BE CAREFUL WITH THOSE PLEADINGS! IMPLIED WAIVER OF THE ATTORNEY-CLIENT PRIVILEGE

In my former life as a litigator for the Internal Revenue Service (someone had to do it), I was always amazed at the “deer in the headlight” looks I received when I informed an attorney that he/she waived the attorney-client privilege by including in his/her pleading something to the effect of, “and petitioner is not liable for penalties as she relied upon advice of counsel.” Yes, it is time to turn over that advice of counsel. The privilege is waived.

But what if, instead of indicating the petitioner relied upon advice of counsel, the pleading simply states the following:

there is or was substantial authority for the Partnership’s and its partners’ tax treatment of any items resulting in an underpayment of tax, and the Partnership and its partners reasonably believed that their tax treatment of such items was more likely than not the proper [tax] treatment: and

any underpayment of tax was due to reasonable cause and with respect to which the Partnership and its partners acted in good faith.

Would that language in a pleading waive the attorney-client privilege? The United States Tax Court said yes. See: AD Investment 2000 Fund LLC, Community Media, Inc. and AD Global 2000 Fund, LLC, Warsaw Television Cable Corp. v. Commissioner, 142 T.C. No 13 (April 16, 2014), (AD Investment and AD Global) available at: http://www.ustaxcourt.gov/InOpHistoric/adinvestmentdiv.halpern.TC.WPD.pdf. The Tax Court granted the IRS’s motion to compel the production of six opinion letters from the law firm of Brown & Wood, LLP and further indicated it would impose sanctions if the petitioners failed to comply.

The consolidated case arises out of the ominous sounding “Son of BOSS” tax shelter that was sold to investor partnerships (and LLCs) in the 1990s. The world came crashing down on Son of BOSS and in fact the law firm of Sidley & Austin, which merged with Brown & Wood, paid a $39.4 million civil tax shelter promoter penalty to the IRS in 2007. Now those partnerships and LLCs that did not take advantage of the government’s Son of BOSS settlement initiative (IRS Announcement 2004-46) are in court, including these two LLCs (that elected to be taxed as partnerships) at issue, AD Investment and AD Global.

Despite what was undoubtedly thought to be a careful wording of the pleading, Judge Halpern wrote in a full Tax Court opinion that, “by putting the LLCs’ legal knowledge and understanding into contention in order to establish a good-faith and state-of-mind defenses, [petitioners] forfeit the LLCs’ privilege protecting attorney-client communications relevant to the content and the formation of their legal knowledge, understanding, and beliefs.”

AD Investments and AD Global argued that “the petitions do not assert any advice-of-counsel defense, nor do they mention (or even allude to) any advice from the attorneys.” Judge Halpern cited to U.S. v. Exxon Corp., 94 F.R.D. 246, 248 (D.D.C. 1981) and to Professor Paul R. Rice’s evidence treatise (“the most common situation in which courts have found waiver is where the client claims that he acted on the ‘good faith’ belief that his conduct was reasonable and legal”) and determined the privilege was waived. He stated the following: “it is only fair that respondent [the government] be allowed to inquire into the bases of that person’s knowledge, understanding, and beliefs including the opinions (if considered).”

A tax practitioner must be especially careful not to waive the attorney-client privilege unless he/she intend to do so. See: Lee Sheppard, The Tax Court Didn’t Repeal Attorney-Client Privilege, Forbes 4/20/14 (privilege is easily waived in tax cases); and Claudine V. Pease-Wingenter, Skating Too Close to the Edge: A Cautionary Tale for Tax Practitioners about the Hazards of Waiver, 81 U. Cin. L. Rev. 953 (2013) (attorney-client privilege waiver is a “huge trap for the unwary”).

Written by Ann M. Murphy, Professor, Gonzaga Law School