The District of Columbia Court of Appeals held that the work product privilege protected two documents created by taxpayer Dow Chemical Inc. from discovery by the IRS and might protect another document created by Dow’s independent auditor, Deloitte LLP.
The D.C. Circuit thus affirmed a holding by the District Court for the District of Columbia (U.S. v. Deloitte & Touche LLP, 623 F. Supp.2d 39 (D.D.C. 2009)) as to the first two documents and vacated and remanded for further consideration the lower court’s holding that the Deloitte document was also protected. The circuit court directed the district court to review the document in camera, which it had not done in earlier proceedings, to determine whether it is protected as work product or fully or partly discoverable. (During an in camera review, the presiding judge reviews the documents privately before ruling on whether they are discoverable.) The circuit court’s decision also affirmed the district court’s holding that Dow did not waive the privilege for its documents by disclosing them to Deloitte.
The dispute arose in an ongoing suit filed in 2005 in the U.S. District Court for the Middle District of Louisiana involving IRS adjustments of the returns of two Dow-owned partnerships (Chemtech Royalty Associates LP v. U.S., docket no. 05-944). The government subpoenaed documents from Deloitte, which turned over some but withheld the three, for which the government moved to compel production. The government later conceded two were protected as work product: a memo prepared by a Dow accountant and in-house attorney and a tax opinion prepared by Dow’s outside counsel. Both were disclosed to Deloitte in its financial audit of Dow, to allow Deloitte to review the adequacy of contingent reserves for the disputed Chemtech transactions. The third, the subject of the circuit court’s remand, was a Deloitte memo summarizing a meeting between its employees and Dow employees and outside counsel about the financial audit and the company’s accounting for possible tax litigation.
On appeal, the government claimed that Dow waived protection by disclosing the documents to Deloitte and that the Deloitte document wasn’t protected because it was prepared as part of a financial audit rather than in anticipation of litigation, as required under the work product doctrine.
The D.C. Circuit said the Deloitte memo might contain material prepared in anticipation of litigation that would qualify for the work product privilege. Notably, the court rejected the government’s reliance upon the First Circuit’s holding in U.S. v. Textron (577 F.3d 21 (2009)) for its argument that a document prepared as part of an independent financial audit is categorically not prepared in anticipation of litigation and therefore not entitled to work product protection. The D.C. Circuit noted that the First Circuit had applied the “because of” test in analyzing the documents in question, under which the “material generated in anticipation of litigation may also be used for ordinary business purposes without losing its protected status.” While the First Circuit in Textron denied protection to a document that was likewise prepared pursuant to a financial audit, it did so after examining the document and concluding it was not prepared because of anticipated litigation. The “because of” test is used by the majority of circuits. (The Fifth Circuit asks whether anticipated litigation is the “primary motivating purpose” for a document’s creation.)
The D.C. Circuit also rejected the IRS’ argument that Deloitte was a potential adversary to Dow or a conduit to other adversaries and that disclosure of its documents to Deloitte thus waived work product protection. Deloitte could not be considered a potential adversary, since even a threat of litigation between an auditor and client would be grounds for the auditor’s withdrawal, the court said, citing the AICPA Code of Professional Conduct. Nor could it be considered a conduit to adversaries, since, as the district court concluded, all evidence was consistent with an expectation by Dow that Deloitte would keep Dow’s information confidential. Moreover, the court said, such a waiver has usually been asserted with respect to the attorney-client privilege, which focuses on confidentiality of communications between parties. The work product privilege, on the other hand, serves a different purpose of maintaining a fair adversarial legal process, it said.
By Tax Matters editor Paul Bonner.
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