First Circuit Holds that Tax Accrual Work Papers Are Not Protected Work Product
The full First Circuit has overruled a panel decision that concluded that tax accrual work papers which included company lawyers' documented calculations of the probability of prevailing against potential challenges by the Internal Revenue Service (“IRS”) are protected by the work product doctrine.
In an en banc opinion, the Court of Appeals holds that such material is not protected from an IRS demand, because, as it would have been prepared solely for a business purpose and was “independently required by statutory and audit requirements,” it was not “prepared for use” in litigation or trial, as required by the Federal Rules. See United States v. Textron Inc., No. 07-2631, 2009 U.S. App. LEXIS 18103 at *13 (1st Cir. Aug. 13, 2009). The Court’s dissent contends that this is a new work product standard that is more narrow than the previously most restrictive “primary purpose” test. Id. at *30.
Whether this holding can be confined to IRS demands for tax calculation materials because of the statutory and regulatory requirement remains to be seen. The First Circuit majority’s reasoning does not imply such a restriction. Even if such a restriction should apply, the holding may well cover any materials subject to a federal, state, local or foreign requirement for document creation or retention.
If applied generally, this decision will impose a new restriction on work product protection and may provide a new window into an opposing party’s business litigation strategy.
Case Background
The IRS issued an administrative summons to Textron Inc. pursuant to 26 U.S.C. § 7602 (2006) seeking tax accrual work papers for Textron’s 2001 tax returns. Textron refused to comply with the IRS summons and asserted a number of grounds, including the attorney-client privilege and work product doctrine.
When the IRS responded by initiating an enforcement action in Rhode Island federal court, Textron argued that it had prepared the work papers because it “anticipated the possibility of litigation with the IRS,” contending that the “work papers were generated within its Tax Department but that tax lawyers in that department were centrally involved in their preparation and that Textron…also used an outside counsel to advise it on tax reserve requirements.” The tax accrual work papers also included estimates by Textron’s counsel of the probability of a successful defense to potential challenges raised by the IRS. United States v. Textron Inc., 507 F. Supp.2d 138, 150 (D.R.I. 2007). Textron contended Textron Inc., 2009 U.S. App. LEXIS 18103 at *8-9.
The district court disagreed with Textron on attorney-client privilege, holding that the privilege was waived when Textron provided the work papers to its outside accountant, Ernst & Young. Textron Inc., 553 F.3d 87; Textron Inc., 507 F. Supp.2d at 150. But the district court accepted Textron’s work product claim, holding that, despite the fact that the work papers were used for a business purpose, the tax accrual work papers “would not have been prepared at all ‘but for’ the fact that Textron anticipated the possibility of litigation with the IRS.” Textron Inc., 507 F. Supp.2d at 143.
On the IRS’ appeal, a three-judge panel affirmed the district court’s ruling in January 2009, purporting to follow the Circuit’s prior decision in Maine v. United States Dep’t of Interior, 298 F.3d
60, 68 (1st Cir. 2002), rejecting the proposition that the “mere presence of a business or regulatory purpose defeats work-product protection.” Textron Inc., 553 F.3d 87. This essentially
adopted the rationale of other Circuits that “dual purpose documents created because of the prospect of litigation are protected even though they were also prepared for a business purpose.” Id.
In March 2009, the full First Circuit vacated the panel’s decision. Then on August 13, 2009, in a 3-2 decision, the Court reversed the district court’s ruling, holding that the Textron tax accrual work papers
are not protected by the work product doctrine.
Majority Decision
While purporting to rely on the “because of” test, set forth in its opinion in Maine, the Court’s majority holds that, “documents that are prepared in the ordinary course of business or that would have been created in essentially similar form irrespective of the litigation” are not protected under the work product doctrine. Textron Inc., 2009 U.S. App. LEXIS 18103 at *24. As the dissent aptly notes, in reaching this conclusion, the majority “really conducts a new analysis of the history of the work product doctrine and concludes that in order for the work product protection to apply, the documents must be “ ’prepared for any litigation or trial.’” Textron Inc., 2009 U.S. App. LEXIS 18103 at *32 (emphasis in original) (dissent).
