Kathryn Keneally specializes in white-collar crime, tax controversy, and commercial litigation. In practice in New
York City, she is a member of the U.S. Sentencing Commission Practitioners' Advisory Group. She
is chairperson of the ABA Subcommittee of the Tax Section's Civil and Criminal Penalties
Committee on Department of Justice Procedures. She is a member of The Champion Advisory
Board.
The full reach of the attorney-client privilege and the work product immunity to the activities of corporate counsel has long been of vital importance and some debate. The attorney will often be an officer of the corporation, and will have responsibilities that mix legal advice with business judgment. Nonetheless, the corporation's need to have its business decisions informed by an understanding of the applicable law is essential. In this era of complex government regulation, an ill-informed misstep by corporate officers or employees can have severe civil and criminal consequences for the corporation.
The Second Circuit in United States v. Adlman (hereinafter Adlman II) 1 addressed the application of work product immunity to the real world of today's corporate counsel, and held that its reach extended to legal analysis that had the mixed purpose of aiding the corporation in making a business decision and preparing for anticipated litigation.2 Moreover, the court determined that the work product immunity protected not only the work of the attorney, but also that of the experts who aided the attorney. Most significantly, the court found that the work product immunity protected the lawyers' and the experts' work done before the consummation of the business transaction which was anticipated to be the subject of the litigation.
Privilege Issues: Background
The recent holding in Adlman II was the second time that the Second Circuit considered the application of claims of privilege to the same documents.3 In Adlman I, the court addressed and rejected a claim that the documents were protected by the attorney-client privilege, but remanded for reconsideration of the application of the work product immunity.4The documents at issue were a draft and final memorandum prepared by the accountants for the corporation, and delivered to the corporation's counsel. The corporation was considering whether to merge two wholly owned subsidiaries. The merger was expected to create a tax loss of approximately $290 million. The corporation also expected to apply the tax loss as a carryback to earlier years, and thereby offset large gains.5
The corporate counsel, who also held the title of Vice President for Taxes, sought the assistance of a large independent accounting firm to analyze the implications of the transactions under the tax laws. The accounting firm had previously done work for the corporation, and served as its independent auditor. The partner of the accounting firm who specifically addressed the tax issues concerning the merger specialized in evaluating the tax implications of corporate reorganizations. He presented the corporate counsel with a draft memorandum, which was then edited to address questions raised by the counsel.6 In Adlman I, the court described the final memorandum as "58 pages long and contain[ing] a detailed technical analysis of the tax implications of the proposed reorganization."7 In Adlman II, the court elaborated on its description: "The Memorandum was a 58-page detailed legal analysis of likely IRS challenges to the reorganization and the resulting tax refund claim; it contained discussion of the statutory provisions, IRS regulations, legislative history, and prior judicial and IRS rulings relevant to the claim. It proposed possible legal theories or strategies for [the corporation] to adopt in response, recommended preferred methods of structuring the transaction, and made predictions about the likely outcome of litigation."8
Days after completing the final memorandum, the accounting partner also sent a letter to the corporation's Executive Vice President in charge of Finance and Administration. In the letter, the accounting partner summarized the proposed reorganization, and noted that the relevant tax implications had been reviewed and approved by the corporate counsel. The corporation undertook the reorganization in essentially the same manner proposed by the accounting firm.9 The corporation reported the tax loss on its current year return, and then carried the loss back to an earlier year. As a result, the corporation sought a tax refund of tens of millions of dollars.10
Adlman I: Claim of Attorney-Client Privilege Rejected
The IRS audited the returns giving rise to, and claiming the benefit of, the loss created by the merger. The IRS issued a summons for the draft and final memorandum from the corporate counsel, who asserted both the attorney-client privilege and the work product immunity in response."11The memoranda at issue were prepared by an accountant, not by counsel. As a general rule, there is no privilege for communications between an accountant and the client.12 It is well settled, however, that the attorney-client privilege protects confidential communications with an accountant when the accountant has been retained by an attorney to assist the attorney in understanding accounting matters and thereby to render legal advice.13
The Second Circuit in Adlman I recognized the principle that communications to an accountant, retained by the attorney to assist him, were protected by the attorney-client privilege. The court, however, rejected the application of the principle to the record presented in Adlman I.
