcome is the one Dennis Ventry had urged. I will see if we can get him to guest blog again, now that the en banc is out.

[Alice Woolley]

Here is an e-mail exchange I had with Dennis after my post:

DV:I saw your post on Legal Ethics Forum respecting the First Circuit’s decision in Textron. As a guest blogger several months ago, I wrote a post summarizing an article of mine that examined tax work product generally and Textron specifically. The government cited the article in brief at several stages of the litigation, and relied on it during oral argument. In addition, the majority en banc opinion cited it favorably, and the dissent in the vacated panel opinion wrote that it “made scholarly mince meat of Textron’s positions.” I also wrote a subsequent article that the government forward to the First Circuit during its deliberation as new authority. In highly unsolicited fashion, I have attached both articles for your interest.

I conclude in both articles that tax accrual workpapers never deserve work product immunity. Corporate taxpayers create workpapers to comply with federal securities law. They exist exclusively because of financial accounting and disclosure requirements regardless of any prospect for future litigation. That workpapers might discuss the likelihood of litigation or contain analyses that become the subject of litigation at some point in the future does not affect the causality of their creation. While such analyses or discussions might appropriately receive work product protection if contained in other documents, their appearance in documents created for regulatory purposes does not transform them or the documents in which they are contained into materials created in anticipation of litigation.

AW:I suppose I am less convinced that the reason for the preparation of the materials should be the determinative factor; I am more concerned with the fact that the materials contain legal advice. Under Canadian law my argument would be that they are subject to solicitor-client privilege with a limited waiver to provide them to the auditor, which is not a waiver to the world (i.e., the CRA/IRS). My understanding though is that no limited waiver argument is available in US law. In other words, I think it is fair to say that they are not prepared in contemplation of litigation; however, I have difficulties with any client being compelled to provide legal advice to a 3rd party absent some compelling reason, which I don't see as arising simply because the auditor was given access to the opinion in order to comply with legal requirements.

I think though in the end it is simply a matter of competing interests: respect for tax enforcement versus respect for the ability to obtain confidential legal advice. The Court balanced them somewhat differently than I would but I don't view its decision as stupid or wrong headed in any way.

DV:Thanks, Alice.

In short, I agree completely with your observations. In fact, the last few pages of the longer article, Protecting Abusive Tax Avoidance, suggests that strict application of the work product doctrine can produce harsh results that might be mitigated by some kind of sliding scale approach or even more liberal use of limited waiver. It also observes that these materials are often appropriately protected by the attorney-client privilege (or even the tax practitioner-client privilege reflected in our Internal Revenue Code section 7525). And it takes great pains to indicate that the article’s conclusions “do not prevent other kinds of tax materials or advice, such as legal opinions, from qualifying for protection. Indeed, the above conclusions preserve the vitality of the attorney-client privilege, the tax practitioner-client privilege, and, for that matter, the work product doctrine. In fact, in many respects, this article and its conclusions aim to save these privileges either from irrelevance (that is, with the attorney-client and tax practitioner-client privileges being swallowed by the work product doctrine) or irreparable alteration (that is, with work product expanding beyond its traditional province of protecting the adversarial process).” But it concludes that “[i]f tax professionals and their clients want the protection of these privileges, their tax advice must fit within the privileges’ respective requirements. If the advice falls outside the requirements, tax professionals are not entitled to manufacture an entirely new category of protection just because it would make their job easier (or, alternatively, because they carelessly waived the privilege or cannot overcome a showing of good cause or other applicable exception).”

How else can the taxing authority fulfill its regulatory function of making sure that all taxpayers—particularly those who pay considerable sums of money to obscure rather than clarify their financial history—pay their fair share?

[air max]

The future belongs to those who believe in the beauty of their dreams.