By contrast, the “because of” test first introduced by the Second Circuit in United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998) and later adopted by a majority of federal circuit courts, including apparently the First Circuit in Maine, asks whether “’in light of the nature of the document and the factual situation in the particular case, the document can be fairly said to have been prepared or obtained because of the prospect of litigation.’” See Maine, 298 F.3d at 68 (emphasis in original) (quoting United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998)).
To support its new statement of the work product standard, the majority turns to the language of Federal Rule of Civil Procedure 26(b)(3), reasoning that “‘prepared in anticipation of litigation for trial’ did not, in the reference to anticipation, mean prepared for some purpose other than litigation: it meant only that the work might be done for litigation but in advance of its institution.” Textron Inc., 2009 U.S. App. LEXIS 18103 at *21 (emphasis in original).
The court noted that if the judge in the district court had made a prepared for use finding then he would have determined that the Textron work papers were not prepared for use in litigation. Id. at *16. “[I]n saying that Textron wanted to be ‘adequately reserved,’ the district judge did not say the work papers were prepared for use in possible litigation – only that the reserves would cover liabilities that might be determined in litigation.” Id. (emphasis in original). The majority of the court then added the additional factor that “the Textron work papers were independently required by statutory and audit requirements” in confirming its view that “the work product privilege does not apply.” Id. at *13.
Dissent
In a vigorous dissent, Circuit Court Judges Torruella and Lipez characterized the majority opinion as purporting to rely on the First Circuit precedent, while rejecting the Maine test that allows “protection for dual purpose documents.” Id. at *29-65. The dissent asserts that the majority has adopted a new standard requiring a determination that documents were “prepared for” use in litigation. The dissent asserts that the majority’s new standard is “an even narrower variant of the widely rejected ‘primary motivating purpose’ test used in the Fifth Circuit and specifically repudiated” by the First Circuit in Maine. Id. (referencing the Fifth Circuit’s standard articulated in United States v. Davis, 636 F.2d 1028, 1040 (5th Cir. 1981) and United States v. El Paso Co., 682 F.2d 530, 543 (5th Cir. 1982)).
The dissent also challenges the majority’s apparent conclusion that Textron’s business and litigation purposes were distinct: “Though other business needs also contributed to Textron’s need to create the documents, those needs depended on Textron’s anticipating litigation with the IRS….[W]ithout the anticipation of litigation, there would be no need to estimate a reserve to fund payment of tax disputes…In this way, the dual purposes leading to the documents’ creation were intertwined, and work-product protection should apply.” Id. at *56-57 (internal citations omitted) (citing In re Grand Jury Subpoena, 357 F.3d 900, 910 (9th Cir. 2004)(“The documents are entitled to work product protection because taking into account the facts surrounding their creation, their litigation purpose so permeates any non-litigation purpose that the two purposes cannot be discretely separated from the factual nexus as a whole.”))
The dissent also cautions that the majority’s denial of the work product protection to the Textron counsel’s work papers would put the company at a distinct disadvantage. “Revealing such impressions would have clear free-riding consequences. With this information, the IRS will be able to immediately identify weak spots and know exactly how much Textron should be willing to spend to settle each item. Indeed, the IRS explicitly admits that this is its purpose in seeking the documents.” Textron Inc., 2009 U.S. App. LEXIS 18103 at *44.
Future Implications
While the statutory and regulatory requirements to maintain tax calculation records may distinguish the majority’s Textron holding, corporate counsel should be aware that their preparation of documents required for a business purpose may trump a claim of work product protection where the documents were also relevant to anticipated litigation. Moreover, if the dissent is correct, “one party in a litigation will be able to discover an opposing party’s analysis of the business risks of the instant litigation, including the amount of money set aside in a litigation reserve fund….” Id. at *47.