The corporate counsel submitted an affidavit in Adlman l stating that his responsibilities included advising the corporation's management as to the consequences of transactions under the tax laws, and that, as his client, they had specifically sought his legal advice on the proposed merger. He attested that he sought the assistance of the accounting firm because he was not an expert in the area of the tax consequences of corporate reorganizations. He attested that the memoranda enabled him to reach certain conclusions regarding the tax consequences of the transaction, which he communicated as legal advice to the corporation's management. Affidavits from other corporate officers and the accounting partner corroborated counsel's affidavit, and confirmed that the memoranda were intended to be kept confidential.15
The court, however, characterized the relationships differently. The court noted that the corporate counsel was also an officer of the corporation, and that the accounting firm was in the regular employ of the corporation in connection with general accounting, advisory and auditing services. Moreover, the accounting firm provided extensive services to the corporation in connection with the specific proposed merger at issue in the case. The court noted that if the corporation directly sought advice from the accounting firm concerning the tax implications of the merger, the privilege would not apply.16
In particular, the court emphasized the absence of "contemporaneous documentation" that supported the position that the accounting firm, "in this task alone, was working under a different arrangement from that which governed the rest of its work" for the corporation.17 The court noted that there was no separate retainer agreement for the work rendered to the corporate counsel, and that the accounting firm's "billing statements lump[ed] the work done in this consultation together with its other accounting and advisory services."18 As the court cast the relationship, the corporation could be viewed as relying upon the accounting firm to provide tax and business advice in connection with the merger.19
Thus the court found that the facts in Adlman I were "subject to competing interpretations."20 Because the burden of establishing the attorney-client privilege rests with the party claiming its protections, the court held against the claimant.21
The corporation also contended that the memoranda were prepared in anticipation of litigation with the IRS over the claimed tax losses, and were therefore protected by the work product immunity. The district court rejected the claim "for the sole reason that at the time of . . . [the] creation of the memoranda, neither the litigation nor the events giving rise to it . . . had yet occurred."22 Finding that the district court had applied an unduly restrictive standard, the Second Circuit remanded on this issue. On remand, the district court determined that the memoranda were not prepared in anticipation of litigation, and the matter was again appealed to the Second Circuit.23
Adlman II: Work Product Immunity Is Extended to Documents Prepared Prior to an Event Anticipated to Result in Litigation
Rule 26 (b) (3), Fed. R. Civ. P., protects from disclosure materials "prepared in anticipation of litigation" unless the party seeking disclosure demonstrates "substantial need" and "that the party is unable without undue hardship to obtain the substantial equivalent of the materials by other means." The Rule directs that in those instances in which disclosure is allowed, "the court shall protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of an attorney or other representative. . . ."24 Rule 16(b)(2), Fed. R. Crim. P., accords similar protection in criminal cases to "reports, memoranda, or other internal defense documents made . . . in connection with the investigation or defense of the case. . . ."25The core issue in Adlman II was whether the memoranda were prepared in anticipation of litigation.
The corporate counsel's affidavit in support of the assertion of the work product immunity stated that the attorney anticipated that the proposed transaction would result in litigation for several reasons. The tax treatment of the proposed transaction would inevitably attract the IRS's attention for two primary reasons. First, the corporation had been audited by the IRS on an annual basis for at least the past 30 years.26 Second, federal law prohibited the payment of any refund over a certain dollar amount until 30 days after the IRS provided a report concerning the basis for the refund to the Joint Congressional Committee on Taxation -- and the tax refund anticipated by the transaction certainly far exceeded the reporting threshold.27 Finally, the corporate counsel noted, there was no case or IRS ruling directly on the point concerning the tax treatment of the transaction. This, he reasoned, effectively assured litigation between the IRS and the corporation.28
In addition to demonstrating that litigation was a virtual certainty, the corporate counsel claiming work product immunity in Adlman II had another hurdle to overcome. The memoranda were not prepared solely in anticipation of litigation, and indeed the court recognized that "the primary or ultimate purpose" of the undertaking was "to assess the desirability of a business transaction. . . ."29 Thus, the court in Adlman II identified as an issue of first impression in the Second Circuit, whether work product immunity is applicable to "a litigation analysis prepared by a party or its representative in order to inform a business decision which turns on the party's assessment of the likely outcome of litigation expected to result from the transaction."30
The court viewed the issue as turning on whether, to establish that a document was prepared in anticipation of litigation, the claimant was required to show that the document was prepared "primarily or exclusively to assist in litigation," or only that it was prepared "'because of existing or expected litigation."31 While recognizing that other courts had phrased the standard variously, the Second Circuit concluded that the more inclusive protection better accorded with the language and purpose of the work product doctrine.32
Broad Reach and Limitations of Adlman ll
The court in Adlman II recognized the potentially broad reach of its decision. In addition to determining that the work product doctrine protected legal analysis of potential litigation that preceded the transaction which was anticipated to give rise to the litigation, the court set out several other examples as to how the doctrine should operate in a range of business settings. In one example, the court contemplated a merger or other joint undertaking between two entities, in which one entity requests that the other make a candid assessment of existing litigation.33In another example, the court suggested that the work product doctrine could extend to an analysis of ongoing or anticipated litigation by a company's attorneys to enable the company's independent auditors to determine the appropriate amount of a reserve against potential losses.34 In each example, the hypothetical document "would be created to inform the judgment of the business associate concerning the business decision, and [n]o part of its purpose would be to aid in the conduct of the litigation."
Nonetheless, because each example hypothesized by the court would "reveal the attorneys' most intimate strategies and assessments concerning the litigation," the court suggested that such documents should not be discoverable by a litigation adversary.35 Thus the court stated: "We see no basis for adopting a test under which an attorney's assessment of the likely outcome of litigation is freely available to his litigation adversary merely because the document was created for a business purpose rather than for litigation assistance."36
The court concluded: "The fact that a document's purpose is business-related appears irrelevant to the question whether it should be protected" under the work product doctrine.37
The Second Circuit expressly emphasized the limitations of its holding as well. In rendering its opinion in Adlman II, the court said: "We hold that a document created because of anticipated litigation, which tends to reveal mental impressions, conclusions, opinions or theories concerning the litigation, does not lose work-product protection merely because it is intended to assist in the making of a business decision influenced by the likely outcome of the anticipated litigation."38 The court immediately added that, "where a document was created because of anticipated litigation, and would not have been prepared in substantially similar form but for the prospect of that litigation, it falls within Rule 26(b)(3)."39 Thus, as the court explained later in the opinion, documents that are prepared in the ordinary course of business, or documents that would have been prepared in essentially the same form regardless of the anticipation or pendency of litigation, cannot be shielded from disclosure by the work product doctrine.40
The court also cautioned that work product immunity is, of course, not absolute. The party seeking disclosure may show substantial need and an inability to obtain the information elsewhere without undue hardship.41 The Second Circuit also noted the possibility that a court may direct that a document be redacted, so that factual material may be disclosed while the mental impressions, strategies and analysis relating to anticipated or pending litigation may remain protected.42
The court reiterated the reach and limitations of its decision in its instructions on remand. The Second Circuit directed the district court to order the documents at issue disclosed only if the district court concluded that the substantially same documents would be prepared in "the ordinary course of business of undertaking the restructuring"; conversely, the Second Circuit directed that the documents should be withheld if the district court found that the documents would not have been prepared "but for [the corporation's] anticipation of litigation with the IRS over the losses generated by the restructuring."43
Notably, the Second Circuit considered the dispositive determination to be whether the memoranda would have existed in its current form but for the anticipated litigation, and thereby was protected by the work product doctrine. The court ruled on the record before it that the IRS had not -- and could not -- show sufficient substantial need and unavailability to overcome the work product protection. The court reasoned that the memoranda fell within the most protected category of work product, because the memoranda contained the mental impressions of counsel. Without deciding "whether such work product is ever discoverable," the Second Circuit held that "at a minimum, such material is to be protected unless a highly persuasive showing is made."44
In its remand instructions, the Second Circuit reiterated the concern that was at the heart of its opinion in Adlman II, and indeed at the heart of the work product doctrine. The adversarial process requires that parties and their representatives have the ability to investigate, analyze, and evaluate the facts and issues that relate to litigation. In a society that is widely recognized for its litigiousness, businesses and individuals may well anticipate litigation long before its onset, and may need to weigh the risks of litigation in advance of a variety of activities. The candid, analytical review of litigation risks cannot be fairly done only to be handed over to a current or future adversary. Thus, as the Second Circuit concluded, the decision in Adlman II is the logical extension of the long-standing principles of work product immunity.
Notes
1. 134 F.3d 1194, 1998 U.S. App. LEXIS 2633 (2d Cir. 1998) (Adlman ll), At the time of publication of this column, page citations to the official reporter were not available. Thus, only page citations to the decision as reported by LEXIS have been included.2. It is my privilege and pleasure to recognize my partner, Bryan C. Skarlatos, and my former partner, John J. Tigue, Jr., now of the Morvillo Abramowitz firm, and Linda A. Lacewell, once associated with my firm and then the Morvillo firm, and now with the U.S. Attorney's Office, for their accomplishment as the attorneys who obtained the Adlman II opinion.
3. The only common member of the two panels of the Second Circuit was Circuit Judge Pierre Leval, who was the author of both Adlman I and Adlman II. The panel in Adlman I was unanimous; Circuit Judge Kearse dissented in Adlman II.
4. United States v. Adlman, 68 F.3d 1495 (2d Cir. 1995) (hereinafter referred to as Adlman I).
5. Id. at 1497.
6. Id.
7. Id.
8. Adlman II, 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *4.
9. Adlman I, 68 F.3d at 1497.
10. Id. at 1498; Adlman ll 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *4.
11. Adlman I , 68 F.3d at 1498.
12. See United States v. Arthur Young & Co., 465 U.S. 805 (1984).
13. United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).
14. Adlman I, 68 F.3d at 1499-1500.
15. Id. at 1498.
16. Id. at 1500.
17. Id.
18. Id.
19. Id.
20. Id. at 1500.
21. Id.
22. Id. at 1501.
23. Adlman ll, 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *7.
24. Rule 16 (b) (3), Fed. R. Civ. P., codifying Hickman v. Taylor, 329 U.S. 495 (1947).
25. See United States v. Nobles, 422 U.S. 225 (1975).
26. Adlman I. 68 F.3d at 1498; see Adlman ll, 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *7.
27. Id., see also 26 U.S.C. 6405(a).
28. Adlman I, 68 F.3d at 1498; see Adlman ll, 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *7.
29. Adlman II, 134 F.3d 1194, 1998 U.S. App. LEXIS 2633, at *2
30. Id., 1998 U.S. App. LEXIS 2633, at *9.
31. Id., 1998 U.S. App. LEXIS 2633, at *12.
32. Id., 1998 U.S. App. LEXIS 2633, at *12-13.
33. Id., 1998 U.S. App. LEXIS 2633, at *19-20.
34. Id., 1998 U.S. App. LEXIS 2633, at *20-21.
35. Id., 1998 U.S. App. LEXIS 2633, at *19-20.
36. Id., 1998 U.S. App. LEXIS 2633, at *22.
37. Id.
38. Id., 1998 U.S. App. LEXIS 2633, at *2.
39. Id.
40. Id., 1998 U.S. App. LEXIS 2633, at *29.
41. Id., 1998 U.S. App. LEXIS 2633, at *30.
42. Id.
43. Id., 1998 U.S. App. LEXIS 2633, at *32-33.
44. Id., 1998 U.S. App. LEXIS 2633, at *33-34. The court also rejected the IRS's contention that the documents were relevant to a determination of whether the transaction had a valid business purpose or was driven solely by tax benefits. The court observed that the memoranda reflected the legal analysis of the accountants, and not the motives of the corporate executives. Moreover, the court noted that "[w]hile the memorandum unquestionably presupposes a desire to achieve a favorable tax result, such a desire is in no way incompatible with the existence of a legitimate non-tax business reason, for its choice." Id., 1998 U.S. App. LEXIS 2633, at *34-35. n
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